The Masters' Select Funds
Annual Report
[GRAPHIC]
Masters' Select Equity Fund
Masters' Select International Fund
December 31, 1999
LITMAN/GREGORY FUND ADVISORS, LLC
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masterselectfunds.com
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The Masters' Select Concept
............
In constructing the Masters' Select Funds, our goal was to design funds that
would isolate the stock-picking skills of a group of highly regarded managers
and also serve as core equity fund holdings for almost any long-term investor
seeking domestic or international stock market exposure. To meet this objective,
we designed the funds with both risk and return in mind, placing particular
emphasis on the following factors.
1. First, only investment managers we believe to have exceptional long-term
performance in their respective specialties were chosen to manage each
fund's portfolio.
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2. Second, and of equal importance, each stock picker runs a very focused
portfolio of not more than 15 of his or her favorite stocks. We believe
that most stock pickers have an unusually high level of conviction in only
a small number of stocks and that a portfolio limited to these stocks will,
on average, outperform over a market cycle.
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3. Third, even though each manager's portfolio is focused, the overall funds
are well diversified by style, industry and number of stocks. Given the
diversification across styles, we don't expect the funds to top the charts
in any single period. We are shooting for superior performance over a full
market cycle, counting on the funds' structure and the managers' talent to
get us there.
The Masters' Select Funds Annual Report December 31, 1999
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Contents
Portfolio Fit.............................................................. 2
Letter to Shareholders..................................................... 3
Masters' Select Equity Fund Review......................................... 13
Interview: Foster Freiss................................................... 16
Equity Fund Stock Highlights............................................... 20
Equity Fund Portfolio Summary.............................................. 24
Masters' Select International Fund Review.................................. 27
Interview: Ted Tyson....................................................... 30
International Fund Stock Highlights........................................ 32
International Fund Portfolio Summary....................................... 35
Report of Independent Accountants.......................................... 38
Statements of Assets and Liabilities....................................... 39
Statements of Operations................................................... 40
Statements of Changes in Net Assets........................................ 41
Financial Highlights....................................................... 43
Notes to Financial Statements.............................................. 44
Change in Independent Accountants.......................................... 47
Service Directory
Fund Information
To request a prospectus, financial report, IRA
application or information, call 1-800-656-8864,
24 hours a day, seven days a week.
Advisor Services
Registered Investment Advisors, broker/dealers
and financial professionals may call
1-925-253-5213 for advisor services.
Existing Shareholder Inquiries
To request action on your existing account,
contact the transfer agent, NFDS, at 1-800-960-0188
from 9:00 a.m. to 6:00 p.m. eastern time,
Monday through Friday.
Mail correspondence to:
Masters' Select Funds
c/o NFDS
P.O. Box 219922
Kansas City, MO 64121-9922
Overnight address:
Masters' Select Funds
c/o NFDS
330 W. 9th Street
Kansas City, MO 64105
1-800-960-0188
24-Hour Automated Information
1-800-960-0188
For automated reporting of daily prices, account
balances and transaction activity, call 1-800-960-0188,
24 hours a day, seven days a week. Please have your
Fund number (see below) and account number ready to
access your investment information.
Published Daily Price Quotations
Daily net asset value per share of each Fund is
reported in mutual fund quotations tables of major
newspapers in alphabetical order as follows:
Transfer Agent
Abbreviation Symbol Cusip Fund Number
------------ ------ ----- -----------
MstrSeltEq. MSEFX 576417109 305
MstrSeltInt MSILX 576417208 306
Website:
mastersselectfunds.com
The Masters' Select Funds Annual Report December 31, 1999
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Portfolio Fit
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As with all equity funds, Masters' Select Equity and Masters' Select
International are appropriate for investors with a long-term time horizon, who
are willing to ride out occasional periods when the funds' net asset values
decline. Within that context we created the funds to be used as core equity and
core international fund holdings. Although performance in each specific down
market will vary, we purposely set the allocations to each manager with the
objective of keeping risk about equal to that of their overall benchmarks. At
the same time, we wanted enough exposure to small-caps and growth stocks to
attempt to deliver good performance in a bull market. In the end the focus on
the highest-conviction stocks of a group of very distinguished managers with
superior track records is what we believe makes the funds ideal core equity and
core international fund holdings.
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Dear Fellow Shareholders:
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Nineteen ninety-nine was an outstanding year for the Masters' Select Funds. Both
funds outperformed all their benchmarks in convincing fashion, with Masters'
Select International delivering a huge 75% return. In addition, Morningstar, the
respected mutual fund tracker, named Masters' Select Equity as one of it's
"Twelve Funds for the New Millennium,"* and for the second year in a row, Money
magazine included the fund in its "Money 100" list of "The World's Best Mutual
Funds."** Now, as Masters' Select Equity has completed its third year and
Masters' Select International has completed its second, we'd like to reflect on
the Masters concept and address questions that have arisen along the way. We do
so in the Q&A format that follows.
IT HAS BEEN THREE YEARS SINCE THE FIRST MASTERS' FUND WAS LAUNCHED. IS THE
CONCEPT WORKING?
To evaluate the success of the Masters' Select concept we believe that there are
two factors to assess.
First, is there evidence that the concentrated approach has added value? We've
stated our belief that, in the right hands, concentration will result in higher
returns over a market cycle than a more diversified approach. To evaluate
whether concentration is working we compare the performance of the Masters'
managers to that of their own funds. The numbers, summarized below, strongly
demonstrate that our approach of allowing our managers to invest only in their
highest-conviction ideas has added considerable value so far.
Across the two funds, nine of the twelve managers have outperformed their own
funds (this included Bruce Bee and Jean-Marie Eveillard, who are no longer
subadvisors. Ted Tyson is not included because he does not manage a mutual
fund).
The Masters' Select Concept: The Value of Concentration
Cumulative Performance Since Inception
MASTERS' SELECT EQUITY FUND
Performance of Masters' Select Equity 87.58%
Performance of Masters' Select Equity managers "own funds" 69.59%
MASTERS' SELECT INTERNATIONAL FUND
Performance of Masters' Select International managers 101.67%
Performance of Masters' Select International managers "own funds" 89.31%
1 Inception dates are 12/31/96 and 12/1/97 respectively for Masters' Select
Equity and International Funds.
2 Manager's own fund performance equals the total return earned by the
unaffiliated no-load funds managed by the managers multiplied by the target
percentage of Masters' assets allocated to each manager. There may be
differences among these funds with respect to charges, expenses and
investment policies that affect performance. For the International Fund, we
include returns for the Fund and the managers' funds only for time periods
during which they managed their Masters' Select portfolio and a seperate,
publicly traded mutual fund.
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* Funds included in the "Twelve Funds for the New Millennium," published by
Morningstar, were determined based on criteria established by Morningstar,
including manager experience, articulation of strategy, fund expenses and
commitment to shareholders.
** The "Money 100" list of outstanding mutual funds was determined by a team
of editors/writers at Money magazine based on criteria developed at Money,
including but not limited to consistency of return, stability of management
and reasonableness of fund expenses.
The Masters' Select Funds Annual Report December 31, 1999
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The second factor that we evaluate in assessing the success of the Masters'
Select concept is how the managers have done relative to appropriate benchmarks.
We believe it is important to measure managers relative to specific benchmarks
because our funds represent a mix of styles. In our opinion, the mix of styles
makes it inappropriate to compare the fund against any single style group.
With respect to Masters' Select Equity, we group managers in several ways. In
our large-cap manager group we include Mason Hawkins, Robert Sanborn (for the 14
months he has been part of the fund), Sig Segalas and Shelby Davis. These
managers have generated a cumulative total return of 106.8% versus 107.7% for
the S&P 500 Index since inception. At first blush this return seems mildly
disappointing in that the managers did not outperform the S&P 500. Our managers
have faced a bit of a headwind, however, because, as a group, they are less
large-cap oriented and less growth-oriented than the S&P 500.Two of the four are
value managers (Hawkins and Sanborn), one is a blend manager (Davis) and only
one is a pure growth manager (Segalas). During this period large growth stocks
have decisively outreturned large value stocks (more on this later). If we
compare performance of our managers with a large-cap index that is style
weighted in the same proportion as our managers, our managers stack up very
well. This style-weighted index returned 101.8% over the three-year life of the
fund versus 106.8% for our managers. (The style weighting is as follows: since
Sanborn was added, 50% to large-cap value stocks, 25% to large-cap growth stocks
and 25% to the S&P 500; prior to Sanborn's addition, 100% S&P 500, as Segalas,
Davis and Hawkins collectively represented a style neutral mix. The style
indexes we use are the S&P/Barra Growth and Value indexes.)
Our small-cap manager group has outperformed the Russell 2000 Index by a wide
margin, generating a cumulative total return since inception of 121.6% vs. 44.6%
for the index. If we use style-weighted benchmarks, (the Russell 2000 Growth to
track Friess and the Russell 2000 to track Weiss), the benchmark return is 54%,
still far behind our managers' returns.
