Large Cap Value

For the Period Ending: 06/30/2016



Investment Philosophy

  • Mathematical fact - The present value of any investment is the sum of all its expected future cash flows discounted at some interest rate
  • Cash flow growth drives stock value over time. Changes in what investors pay for those cash flows drive excess investment returns

Long term excess returns can potentially be achieved by:

  • Fundamental research focused on sustainable cash flow generation which drives intrinsic value estimates
  • Disciplined focus on proprietary intrinsic value targets as well as persistent macro overlay minimizes big mistakes
  • Portfolio concentration enables best ideas to meaningfully impact performance

Investment Process/Buy Discipline

Our Large Cap Value strategy aims to identify companies whose fundamental health is strong but whose stock price has declined due to transitory factors. Through consistent application of rigorous valuation analysis, we seek to build a portfolio of companies that are currently trading below their intrinsic value with identifiable catalysts to reach or exceed fair value.

Our investment process begins with a universe of companies with market capitalizations generally in excess of $10 billion. Next, the universe is filtered/narrowed down to approximately 100 securities by screening a variety of fundamental factors, low relative valuation on standard valuation metrics, high and/or rising free cash flow yield, prudent capital allocation, and durable business models. Within this narrowed universe more rigorous fundamental analysis is conducted looking at the origin of profit and cash flow drivers. To these companies we apply a proprietary discounted cash flow analysis that incorporates more than a dozen financial statement metrics. These metrics are normalized to adjust for broad economic cycles, specific industry cycles, and one-time events. These metrics are also adjusted to account for qualitative factors we feel will drive a company’s performance over the investable time period. Metrics may be adjusted for their perceived quality, e.g., inventory decline associated with planned output reduction rather than sales increase or management/product changes. Finally, cash flows are discounted using an interest rate that incorporates the team’s own long-term rate forecast to produce an estimated intrinsic value for each stock in our universe. Buy candidates typically trade at a discount of 30% or more to their estimated intrinsic value.

Through this process we seek to build a portfolio of 35-45 stocks each with an average holding period of two to three years. Throughout the holding period, we continually reevaluate both quantitative and qualitative factors to ensure their integrity. The reevaluation process may lower our intrinsic value estimate and thus compromise the stock’s capital appreciation potential, usually leading us to sell that particular holding. We use similar analysis to evaluate price declines within the portfolio, thus trying to avoid "value traps."

Minimum Assets Accepted: $10 million


Total Returns


Total Returns1,2,3 Annualized
  YTD3 1 Year 3 Years 5 Years 10 Years
Large Cap Value - Gross1 -1.23% -4.32% 7.52% 9.56% 7.08%
Large Cap Value - Net1 -1.57% -4.98% 6.84% 8.88% 6.43%
Russell 1000 Value Index2 6.30% 2.86% 9.87% 11.35% 6.13%

Calendar Year Returns


Calendar Year Returns 1,2,3,4
  Large Cap Value
Gross1
Large Cap Value
Net 1
Russell 1000
Value Index2
2Q164
1.07%
0.90%
4.58%
YTD3
-1.23%
-1.57%
6.30%
2015
-3.00%
-3.62%
-3.83%
2014
11.94%
11.27%
13.45%
2013
37.46%
36.64%
32.53%
2012
20.05%
19.33%
17.51%
2011
-6.07%
-6.63%
0.39%
2010
18.28%
17.58%
15.51%
2009
24.89%
24.16%
19.69%
2008
-31.97%
-32.40%
-36.85%
2007
3.88%
3.26%
-0.17%
2006
17.84%
17.14%
22.25%

Past performance is no guarantee of future results. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Please inquire for more current performance information.

1 The Large Cap Value composite consists of portfolios seeking to provide capital appreciation. Portfolios within the composite primarily invest in various types of U.S. equity securities of large capitalization companies that the investment manager believes to be undervalued or trading at a significant discount relative to the intrinsic value of the company and/or are out of favor in the financial markets but have a favorable outlook for capital appreciation. For purposes of this composite, large capitalization companies typically are companies with market capitalizations of at least $10 billion at time of acquisition. The Large Cap Value composite was created March 28, 2005. The performance presentation is in U.S. dollars.

Effective July 1, 2015 the composite definition/description was revised in order to provide further clarity of the composite’s investment strategy.

Large Cap Value composite is comprised of 5 accounts that had $1,478.5 million in total assets as of 6/30/16. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2 Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Waddell & Reed Investment Management Company (WRIMCO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in WRIMCO’s presentation thereof.

3 As of June 30, 2016.

4 Actual composite return from April 1, 2016 through June 30, 2016.

5 Data regarding holdings reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

6 Data regarding sector diversification reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

7 Supplemental data: The Large Cap Value percentages reflected are based on the holdings of 1 of 5 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Value composite as a whole or of any other Large Cap Value account currently, or in the future, included in such composite.


10 Largest Holdings 5,7
JPMorgan Chase & Co.4.7%
Citigroup Inc.4.7%
Microsoft Corp.4.3%
Duke Energy Corp.3.7%
Capital One Financial Corp.3.7%
American International Group, Inc.3.7%
MetLife, Inc.3.3%
Dow Chemical Co.3.3%
Comcast Corp. CI A3.1%
Hess Corp.3.0%


LargeCapValueSD

Past performance is no guarantee of future results. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Please inquire for more current performance information.

1 1The Large Cap Value composite consists of portfolios seeking to provide capital appreciation. Portfolios within the composite primarily invest in various types of U.S. equity securities of large capitalization companies that the investment manager believes to be undervalued or trading at a significant discount relative to the intrinsic value of the company and/or are out of favor in the financial markets but have a favorable outlook for capital appreciation. For purposes of this composite, large capitalization companies typically are companies with market capitalizations of at least $10 billion at time of acquisition. The Large Cap Value composite was created March 28, 2005. The performance presentation is in U.S. dollars.