Finally, our international managers, as a group, have outperformed their
benchmarks by a wide margin. Until recently, we tracked Bruce Bee separately
against a small-cap international index and the other four managers against the
MSCI EAFE Index. With Ted Tyson replacing Bee after Bee passed away last summer,
we now are moving to a single index comparison (see the Masters' International
section for a detailed explanation). To keep things simple we show the
cumulative total performance since inception of our managers versus the MSCI
EAFE Index (which performed better than the blended index). Over this period the
index is up 53.7% versus 93.2% for Masters' Select International.
In sum, we are quite encouraged by how the Masters' Select concept is playing
out. Concentration seems to be working well, with our managers' Masters'
performance collectively ahead of their own funds by a substantial margin. And
relative to passive index benchmarks, our international and small-cap managers
have outperformed by a wide margin. And if we account for style bias our
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large-cap managers have also outperformed. During a time when the difficulty of
beating passive benchmarks has been widely publicized, we believe that this
performance is reason to be encouraged about the long-term potential for the
Masters' Select funds.
WHAT ABOUT THE OVERALL PERFORMANCE RECORD AGAINST THE FUNDS' BENCHMARKS?
Rates of Return
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Annualized Since Inception
1999 (12/1/97)
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Masters' Select International 75.01% 37.21%
MSCI EAFE Index 26.96% 22.90%
Lipper International Fund Index 37.83% 23.98%
Let's address each Masters' fund separately.
The story is clear-cut with respect to Masters' Select International. The fund
has convincingly outperformed its peer group and its benchmarks.
Rates of Return
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Annualized Since Inception
1999 (12/31/96)
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Masters' Select Equity 26.45% 23.33%
Custom Index (1) 21.91% 23.58%
Wilshire 5000 23.82% 26.13%
Lipper Multi-Cap Core Index 20.79% 21.88%
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1 This index is composed of a 70% weighting to the S&P 500 Index, a 20%
weighting to the Russell 2000 Index and a 10% weighting to the MSCI EAFE
Index.
In the case of Masters' Select Equity it is true that, although it beat all of
its benchmarks in 1999, since inception the fund has underperformed two
benchmarks while beating its Lipper fund peer group:
As we point out, the individual groups of managers have done well, so why has
the overall fund not done as well relative to its benchmarks? There are four
factors that explain the underperformance:
1. All our benchmarks are style-neutral, while we have a slight bias towards
value. Over a full market cycle we are not concerned about this mild style
bias. Over the past three years, however, growth has dominated value, with
The Masters' Select Funds Annual Report December 31, 1999
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the S&P/Barra Growth Index returning cumulative 149% versus the 68% return
generated by the S&P/Barra Value Index. Though the Masters' Select Equity
value bias is not great, the unusually extreme divergence of growth and
value returns created a performance headwind for the fund. Over the long
term there is no reason to believe that either growth or value will be
superior (though throughout history there have been periods when each style
has been thought of as inherently superior).
2. Masters' Select Equity is smaller-cap than the Wilshire 5000 Index, which
has approximately 10% of its assets in small-cap stocks and over 70% in
large-cap. Our fund was intended to be diversified across a variety of
market segments but not to be identically benchmarked to the "total
market". Consequently, Masters' has two managers specifically focused on
small- and mid-cap stocks with an intended bias toward small-caps. During
the fund's entire life we have averaged around 20% in small-cap stocks and
have rarely held more than 55% in large-cap stocks. Over the past three
years large-cap stocks' performance has dominated that of small- and
mid-cap stocks. This has been another minor headwind for the fund when
compared with the Wilshire 5000. It is less of an issue with respect to the
Custom Equity Index.
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MASTERS' SELECT EQUITY FUND -- CUMULATIVE PERFORMANCE 2/1/97-12/31/99
Masters' Select Equity 82.28%
Custom Equity Index 80.74%
Wilshire 5000 Index 90.50%
Lipper Multi-Cap Core Index 72.84%
3. When the fund was launched in January of 1997, there was a huge influx of
investment that significantly exceeded our expectations. Our subadvisors
were unable to invest this money quickly. As a result, the fund's cash
balance was very high for the month, particularly in the first part of the
month when the market was strong. This single month had a material impact
on the fund's relative performance. If we look at performance excluding
January 1997, the inception-to-date returns relative to the benchmarks are
better and the fund's performance exceeds that of the Custom Equity Index:
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4. One of our original managers, Jean-Marie Eveillard, performed poorly during
his 22 months as a subadvisor of 20% of the fund's assets. Though we
continue to believe that Eveillard is a highly skilled investment manager,
we recognized after some months that he was not comfortable or effective
running a concentrated portfolio. Eveillard was replaced in October 1998.
The past few years have been highly unusual by historical standards, with the
stock market extremely narrow. Over the past two years the median stock in the
S&P 500 has returned only 3.62%. Over a market cycle, we continue to believe
that our diversified approach, combined with the concentration on the part of
our individual stock pickers, will generate strong long-term returns as various
styles move in and out of favor.
IN MASTERS' SELECT EQUITY A MANAGER WAS REPLACED IN 1998. DID YOU LEARN ANYTHING
FROM THAT EXPERIENCE?
We view the original selection of the manager as a mistake and though we can't
guarantee that we won't make another one, we learned some things from the
experience that we believe make that less likely. We now recognize, even more
than we did initially, the importance of determining a manager's comfort with
concentrated investing. To gauge a stock picker's ability to run a concentrated
portfolio we first look for evidence. Has the manager run other concentrated
portfolios and what have been the results? If they have not done so via a fund
they, may have done so with separate accounts they manage. If there is no direct
evidence, through discussions we explore their strategy for running a
concentrated portfolio, with an emphasis on how they differentiate between their
highest-conviction stocks and other stocks they might own in a more diversified
portfolio. We believe that we are well suited to do this job given our many
years of experience assessing stock pickers. Our approach in selecting and
monitoring managers is extensive and thorough and includes lots of contact with
the managers and their team. Overall, we believe that our track record with
Masters' is highly encouraging and supportive of the notion that we are well
positioned to make manager selections.
The Masters' Select Funds Annual Report December 31, 1999
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IS IT REASONABLE TO VIEW THE MASTERS' OWN FUNDS AS INDICATIVE OF THE PERFORMANCE
OF THEIR MASTERS' PORTFOLIO? WHAT IS YOUR ASSESSMENT OF THOSE MASTERS' MANAGERS
WHOSE OWN FUNDS HAVE RECENTLY PERFORMED POORLY?
The performance of the managers' own funds is not necessarily indicative of
their Masters' performance. As noted above, the concentration of their Masters'
portfolio has resulted in significantly better performance, on average, for
Masters' than for the managers' own funds. At this point we are not particularly
concerned that a couple of the managers' own funds had off years in 1999. All
managers, no matter how good they are, go through slumps from time to time. The
one Masters' manager whose own fund's poor recent performance has been heavily
publicized is Robert Sanborn, manager of the Oakmark Fund. Sanborn is a
high-conviction, concentrated investor. We've known him for many years and chose
to include him in Masters' in 1998 because of our confidence in his discipline,
his knowledge of his companies and the quality of the analyst team that backs
him up. We have conducted extensive due diligence on Sanborn and the firm,
including interviews with a number of team members and the firm's CEO. Sanborn's
returns for his own fund have suffered recently because of his extreme value
discipline and also because of some mistakes. But we are quite confident that he
will shine again. Sanborn's struggles are not all that unusual for managers who
tend to concentrate. Consider Tom Marsico, one of the superstars in today's fund
world. Marsico runs the Marsico Funds and was formerly the manager of the Janus
Twenty Fund. He has a superb long-term record and more recently has shot the
lights out with his performance. However, Marsico experienced a lengthy
three-year period from 1992 through 1994 during which his fund lost 1.6%,
underperforming his peer group and his index benchmarks. In the final year of
this period, Janus Twenty lost about $1 billion due to shareholder redemptions.
Since that time Marsico has delivered very high relative returns. More recently
Brandywine Fund and Masters' Select manager Foster Friess was criticized for
moving heavily to cash, which led to a difficult performance period, yet his
fund rebounded with a 53.5% return in 1999. Meanwhile, the Friess team's
performance for Masters', where going heavily to cash is not an option, has been
impressive, outperforming its benchmark in each year.
We closely monitor all our managers via frequent contact and ongoing due
diligence on their overall firms. If performance breaks down we look for red
flags suggesting that the stock picker is not simply experiencing a temporary
slump, but that something fundamental has changed. Red flags include excessive
growth or turnover in the analytical team, investments that are out of character
with the process, evidence that the manager is less committed or focused, and
growing responsibilities in other areas that distract from their primary
portfolio management duties. At present we have a high degree of confidence in
our entire stock-picking team.
WHAT ARE THE BENEFITS OF MASTERS' STYLE DIVERSIFICATION?