Effective July 1, 2015 the composite definition/description was revised in order to provide further clarity of the composite’s investment strategy.

Large Cap Value composite is comprised of 5 accounts that had $1,478.5 million in total assets as of 6/30/16. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2 Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Waddell & Reed Investment Management Company (WRIMCO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in WRIMCO’s presentation thereof.

3 As of June 30, 2016.

4 Actual composite return from April 1, 2016 through June 30, 2016.

5 Data regarding holdings reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

6 Data regarding sector diversification reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

7 Supplemental data: The Large Cap Value percentages reflected are based on the holdings of 1 of 5 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Value composite as a whole or of any other Large Cap Value account currently, or in the future, included in such composite.


Matthew T. Norris   Matthew T. Norris, CFA
  Senior Vice President, Portfolio Manager

Mr. Norris is portfolio manager of the firm’s Large Cap Value investment strategy and has been in this role since 2003 when he joined the firm. From 2005 to 2010 he was the Director of Equity Research and responsible for the firm’s equity research team during that time. Mr. Norris held portfolio management responsibilities for the firm’s Small Cap Value investment strategy from 2010 to 2011.

Prior to joining Waddell & Reed, Mr. Norris was affiliated with Advantus Capital Management, Inc. in St. Paul, MN from 1997 to 2003. He joined Advantus as an equity analyst and was appointed portfolio manager in 2000. Prior to joining Advantus, he was an equity analyst and portfolio manager for Norwest Investment Management, Inc. from 1994 to 1997.

Mr. Norris earned an MBA from the University of Nebraska and a BS in Cellular Biology from the University of Kansas. He is a CFA charterholder.


Manager(s):
Matthew T. Norris, CFA

Portfolio Review
Equity markets had a solid positive return for the quarter, as economic conditions in the U.S. stayed stable. However, the Russell 1000 Value Index return of 4.58% masked a lot of underlying volatility. The large cap value segment beat the S&P for the quarter, with the S&P 500 returning 2.46%. This is a shift, as growth has been leading value for the last few years. The disparity had reached an extreme, and the recent comeback of value investing is notable. It is too early to call it a trend, but there are certainly opportunities for investment. The timeframe of this trend and trend change are unknowable, but signposts to monitor include rising interest rates or slowing GDP growth.

Waddell & Reed’s Large Cap Value strategy underperformed the Russell 1000 Value, largely due to our positioning in Health Care. Our holdings of generic drug manufacturers and HMO’s trailed, as the market preferred the large branded drug makers. Energy continued its strong recent run, rising another 10.83% for the quarter. Investors are clearly expecting oil prices to continue their upward trend. Information Technology and Industrials were bright spots, with better performance out of individual stocks in these areas.

The portfolio has reduced its total number of names as we have fewer solid ideas in this environment. The market has more than tripled from the lows set in March of 2009, and high quality value ideas are scarce. Our cash holdings have been slightly higher than normal, but we continue to search diligently for areas offering returns. Investments are selected individually, but a few themes show through. The portfolio is overweighted in Insurance, Consumer Discretionary and Health Care. All of these areas share certain characteristics we like. Good companies with repeatable business models generating high rates of free cash flow, and low stock prices relative to our estimation of each company’s true intrinsic value. The portfolio has very little representation in the areas of Telecommunications and Industrials. Telecomm stocks simply don’t offer us the value we require, and Industrials business fundamentals are unclear to us at this time. However, we do think there are some emerging ideas there.

Outlook
After seven years and some stops and starts, the U.S. economy has recovered from the recession in 2008 and seems to have settled out in a low single-digit growth area. The Federal Reserve was instrumental in providing liquidity to the markets and economy, which helped facilitate the recovery. However, this can have other, undesired side effects. The next challenge will be for the Federal Reserve to tighten money policy back up, and that is something we will watch carefully. Their guidance suggests one or two further rate increases during calendar 2016. While the economic forces listed above are clearly important factors, the portfolio management team’s first approach is from the company level. We seek to find quality, growing companies whose stocks are trading below what we consider their intrinsic value. Often times this is due to short-term negative factors, and we become larger owners of a company if we feel those negatives are about to dissipate. We continue to search for and make investments one company at a time, to benefit clients over the long run.

The opinions expressed in this commentary are those of the portfolio manager and are current through June 30, 2016. The manager’s views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.

Past performance is no guarantee of future results. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Please inquire for more current performance information.

1 The Large Cap Value composite consists of portfolios seeking to provide capital appreciation. Portfolios within the composite primarily invest in various types of U.S. equity securities of large capitalization companies that the investment manager believes to be undervalued or trading at a significant discount relative to the intrinsic value of the company and/or are out of favor in the financial markets but have a favorable outlook for capital appreciation. For purposes of this composite, large capitalization companies typically are companies with market capitalizations of at least $10 billion at time of acquisition. The Large Cap Value composite was created March 28, 2005. The performance presentation is in U.S. dollars.

Effective July 1, 2015 the composite definition/description was revised in order to provide further clarity of the composite’s investment strategy.

Large Cap Value composite is comprised of 5 accounts that had $1,478.5 million in total assets as of 6/30/16. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2 Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Waddell & Reed Investment Management Company (WRIMCO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in WRIMCO’s presentation thereof.

3 As of June 30, 2016.

4 Actual composite return from April 1, 2016 through June 30, 2016.

5 Data regarding holdings reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

6 Data regarding sector diversification reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

7 Supplemental data: The Large Cap Value percentages reflected are based on the holdings of 1 of 5 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Value composite as a whole or of any other Large Cap Value account currently, or in the future, included in such composite.