Most people invest over a lifetime and for this reason we built our funds to do
well over an investing marathon. Over the long run different styles will be in
and out of favor at different times. Diversification ensures that we will always
have a portion of the fund that participates in what is working. Our belief in
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this diversified approach is based on several factors:
1. To focus on only one style (e.g., large-cap growth) assumes that a single
style will dominate over the long-term or that investors can consistently
anticipate when each style will lead the pack. There is not convincing
evidence that supports either of these conclusions.
2. When a style is popular it tends to get overextended. Many investors chase
performance, often participating in the tail-end of a winning run but also
owning it when it falls. Because all styles have experienced periods during
which they have significantly outperformed other sectors of the equity
market, a long-term diversification policy ensures that investors will
participate, but won't be lured into a significant over-allocation to a
style that suddenly shifts out of favor. Long-time investors will remember
the compelling cases that were made for gold in the late 1970s and early
1980s, small-caps in the early 1980s, and international stocks in the late
1980s. In each case the stories were overwhelmingly positive near the peak.
Many investors who became overly enthusiastic suffered through years of
sub-par performance. Over the long term we expect that the performance
discrepancies among styles will be less significant than in the short-term.
3. We designed our two Masters' Select Funds as core funds that could form the
central part of a larger portfolio or stand on their own. If Masters'
shareholders want to be skewed significantly towards a particular style or
market cap they can supplement their Masters' investment with other funds.
The Masters' Select Funds Annual Report December 31, 1999
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HOW WAS THE MASTERS' STYLE MIX DETERMINED?
In the case of Masters' Select Equity we targeted 20% of the fund to small-cap
stocks. Though this is an overweighting compared with the overall market we
believed that there is more potential value to be added via concentrated
investing in the small-cap market. This has turned out to be the case. To cover
this sector, we selected the two small-cap managers in whom we have the most
confidence, Dick Weiss and Foster Friess. In the large-cap sector we started out
style-neutral with a large-growth manager, a value manager, and a blend manager.
Because our small-cap managers have a slight growth bias, however, we picked a
global value manager (originally Eveillard but now Mason Hawkins) as a
potentially "out-of-sync" manager who could provide offsetting diversification.
We currently have the following mix:
* 30% in Blend or, as we call it Growth-at-a-Reasonable Price (1/3 of this
must be small- and mid-cap)
* 40% in Value, with all-cap exposure but a mid- to large-cap bias. This also
includes some potential international exposure (recently the international
has been minor)
* 30% in Growth (1/3 of this is in small- and mid-cap)
We have no plans to change the value bias though it is possible that we would
reconsider that at some point.
Regarding Masters' Select International, we sought to be style-neutral with some
small-cap exposure. Ultimately, however, our subadvisor selection was driven
mostly by our desire to pick the best available managers. There is a dearth of
core international value-oriented managers whom we think are skilled, so we've
ended up with a slight growth bias. Our core managers included two blend
managers (Hayes and Yockey), one pure value manager (Herro) and another eclectic
value manager in Jaworski, who sometimes can look more like a blend manager.
Bruce Bee was value oriented, whereas his replacement, Tyson, is a growth
manager. The fund has a growth bias because Hayes and Yockey both tend to be on
the growth side of blend. Three of our managers--Yockey, Herro and Tyson--look
at small and mid-sized companies as well as large-caps.
FUND RATING SERVICES SUCH AS MORNINGSTAR CATEGORIZE MASTERS' SELECT EQUITY AS
"LARGE BLEND". IS THIS ACCURATE?
We don't agree with this categorization. There is a tendency in the fund-ranking
business to want to assign all funds to a single category. As one of the
pioneers in style analysis of mutual funds we're intimately familiar with the
issues. Funds like ours that have multiple managers who cut across styles and
market caps don't lend themselves to this type of categorization. Despite our
contention that Masters' Select Equity is misclassified as Large Blend, it has
outperformed the average Large Blend fund over its three-year life, according to
Morningstar. This is a period when the larger-cap and growthier funds we compete
against in this category have had an advantage due to the biases in the market.
TURNOVER HAS BEEN HIGH IN MSEFX AND LOWER IN MSILX. WHAT ARE THE IMPLICATIONS?
Turnover in both our funds has been driven by two factors. Much of the turnover
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is simply a by-product of active management. A material portion during the past
two years, however, has been tax-driven. We have encouraged our managers to take
losses in stocks when they have another stock idea that is equally compelling.
With the market volatility experienced over this period there have been a number
of tax-related sales, without which turnover would have been significantly
lower. Some investors believe that high turnover goes hand-in-hand with poor tax
efficiency. Studies have shown that this is not the case. Some turnover is
actually driven by a desire to be tax-efficient. For example, in 1998 Masters'
Select Equity's turnover was 135% yet the fund had a $.01 per share capital gain
distribution.
In the case of both funds, turnover was also higher due to the replacement of a
manager (in 1998 for Equity and in 1999 for International).
Turnover is also a function of management styles. And though it is too early to
draw a firm conclusion, indications are that, on average, the Masters' Select
Equity managers will exhibit higher turnover than the International managers.
TAX EFFICIENCY HAS BEEN EXCELLENT FOR MASTERS' SELECT INTERNATIONAL BUT
INCONSISTENT FOR MASTERS' SELECT EQUITY. WHAT SORT OF EXPECTATION SHOULD
SHAREHOLDERS HAVE?
In both funds we are tax conscious. We make sure that we sell the most
tax-efficient lots when partial sales are made, we ask our managers to be
cognizant of the timing of gains when a stock is about to go "long-term," and we
pay attention to opportunities to take losses. If a holding is significantly
underwater and there is another stock that the stock-picker has equal conviction
toward, we encourage the manager to sell, especially if the loss is short term.
So far our collective efforts have resulted in a total distribution in the
International Fund of only $0.50 over its life, despite a gain of 93% (an
increase in value of $9.32 per share since inception). Masters' Select
International has been very tax efficient. In the case of Masters' Select
Equity, after $.01 capital gains distribution in 1998 there was a sizable
distribution in 1999. This distribution was partly a function of a number of
very large moves in some of our managers' stocks that reduced their ongoing
long-term appeal and triggered sales. In addition, after the severe market
correction in 1998 Masters' Select Equity experienced net outflows for the first
six months of 1999. This resulted in a shrinking shareholder base to spread the
gains across. We have since instituted a 2% redemption fee, payable to the fund,
to deter shareholders who don't hold their shares for at least six months.
(Masters' Select Equity has experienced net inflows in each of the past six
months.) Finally, several of the undervalued positions were recognized as
takeover targets that triggered sales. The net result of all these factors for
the Equity Fund was a large gain, and unfortunately a significant portion of it
was a short-term capital gain.
We believe that the future distributions in Masters' Select Equity will not be
as high as they have been, partly because we expect a lower-return environment
and partly because of our expectation that the fund will benefit from net
inflows rather than outflows. In general, however, we can't say that we expect
The Masters' Select Funds Annual Report December 31, 1999
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our funds to be highly tax-efficient; nor do we think that they will be
tax-inefficient. Over the long run it is fair to expect that they will be about
average, though admittedly this is hard to predict. Our goal is to deliver over
a market cycle, enough returns on a pre-tax basis to allow for high after-tax
returns as well.
EXPENSES HAVE DECLINED STEADILY. WILL THIS CONTINUE?
Expenses have continued to decline. As we write this they are accruing at 1.25%
for Equity and 1.16% for International. (As reported in the financial
statements, our full-year 1999 expenses were 1.26% for Equity and 1.29% for
International.) The reasons for the declines have been asset growth, attention
to the fund's overhead, and importantly, our success in negotiating lower fees
with our new sub-advisors compared with the sub-advisors they replaced. These
savings are passed through to shareholders. We believe that the Equity fund's
expenses have the potential to drop a bit further as assets grow. We also intend
to reduce the management fee by 0.10% on assets above $750 million. We plan to
close the Equity Fund at $750 million, but expect there to be continued asset
growth from appreciation and existing shareholders.
In the case of the International Fund, expenses can drop a bit more with asset
growth. Currently the fund has significantly below-average expenses relative to
the average international fund (the peer group average is 1.68% according to
Lipper Analytical Services). We intend to reduce the management fee 0.10% on
assets above $1 billion. This is the level at which we expect to close the
International Fund to new investors, but we expect continued asset growth from
performance and additional investment from existing shareholders.
WHAT ARE REASONABLE PERFORMANCE EXPECTATIONS FOR THE FUNDS?
We believe that it is reasonable to expect both Masters' Select Funds to
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comfortably beat their benchmarks over a full market cycle (typically five to
ten years). Along the way we believe that Masters' Select Equity will do a bit
better when small-cap stocks and value outperform. There have been many extended
periods of time when small-cap and value have delivered superior performance.
Masters' Select International has the potential to perform somewhat better in
more growth-oriented markets.
Though we are optimistic about the potential relative performance of Masters'
Select, in general we expect stock market returns, as measured by the S&P 500
Index to be significantly lower over the next five years than they have been
over the past five years. Stock returns are driven by three variables:
1. Dividends--at just over 1% these are now miniscule so there won't be much
return here.
2. Earnings growth--on average earnings growth correlates to GDP growth.
Reasonable expectations are 6% to 7% per year, though some years will be
significantly higher or lower. Because stocks sell at a multiple of their
earnings this is an important driver of returns.
3. Changes in the price/earnings multiple. As we write this, multiples are
higher than they have ever been, far in excess of levels we have ever
experienced. Though there are lots of reasons to be optimistic about the
economy, we believe that the market has probably already "priced-in" the
favorable outlook. For this reason we think investors should not expect
more growth in the price/earnings multiple. In fact, there is a possibility
that multiples could shrink.
We believe that there is more potential upside in foreign markets, though not
significantly more than in the broad U.S. stock market (smaller- and mid-cap
stocks and some segments of the value universe).
In general, we believe the return from stocks will be lower than what investors
have recently grown accustomed to. Even so, there are swaths of the stock
universe (small- and mid-cap stocks and some segments of the value universe)
that do have the potential for P/E multiple growth. This belief along with our
confidence in our stock pickers' ability is the reason we believe our funds have
the potential to outperform as the rest of this market cycle unfolds. Of course
when it comes to returns, investors know that there are no guarantees.
WHAT ARE YOUR BIGGEST CONCERNS?
Our biggest concern is unreasonable expectations on the part of investors who
have been conditioned by recent performance to think that 20%-plus annual
returns are normal. We also worry that the performance of Masters' Select
International Fund will attract naive investors who have made a decision to buy
the fund based solely on one year's huge performance. This is partly the reason
for this lengthy discussion. We want our shareholders to be as informed and
knowledgeable as possible.
We are also concerned about the growing short-term orientation of investors. The
Masters' Select Funds are structured as long-term vehicles. We have encouraged
our managers to manage their portfolios to maximize long-term performance and
always put that objective above near-term concerns. Investors who don't
recognize that the short-term is uncertain and who expect top-quartile
performance each year are encouraged to look elsewhere. Investors who understand
the power of patience and compounding and the futility of predicting short-term
market behavior are encouraged to partner with us.
As always we greatly appreciate the trust that you have placed in us, and we
will work hard to continue to earn it. For additional detail on each Masters'
Fund see the individual sections of this report. Also, visit our website at
mastersselectfunds.com.
Sincerely,
/s/ Ken Gregory
Ken Gregory
Litman/Gregory Fund Advisors, LLC
12
<PAGE>
MASTERS' SELECT EQUITY FUND REVIEW
..........
Masters' Select Equity had an excellent year in 1999, beating all of its
benchmarks. For the second straight year the average stock significantly lagged
the capitalization-weighted market averages, with tech stocks leading the way.
Unlike 1998, however, during 1999 companies of all sizes participated in the
technology sector move. Thus, our large-cap growth manager and both of our
small-cap managers contributed significantly to the Fund's return in 1999. Over
the course of the fund's three-year life, each of the managers who have been
with the fund since its inception have experienced periods of dominant
outperformance that have pulled the overall fund's return higher. Rotating
performance leadership is what we expected when we created Masters' Select
Equity and it is what we continue to expect. Why? There are two reasons:
First, each manager will experience various levels of short-term success: Over
the course of a career a skilled manager will experience some periods during
which it seems he or she can do no wrong and, occasionally, other periods where
he or she can do little right. The potential for these swings is greater with a
concentrated portfolio, though we believe that over a market cycle returns are
likely to be higher with concentration. This hypothesis is playing out with
Masters' Select Equity.
Second, style leadership varies over time; it always has and always will. There
is a tendency for some investors to become caught up in the optimism that drives
- --------------------------------------------------------------------------------
COMPARISON CHART
The value of a hypothetical $10,000 investment in the Masters' Select Equity
Fund from its inception (12/31/96) to present as compared with the Wilshire 5000
Index and the Lipper Multi-Cap Core Index.
Masters' Select Lipper
Equity Fund Wilshire 5000 Multi-Cap Core
----------- ------------- --------------
12/31/96 10,000 10,000 10,000
01/31/97 10,290 10,536 10,474
02/28/97 10,320 10,531 10,443
03/31/97 9,860 10,065 10,057
04/30/97 10,210 10,504 10,405
05/31/97 10,920 11,249 11,107
06/30/97 11,530 11,765 11,526
07/31/97 12,790 12,670 12,402
08/31/97 12,500 12,194 12,061
09/30/97 13,560 12,913 12,724
10/31/97 12,850 12,483 12,246
11/30/97 12,740 12,892 12,454
12/31/97 12,911 13,130 12,627
01/31/98 12,845 13,201 12,698
02/28/98 13,925 14,162 13,605
03/31/98 14,415 14,872 14,243
04/30/98 15,081 15,049 14,397
05/31/98 14,557 14,648 14,002
06/30/98 14,732 15,163 14,395
07/31/98 14,579 14,831 14,102
08/31/98 11,850 12,521 11,906
09/30/98 12,210 13,339 12,471
10/31/98 13,140 14,332 13,322
11/30/98 13,883 15,234 14,036
12/31/98 14,834 16,209 14,988
01/01/99 15,304 16,805 15,485
02/01/99 14,572 16,195 14,888
03/01/99 15,413 16,820 15,358
04/01/99 16,955 17,627 15,985
05/31/99 16,736 17,241 15,806
06/30/99 18,059 18,134 16,581
07/31/99 17,589 17,552 16,216
08/31/99 17,304 17,389 15,933
09/30/99 16,898 16,935 15,536
10/31/99 17,365 18,012 16,325
11/30/99 17,728 18,615 16,850
12/31/99 18,758 20,071 18,103
The hypothetical $10,000 investment at Fund inception and includes changes in
share price and reinvestment of dividends and capital gains. The Wilshire 5000
and Lipper Multi-Cap Core Indexes are unmanaged, do not incur fees or expenses,
and can not be invested in directly.
- --------------------------------------------------------------------------------
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
- --------------------------------------------------------------------------------
PERFORMANCE THROUGH DECEMBER 31, 1999
Since Inception
------------------------------
Cumulative Average
1999 Total Annual
Return Return (4) Total Return (4)
------ ---------- ----------------
Masters' Select Equity 26.45% 87.58% 23.33%
Custom Index (1) 21.91% 88.74% 23.58%
Wilshire 5000 Index (2) 23.82% 100.71% 26.13%
Lipper Multi-Cap Core Index (3) 20.79% 81.03% 21.88%
1 The Custom Equity Index is composed of a 70% weighting in the S&P 500
Index, a 20% weighting in the Russell 2000 Index and a 10% weighting in the
MSCI EAFE Index. We believe that these weightings will approximate the
asset allocation of the Fund over time.
2 The Wilshire 5000 Index measures the performance of all U.S. headquartered
equity securities with readily available pricing data. The index has a
higher proportion of large-cap stocks than does the Masters' Select Equity
Fund.
3 The Lipper Multi-Cap Core Index is composed of mutual funds that invest in
a variety of market capitalization ranges, without concentrating 75% or
more of their equity assets in any one market-capitalization range over an
extended period of time. Lipper Analytical Services includes Masters'
Select Equity Fund in this category, and accordingly we replace the Lipper
Growth Fund Index with the Lipper Multi-Cap Core Fund Index.
4 Inception date of Masters' Select Equity Fund is 12/31/96.
5 Indexes are unmanaged, do not incur fees, and cannot be invested in
directly.
Past performance does not guaranty future results. Share prices fluctuate, and
investors may have a gain or loss when they sell shares.
- --------------------------------------------------------------------------------
14
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- --------------------------------------------------------------------------------
ASSET CLASS RETURN CYCLES
1975-1983 1984-1988 1989-1993 1994-1999
--------- --------- --------- ---------
S&P/Barra Value 18.71% 17.08% 13.55% 22.60%
S&P/Barra Growth 12.60% 13.21% 15.10% 34.49%
Small Stocks 31.98% 7.90% 13.94% 12.92%
Foreign 15.59% 35.78% 2.29% 7.92%
Source L/G Research, Inc.
- --------------------------------------------------------------------------------
a style to excess in the late stages of a dominating run. This happens because
the story is usually quite compelling. Thus, investors bought into the small-cap
story hook, line and sinker in the early 1980s towards the end of a magnificent
run; they flocked to international funds in the late eighties and early nineties
when it was widely believed that the competitiveness of the U.S. economy had
slipped behind that of Japan and Europe; and they embraced value in the early
nineties when Wall Street and academia told them it was an inherently superior
strategy. Now technology and large-cap growth is in. This too will pass. The
chart on page 15 depicts various periods of style dominance over the past 25
years.
For those of us who have been around for a number of these cycles, the
enthusiasm toward an asset class or investment style that has performed well for
several years rings familiar. More often than not it represents a classic
investor decision error. The following describes two such errors:
Overweighting the recent past: People like patterns, and the recent past
represents a nice, easy-to-find pattern that can become the basis for an
investment decision. A style or fund that has just had a great year or a great
few year's can influence investors to believe that the recent past will repeat
itself in the future, but they often come to this conclusion with little real
research. Although some performance trends persist, many don't. Applying
simplistic extrapolation ignores the fact that whether a trend does or doesn't
persist is based on underlying, fundamental reasons, not its membership in a
"trend class" that was artificially created to describe observed events. The
superior risk-adjusted return patterns that academia and Wall Street saw in
small-caps in the late 1970s and early 1980s and value stocks in the early 1990s
have not continued. That doesn't mean they won't come back but it does point out
the skepticism we should have about any widely held market view.
Overconfidence: Studies show that people are exceedingly overconfident in
assessing their own ability and knowledge, especially relative to others.
Confidence provides a sense of control and order. But in investing it leads to
shortcuts. Investors react emotionally to a favorable story. They overestimate
their own knowledge and rely too heavily on their intuition. With the benefit of
hindsight, they exaggerate the talent behind successful decisions, and tend to
sweep poor decisions under the rug. As a result they make inappropriate choices,
investing in things they don't really understand in the mistaken belief that
their favorable intuition is enough to justify the action.
In designing Masters' Select Equity we sought to create a core holding that
would provide the overall diversification to make it competitive in any
environment. Although it won't be a market leader in all, or even most
environments (the curse of diversification), we are optimistic that the fund
will be able to deliver consistently competitive performance. If it does, it is
likely to generate an excellent long-term return compared with other
style-specific funds that offset periods of great performance with other periods
of very poor performance.
As we look forward, your fund is positioned with a sizable amount of mid-cap
exposure in addition to its small-cap exposure. Most of the mid-cap exposure is
value oriented (coming from Hawkins and Sanborn) whereas more of the pure
large-cap exposure is more growth oriented. Though we play no part in stock
selection, we are comforted to observe that on a purely statistical basis the
best relationships between price and growth potential in today's market appear
to be outside the large-cap sector.
Please see the introduction to this report for a thorough discussion of the
Masters' Select concept and a detailed review of performance.
- --------------------------------------------------------------------------------
PORTFOLIO COMPOSITION (12/31/99)
As reflected in this chart, your Fund is well diversified in terms of industry
exposure and market capitalization exposure. Masters' Select Equity holds 71
securities, exclusive of cash equivalents.
Performance Through December 31, 1999
Cash Equivalents 6.0%
Large-Caps 47.0%
Foreign Securities 2.0%
Small-Caps 18.0%
Mid-Caps 27.0%
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
FOSTER FREISS PHOTO
An Interview with
Foster Freiss
..........
Foster Freiss manages approximately 10% of the Masters' Select Equity Fund.
WHAT FIRST ATTRACTED YOU TO THE BUSINESS OF STOCK PICKING?
A professor of mine at the University of Wisconsin was on the board of a company
that he was really excited about. I bought some shares and lost about 60% of my
money. My determination to get that money back got me started in the investment
business.
HOW DID YOUR INVESTMENT PHILOSOPHY DEVELOP?
My first employer in the business, Baird Brittingham, got me interested in
growth stock investing. He was investing in growth stocks when others were
focused on steady income streams from bonds or stocks paying big dividends.
After witnessing the entrepreneurial spirit within these companies during my
years working for Baird, I knew I wanted to focus on them when I started my own
business.
As for our moderate price-earnings (P/E) ratio discipline, it was something that
I developed after witnessing periods of exaggerated speculation in the stock
market. In 1962, price-earnings ratios were so outrageous for some companies
that even if you extrapolated earnings five or six years down the road, you
still had PEs that were way out of whack.
I became very sensitized to the story about the Holland tulip bulb fiasco. There
have been all kinds of bubbles since, and each one reinforced an early lesson
from my mentor Baird: buy earnings, not dreams.
CAN YOU DESCRIBE THE KEY ELEMENTS OF YOUR STOCK PICKING DISCIPLINE?
At the core of the Friess strategy is the belief that you never invest in the
stock market, but rather in individual businesses. The benefits of focusing on
the strength and promise of individual companies outweigh the effects of more
16
<PAGE>
difficult to predict broad factors such as interest rates, foreign currency
values, commodity prices and general market trends.
We capitalize on the historic relationship between earnings performance and
stock prices by isolating companies growing earnings at least 20% year over year
that sell for reasonable multiples of forward earnings. Intensive contacts with
company managements, their competitors, customers and suppliers help us
determine which companies fitting our criteria are most likely to exceed Wall
Street earnings expectations. We look for companies with "sizzle," a catalyst
like a new product, management team or market opportunity that will garner
attention.
We typically avoid overresearched, big-name companies like the Microsofts,
Wal-Marts and Home Depots of the world. We instead look for #7 companies in an
industry making a move to the #3 spot, often leading to P/E ratio expansion as
the companies' profiles increase. We also require potential holdings to have at
least three years of earnings history, which prevents us from owning most pure
play Internet stocks.
YOU'VE BUILT A GREAT LONG-TERM RECORD AT THE BRANDYWINE FUND. WHAT FACTORS HAVE
BEEN MOST IMPORTANT IN DRIVING YOUR SUCCESS?
Our long-term track record was built by sticking to our earnings growth and P/E
ratio disciplines no matter what the market environment. While there will be
times when interest rate concerns and other macro-level factors influence stock
prices, we operate on the premise that individual-company fundamentals always
emerge as the true determinant of stock prices over the long haul. Investing in
individual companies and making sure we know their fundamentals inside and out
are at the cornerstones of our long-term success.
The people who put those disciplines to work each day are also responsible for
our long-term record. Talented and hard-charging Friess teammates like Bill
D'Alonzo, Jack Fraser, Andy Graves, David Harrington and Tripp Rudisill, among
others, keep their noses to the grindstone looking for the next Nokia or Sun
Microsystems.
AS YOU RESEARCH COMPANIES, WHAT ARE YOUR MOST IMPORTANT SOURCES OF INFORMATION?
Company managements, competitors, customers and suppliers are important sources
of information for both existing and potential holdings, as are income
statements, balance sheets and SEC filings.
Repeated customer contacts that yield complaints regarding a company's level of
service might be an early sign of a negative fundamental development for that
company if customers choose to take their business elsewhere. Or, as another
example, if contacts up and down the food chain from cellular phone company
managements to electronics store managers cite strong demand for a new phone
powered by a specific microchip, we might begin pursuing the chip supplier as a
potential holding.
We also comb through financial information, including 10-Qs and 10-Ks filed with
regulators, checking every statement and footnote. We analyze accounting,
currency exposure and a list of other factors that influence earnings to make
sure the assumptions we make after further investigation are sound.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
HOW DOES YOUR TEAM WORK TOGETHER AND HOW DO THE RESEARCH EFFORTS OF THE TEAM
CONTRIBUTE TO THE PORTFOLIO YOU RUN FOR MASTERS' SELECT?
Our research group is divided into seven teams. Each team consists of a research
team leader, researchers, associate researchers and support staff personnel
called research managers. Although all researchers and associate researchers
employ a generalist approach that enables them to pursue opportunities in any
industry sector, each sector is assigned one researcher as a specialist who
shares insights and contacts with researchers pursuing ideas within the
specialist's area of expertise i.e., telecommunications, software, retail, etc.
The Helmsman Team oversees interaction between teams. Five of the seven research
team leaders and I rotate helmsman responsibilities, with Bill D'Alonzo "at the
helm" most often. Once a team decides to take action on a stock, the research
team leader proposes the idea to the helmsman, who ensures that the proposed
action has been extensively analyzed and is consistent with the Friess
investment disciplines.
The Friess research team structure is unique in that the separate teams are not
in competition. They cooperate, sharing information from each contact they make
and alerting others to potential opportunities. A researcher's compensation is a
function of both performance and his ability to cooperate within the overall
team structure.
This approach benefits the Masters' Select portfolio the same way it does all
Friess portfolios. Our separate team structure benefits clients and shareholders
by preserving quick decision making and other advantages that smaller teams
offer while allowing us to harness the knowledge and experience of the entire
group. Instead of trying to beat the guy in the office next door, our
researchers focus on ensuring that the best available ideas comprise our
portfolios. Each teammate's success is paramount to all other teammates.
Over the past few years, large-cap growth companies have had a great run. Do you
think investors have become too enthusiastic or do the prospects for these
companies justify current prices?
We don't make decisions based on a company's market cap, so we don't spend time
worrying about large-cap valuations, per se. We're not going to buy a Wal-Mart
growing earnings at 13% for 45 times earnings when we can buy another
company--be it small, mid or large cap--growing earnings 40% for 20 times
earnings.
So it all depends on which large-cap growth companies you consider.
Investors seem enthusiastic regarding some large-cap stocks beyond what we deem
reasonable, but we don't get caught up in enthusiasm for companies that violate
our disciplines like JDS Uniphase, Qualcomm or Yahoo. Excess liquidity, investor
perceptions and the popularity of S&P 500 index funds have contributed to
run-ups in many high PE, relatively slow growing large-cap stocks we typically
wouldn't own. When expectations for stocks can't be justified our discipline
requires that we sell them. We have a mandate to focus on small and mid-cap
stocks for Masters' Select Equity. In our funds we hold some large-cap stocks,
so there are a number of large-cap stocks we think investors still
underestimate.
18
<PAGE>
WHAT IS YOUR GENERAL VIEW OF INTERNET STOCKS? IN GENERAL, ARE INVESTORS
OVER-OPTIMISTIC?
Some excellent long-term opportunities will no doubt emerge from the Internet
sector, though it's clear that the day-trading crowd isn't focused on the long
haul. Our requirement that potential holdings have at least three-year earnings
histories will keep us out of some winners like it did with Amgen during the
biotech craze of the early 1990s, but it will also help us avoid the pains that
many other investors will experience as the industry evolves. Merrill Lynch
Internet guru Henry Blodget recently estimated that 75% of today's Internet
companies won't exist in three to five years.
Some Internet valuations represent a company's prospects at least that far into
the future. We focus on earnings over the next four to six quarters since
managements have told us over the years that they can't accurately forecast
performance beyond that timeframe.
That said, some Internet winners now have earnings and if their price-earnings
ratios become reasonable, we'll add them to the portfolio if their upside is
compelling.
HOW ATTRACTIVE ARE TODAY'S OPPORTUNITIES, AT A STOCK-PICKING LEVEL, COMPARED
WITH OTHER POINTS IN TIME IN YOUR CAREER?
The good thing about being an active manager is that there are almost always
opportunities. We have more ideas today than we have assets to fund, so we're
satisfied.
WHAT ARE YOUR PRIMARY CONCERNS WITH RESPECT TO TODAY'S INVESTMENT CLIMATE?
Individual companies are our focus, not the investment climate. We don't concern
ourselves with broad factors until they threaten earnings, throw expectations
out of whack or otherwise influence individual-company fundamentals. Marketwide
distractions, good or bad, are short-term events. Investors always return to
evaluating companies on their own merits, which is why our company-by-company
process has fared so well over the long haul.
HOW DOES RUNNING A VERY CONCENTRATED PORTFOLIO (THAT IS ALSO PART OF A BROADLY
DIVERSIFIED FUND) DIFFER FROM A MORE BROADLY DIVERSIFIED PORTFOLIO?
Risk and reward are magnified, though that doesn't mean we would approach
running a more concentrated portfolio differently than a portfolio of 150
stocks. Our discipline of replacing good ideas with great ones works in both
situations. A chain is only as strong as its weakest link whether it's one foot
long or 20 feet.
When our research uncovers an idea that is better than a holding in the current
portfolio, the current holding is sold to make room for the new opportunity. We
sometimes describe this practice as our "pigs at the trough" discipline, because
we've observed that a pig that has eaten its fill is displaced by a hungrier pig
at the barnyard trough.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
Masters' Select Equity Fund Stock Highlights
..........
EMC--Spiros "Sig" Segalas
..........
Until several years ago, EMC Corporation was a company known to very few on Wall
Street. Now, by contrast, EMC is viewed as one of the bluest blue-chip
technology companies, on par with Cisco Systems and Microsoft. This is for one
simple reason: the rise of the Internet has caused an explosion in data traffic,
which has, in turn, driven a concurrent spike in the need to store this data.
This has dramatically increased the need for enterprise data storage and storage
has become a crucial purchase for all corporations. To better illustrate this
trend, demand for storage (as measured in terabytes) is expected to more than
double every year for the foreseeable future. This should manifest itself
through continued strong orders from EMC's traditional customers in industries
such as finance and telecommunications. However, this torrid growth rate masks
the demand generated by Internet-based companies, or the "dot coms", as they are
now known. Demand from this customer set, which is rapidly becoming a more
meaningful part of EMC's revenue stream (now ~15%), can grow geometrically in a
very short period of time. It is not uncommon for these companies to purchase
the annual amount of new storage required by a traditional global customer in a
matter of days. The following examples provide further color on the purchasing
power of the dot-coms:
Excite.com: 49 terabytes of storage from EMC in 2 years
Amazon.com: 42 terabytes of storage from EMC in 6 months
Mail.com: 28 terabytes of storage from EMC in 45 days!
For perspective, the entire data storage market in 1994 was 75 terabytes. Demand
for mass storage from the dot-coms continues to accelerate in step with the
expansion of the Internet. Mail.com is one of the most recent additions to EMC's
customer base, showing that if EMC's Internet business continues to increase at
a steady clip, the day of the 100 terabyte order is not far off.
EMC's revenues have grown consistently by more than 30% for several years. Three
factors should enable this growth to continue. The first is continued strength
in EMC's traditional high-end storage business (systems > $500,000). The
Company's technological lead and maniacal focus solely on storage (as opposed to
servers and storage like HP, IBM and Sun) has given EMC the best sales pitch in
the industry. The second is the company's recently completed acquisition of Data
General, which gives EMC a mid-range storage solution ($50,000 to $100,000) that
it had not traditionally offered, opening up a new market opportunity. The third
is EMC's rapidly growing software business (> 50% annually) which should add
over $1 billion in revenues in calendar year 2000. Software carries much higher
margins than hardware. This has caused significant margin expansion and has been
an increasing contributor to EMC's strong earnings growth. Current demand trends
and competitive leadership position EMC well for the future. We expect the
company to earn $1.90 in 2001, up from $1.06 in 1999. The stock should continue
to command a blue-chip technology multiple and should prove to be a strong
investment for the year ahead.
20
<PAGE>
Fairchild Semiconductor International--
Foster Friess
..........
With semiconductor demand surging and the Asia-Pacific region recovering, Wall
Street is having a hard time pegging the prospects for Fairchild Semiconductor's
bottom line. Adding to the situation, Fairchild is focusing on higher-margin
products, migrating away from the commodity-based pricing model of its past.
NYSE-listed Fairchild, which developed the technology that spawned the modern
computer chip industry, was acquired by Schlumberger in the 1970s and sold to
National Semiconductor in the 1980s before a 1997 management buyout. The company
went public in August 1999 and has since topped consensus earnings estimates for
its August and November quarters by 62% and 22% respectively.
Fairchild sports more than 10,000 products in its portfolio, including
semiconductor building-block components for an array of end uses, allowing the
company to stand out in its industry as a "one-stop-shop" for multiple needs.
Customers include Compaq Computer, IBM, Lucent Technologies and Samsung.
Fairchild is emphasizing its power management products, which are enjoying
robust demand thanks to explosive growth in sales of battery-powered devices
such as cellular phones, Internet appliances and laptop computers. New
higher-margin products grew from 22% of revenues in the August quarter to 28% in
the November quarter. This trend combined with cost reductions and strong demand
helped improve gross profit margins to nearly 32% from just over 26% six months
ago.
Earnings before one-time charges were $30.9 million in the latest quarter,
compared with a $9.2 million loss the year before. Business in Japan doubled in
the past year and improved markedly in other overseas markets. At year-end 1999,
Fairchild shares sold at less than 25 times 2000 consensus estimates. Wall
Street expects earnings to grow in excess of 20% this year and next, a
conservative assumption given the company's new focus.
Fortune Brands--Robert Sanborn
..........
Fortune Brands (FO) combines many things I like in a stock: strong,
understandable branded businesses; a reinvigorated top management; and, most
important, market valuation that does not come near to underlying value.
FO has three business segments: Home and Office (about half the business,
including brands such as Moen faucets, Master Lock, Aristokraft cabinets, Day
Timer management systems, and Swingline staplers); Golf (Titleist, Footjoy, and
Cobra); and Spirits (Jim Beam and DeKuyper). Fully 80% of sales are from brands
that rank either #1 or #2, and have earned these franchises through many years
of effective brand management. These are moderate-growth brands, but ones that
are very well-known within their markets and should enjoy strong persistence.
The company is headed by Norm Wesley, a fairly young individual who had
previously run the Home and Office division. We have met Norm several times and
find him to be a very straight shooter whose first big move was relocating
corporate headquarters from opulent space in Old Greenwich, CT. to more
utilitarian space in suburban Chicago. While a cost-saving measure to the tune
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
of $30 million per year, more important, it sends a message to the operating
divisions that top management is not in an ivory tower. We are very comfortable
with Norm, who will lead an extensive portfolio review of the company early this
year.
Financially, FO is a steady grower whose steady growth should continue. Also, it
is a company that throws off a lot of cash flow. In the year 2000, FO will
generate free cash flow of about $350 million. It will use this money to pay
dividends, make acquisitions (FO is a consolidator in all of its divisions), and
buy back shares or retire debt.
Of course, with us valuation is most important. At its current price of $31, FO
trades at the extremely modest multiple of EPS (plus amortization) of only 11
times, far less than half the multiple of the S&P 500, and has a ratio of
business value (i.e. market value of equity plus net debt) -to-sales of around
1, again a huge discount to the market. In our view, FO is worth approximately
twice its current stock price. If the market does not recognize this value,
either FO will buy back stock at prices well below value or the company will be
bought in its entirety by someone exploiting the value gap. Either way, we
expect to capture the large gap between the current price and value.
Hilton Hotels--Mason Hawkins
..........
Hilton Hotels Corporation's recent purchase of Promus Hotel Corp., with its
Hampton Inn, Embassy Suites and Homewood Suites brands, competitively positions
Hilton as a leading hotel owner, manager and franchiser in the consolidating
hotel industry. Shareholders are entitled to an extremely undervalued stake both
in trophy hotels like the Waldorf Astoria, the Palmer House and the Hilton
Hawaiian Village as well as a rapidly growing free cash flow franchise fee
stream.
Southeastern Asset Management has taken a major position in Hilton for several
reasons: The stock sells at less than 40% of our appraisal when we use
conservative benchmarks for the management company and the real estate; Steve
Bollenbach and his associates are capable operators and intelligent capital
allocators with many flexibilities to build intrinsic value per share; and,
Hilton can grow organically without capital in the high single digits from
franchising and collecting the cash operating profits from the owned hotels.
Household International--
Christopher Davis
..........
As is often the case when a sector of the market falls from favor, good
companies get tarred with the same brush as lousy companies. In 1999, Household
International's stock was doubly cursed to be both in the unpopular financial
sector in general, and in the hated consumer finance business in particular - in
which many fraudulent companies blew up in late 1998. In such times, the
prospects of well-run companies are often improved by the demise of their
irrational competitors. This is the case with Household International whose
business continues to show excellent loan growth and strong margins while its
stock price languishes.
The company lends money to low and middle-income customers out of a network of
1,400 storefront locations nationwide. Although in these days of the Internet,
having physical locations sounds old-fashioned, these branches are both low-cost
22
<PAGE>
and tremendously profitable. CEO Bill Aldinger - who learned about good credit
and expense control as a senior manager at Wells Fargo - doubled the size of the
company two years ago by purchasing Beneficial Corp and has already wrung out
$500 million of cost savings - exactly as promised. He is in the process of
improving Household's underperforming credit card operations, which includes the
Union Privilege and General Motors affinity cards. In fact, the return on assets
in HI's credit card operations has already climbed from an anemic 30 basis
points a year ago to 170 basis points in the fourth quarter. Household's strong
U.K. operation, including the successful Goldfish card, is an underappreciated
asset.
But this is not a fashionable business in today's go-go market and the shares
currently sell at only 11 times 1999's cash earnings of $3.37 per share and less
than 10 times our estimate of $3.90 of cash earnings this year. The good news
about this low valuation is that the company is using its significant excess
capital to repurchase 10% of the outstanding shares within the next two years.
Finally, those who worry about recessions might be reassured to know that having
been founded 120 years ago, Household has not only endured every recession since
World War II but even weathered the Great Depression.
Manugistics Group--Dick Weiss
..........
Manugistics is the number two player in the supply chain management software
market. The company is also developing e-business trading exchanges, which allow
companies to trade and bid over the Internet with suppliers and customers
through a virtual network. Manugistics' software serves as the coordinator for
these Internet exchanges.
A new management team came in during the second quarter of 1999 under the
leadership of Greg Owens, who formerly ran the supply chain service business at
Andersen Consulting. His expertise and contacts within the industry are
beginning to help the company regain traction in the marketplace. We believe
that the company has always possessed strong technology, and with better
marketing and e-strategy will be able to reaccelerate growth in excess of 40%.
Recent business trends are encouraging, as license revenues grew 35%
sequentially in the November quarter. This was better than expected and proves
that the company's new sales effort and market opportunity are attractive. We
believe that Manugistics can transition from a current loss to a $.25 per share
profit in 2000. Most importantly, the stock trades at only 4 times sales, verses
17 times sales for industry-leader I2 Technologies. We therefore believe that
the stock has further upside to $40-$45 over the next six to nine months.
- --------------------------------------------------------------------------------
Neither the information contained herein nor any opinion expressed shall be
construed to constitute an offer to sell or a solicitation to buy any securities
mentioned herein. The views expressed herein are those of the portfolio managers
at the time commentaries are made and may not be reflective of current opinions.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
MASTERS' SELECT EQUITY FUND PORTFOLIO SUMMARY
..........
Schedule of Investments as of December 31, 1999
<TABLE>
<CAPTION>
INDUSTRY SHARES HELD MARKET VALUE PORTFOLIO %
-------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
COMMON STOCKS (94.00%)
Basic Materials
Cooper Industries Construction materials 90,000 $ 3,639,375 0.81%
Geon Company Chemicals 60,000 1,950,000 0.43%
Martin Marietta Materials Construction materials 80,000 3,280,000 0.73%
------------ ------
8,869,375 1.97%
Business Services
Answerthink Consulting Group Consulting 86,000 2,972,375 0.66%
Galileo International Reservations 100,000 2,993,750 0.67%
* Modem Media Poppe Tyson, Inc. Advertising 46,700 3,298,187 0.73%
Waste Management, Inc. Waste Disposal 755,000 12,976,563 2.89%
------------ ------
22,240,875 4.95%
Conglomerate
* Berkshire Hathaway, Inc
Class A Insurance 117 6,563,700 1.46%
------------ ------
Consumer Products
Brunswick Corporation Sporting Goods 255,000 5,673,750 1.26%
Fortune Brands Housewares 160,000 5,290,000 1.18%
* Lear Corporation Auto & Truck Parts 120,000 3,840,000 0.86%
Masco Corporation Building Materials 156,200 3,963,575 0.88%
Nike, Inc. Apparel 110,000 5,451,875 1.21%
Philip Morris Companies, Inc. Tobacco, Food, Beverages 170,000 3,941,875 0.88%
Stanley Works Hardware 250,000 7,531,250 1.68%
------------ ------
35,692,325 7.95%
Consumer Services
* Avis Rent-A-Car Rental Cars 123,500 3,156,969 0.70%
* Bj's Wholesale Club Specialty Foods 145,000 5,292,500 1.18%
* CEC Entertainment, Inc. Restaurants 126,000 3,575,250 0.80%
Charming Shoppes, Inc. Retail 350,000 2,307,812 0.51%
H&R Block Tax Services 120,000 5,250,000 1.17%
* Jack in the Box, Inc. Restaurants 173,000 3,578,938 0.80%
McDonalds Corporation Restaurants 94,000 3,789,375 0.84%
Tiffany & Co. Retail 72,300 6,452,775 1.44%
------------ ------
33,403,619 7.44%
Energy
* Harken Energy Corporation Oil and Gas Exploration 1,900,000 1,425,000 0.32%
* Pioneer Natural Resources Co. Oil & Gas 1,433,300 12,810,119 2.85%
* Precision Drilling Corp. Oil Well Services 120,500 3,095,344 0.69%
* Spinnaker Exploration Co. Exploration 235,000 3,304,687 0.73%
------------ ------
20,635,150 4.59%
</TABLE>
*Non-income producing securities
24
<PAGE>
Schedule of Investments as of December 31, 1999 (continued)
<TABLE>
<CAPTION>
INDUSTRY SHARES HELD MARKET VALUE PORTFOLIO %
-------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Finance
American Express Company Financial Services 94,400 $15,694,000 3.49%
American International
Group, Inc. Insurance 66,100 7,147,063 1.59%
Citigroup Banking 217,700 12,095,956 2.69%
Household International, Inc. Consumer Lending 200,000 7,450,000 1.66%
Morgan Stanley Dean Witter
Discover Financial Services 45,000 6,423,750 1.43%
Transatlantic Holding Insurance 59,200 4,621,300 1.03%
Washington Mutual, Inc. Savings & Loan 290,000 7,540,000 1.68%
Wells Fargo & Company Banking 160,300 6,482,131 1.44%
------------ ------
67,454,200 15.01%
Health Care and Pharmaceuticals
American Home Products Corp. Drugs 71,300 2,811,894 0.63%
* Health Management Association Facilities 350,000 4,681,250 1.04%
* Ventana Medical Systems Equipment 90,000 2,244,375 0.50%
------------ ------
9,737,519 2.17%
Lodging
Hilton Hotels Hotels and Resorts 1,518,247 14,613,127 3.26%
Marriott International Hotels and Resorts 271,000 8,553,438 1.90%
------------ ------
23,166,565 5.16%
Media and Publishing
CBS Corporation Broadcasting 100,300 6,412,931 1.43%
Knight Ridder, Inc. Publishing 35,000 2,082,500 0.46%
Readers Digest Association,
Inc. Publishing 115,000 3,363,750 0.75%
* Univision Communications, Inc Broadcasting 61,600 6,294,750 1.40%
------------ ------
18,153,931 4.04%
Technology
Apple Computer Computer Hardware 47,000 4,830,719 1.07%
* Cisco Systems, Inc. Computer Networks 81,250 8,701,367 1.94%
Eaton Corporation Instruments 70,000 5,083,750 1.13%
* EMC Corp. Storage Devices 76,800 8,390,400 1.87%
* Fairchild Semiconductor, Inc. Semiconductors 151,700 4,513,075 1.00%
Hewlett Packard Company Computer Hardware 148,100 16,874,143 3.76%
International Business
Machines Computer Hardware 80,000 8,640,000 1.92%
* Littelfuse, Inc. Instruments 145,000 3,520,781 0.78%
* LSI Logic Corp. Semiconductors 75,000 5,062,500 1.13%
* LTX Corp. Semiconductors 185,000 4,174,063 0.93%
Manugistics Group, Inc. Software 142,000 4,610,563 1.03%
Mentor Graphics Software 232,000 3,037,750 0.68%
* Microsoft Corporation Software 51,400 5,999,344 1.33%
* Seagate Technology Computer Hardware 115,000 5,354,687 1.19%
* Serena Software, Inc. Software 55,000 1,703,281 0.38%
* Sterling Software, Inc. Software 125,000 3,937,500 0.88%
Texas Instruments Semiconductors 160,300 15,529,063 3.46%
* UCAR International, Inc. Electronic Instruments 600,000 10,687,500 2.38%
Veeco Instruments, Inc. Instruments 75,000 3,508,594 0.78%
* Xircom, Inc. Peripherals 80,000 6,000,000 1.33%
Zoran Corp. Semiconductors 70,000 3,935,312 0.88%
------------ ------
134,094,392 29.85%
</TABLE>
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
Schedule of Investments as of December 31, 1999 (continued)
<TABLE>
<CAPTION>
INDUSTRY SHARES HELD MARKET VALUE PORTFOLIO %
-------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Telecommunications
* Globalstar L.P, Ltd. Services 34,000 $1,497,062 0.33%
* NTL Inc. Services 64,800 8,075,700 1.80%
* Qwest Communications Intl, Inc. Services 179,100 7,695,703 1.71%
Vodafone Airtouch, Plc. Services 129,500 6,410,250 1.43%
------------ ------
23,678,715 5.27%
Transportation
* FDX Corporation Express Mail and Freight 361,000 14,778,438 3.29%
* Seacor Smit, Inc. Water Transport 74,000 3,829,500 0.85%
------------ ------
18,607,938 4.14%
Total Common Stocks (cost $352,228,296) 422,298,304 94.00%
------------ ------
Repurchase Agreement (5.72%) Par Value
- -----------------------------------------------------------------------------------------------------
State Street Bank & Trust Co. $25,711,000 @ 2.5% $25,711,000 25,711,000 5.72%
(agreement dated 12/31/99; to be repurchased at
$25,716,356 on 1/3/2000; collateralized by $21,085,000
in US Treasury Notes due 1/3/2000; value $25,618,275)
(cost $25,711,000)
------------ ------
Total Investments (cost $377,939,296) 448,009,304 99.72%
Cash and Other Assets in Excess of Liabilities 1,237,271 0.28%
------------ ------
Total Net Assets $449,246,575 100.00%
============ ======
</TABLE>
* Non-income producing securities
See Notes to Financial Statements.
26
<PAGE>
Masters' Select International Fund Review
.........
Masters' Select International delivered huge performance in 1999. The fund
soundly beat its benchmarks as all five managers outperformed by a wide margin.
We are pleased to report that the Fund is also significantly ahead of all its
international benchmarks and its peer group over its full life.
- --------------------------------------------------------------------------------
COMPARISON CHART--PERFORMANCE THROUGH DECEMBER 31, 1999
The value of a hypothetical $10,000 investment in the Masters' Select
International Fund from its inception (12/1/97) to present (12/31/99) as
compared with the MSCI EAFE Index.
Masters' Select
International Fund MSCI EAFE Index
------------------ ---------------
12/31/97 10,000 10,000
01/31/98 9,910 10,548
02/28/98 10,990 11,225
03/31/98 11,680 11,571
04/30/98 11,930 11,662
05/31/98 11,770 11,605
06/30/98 11,360 11,693
07/31/98 11,440 11,811
08/31/98 9,400 10,348
09/30/98 9,140 10,030
10/31/98 9,870 11,075
11/30/98 10,580 11,643
12/31/98 11,040 12,101
01/31/99 11,665 12,065
02/28/99 11,534 11,778
03/31/99 12,129 12,269
04/30/99 13,107 12,766
05/30/99 12,563 12,108
06/30/99 13,369 12,581
07/31/99 13,591 12,954
08/31/99 13,521 13,002
09/30/99 13,702 13,134
10/31/99 14,489 13,626
11/30/99 16,538 14,099
12/31/99 19,322 15,365
The hypothetical $10,000 investment assumes an investment at Fund inception and
includes changes in share price and reinvestment of dividends and capital gains.
The MSCI EAFE Index is unmanaged, does not incur fees or expenses, and cannot be
invested in directly.
- --------------------------------------------------------------------------------
PERFORMANCE THROUGH DECEMBER 31, 1999
Since Inception
------------------------------
Cumulative Average
1999 Total Annual
Return Return (4) Total Return (4)
------ ---------- ----------------
Masters' Select International 75.01% 93.21% 37.21%
Custom International Index (1) 29.49% 47.04% 20.33%
MSCI EAFE Index (2) 26.96% 53.65% 22.90%
Lipper International Fund Index (3) 37.83% 56.49% 23.98%
1 The Custom International Index is composed of an 80% weighting in the MSCI
EAFE Index, a 10% weighting in the MSCI Emerging Markets Free Index, and a
10% weighting in the MSCI EAFE Small Cap Index.
2 The MSCI EAFE Index is a broad-based index that measures the performance of
common equities of selected companies in 21 developed countries in Europe,
Australasia and the Far East.
3 The Lipper International Fund Index measures the performance of the 30
largest mutual funds in the international fund investment objective, as
determined by Lipper Analytical Services.
4 Inception date of Masters' Select International Fund is 12/1/97
5 Indexes are unmanaged, do not incur fees, and cannot be invested in
directly.
Past performance does not guaranty future results. Share prices and returns
fluctuate, and investors may have a gain or loss when they sell shares.
- --------------------------------------------------------------------------------
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
We'd like to continue savoring 1999 but life goes on and we must look forward.
As we do so, we are compelled to say that investors shouldn't expect returns of
a similar magnitude to come along often.
Still we remain optimistic about the future for foreign markets. We believe that
significant positive change is happening in many parts of the world. In Europe
the move to a single currency has been a catalyst for change by mandating
more-responsible fiscal and monetary policy, opening up competition across
borders and facilitating improved capital flows throughout Europe. This backdrop
has contributed to the widely reported corporate restructuring boom (focusing on
core businesses, improving profitability, and cutting certain costs) that was
already under way in Europe. In addition, there has been record mergers and
acquisition activity as companies seek to compete in a larger market,
privatization of state-run industries, a rapidly developing corporate bond
market and some improvement in the shareholder orientation of many corporate
managements. There is also great potential for increased equity interest as
European governments seek to promote an equity culture to develop deep capital
markets that will support European companies in a competitive global economy.
Currently, household equity exposure ranges from 5% to 25% of assets, far below
U.S. levels. In addition the need to develop U.S.-style funded pension plans
that are more equity oriented than they have been historically is widely
recognized--though progress is slow. Although there is much positive change to
be excited about, and we are optimistic, Europe is not a slam-dunk positive
story. There is much room for improvement and much will probably happen. But
political risks remain and in a number of areas U.S. companies continue to hold
significant competitive advantages and benefit from a more profit-oriented
culture. Moreover, European stocks have performed very well in recent years and
though on a relative basis they appear more attractively valued than the S&P
500, they are not clearly a bargain. Your fund continues to have a material
exposure to Europe, though the allocation has declined.
Japan remains a conundrum. It appears to be a market that has the potential for
great upside but also significant risk. So, like Europe, Japan does not look
like a sure thing. There are signs of corporate restructuring, though it is not
yet widespread. Japanese companies are not shareholder-friendly, though there
are reasons to believe that many now have no choice but to focus on growing
profits,--something that may lead them to simulate shareholder-friendly
behavior. This is the biggest reason for optimism. There is also the potential
for Japanese investors to considerably increase their minimal stock holdings.
The risks include high debt levels that could be a major problem if the economy
doesn't experience a sustained recovery--not a sure thing. In addition, despite
a market that is more than 50% lower than its bubble level of 10 years ago, the
market is not clearly cheap. High earnings growth will be necessary for Japanese
stocks to deliver sustained high returns.
28
<PAGE>
Probably the best values are in some of the emerging markets and Asia ex-Japan,
many of which remain below levels of several years ago. Our managers tell us
that although there has been some improvement in management quality with respect
to disclosure, capital allocation, and shareholder orientation in certain
countries and companies, there continues to be significant room for improvement,
and the risks, as always, remain highest in these generally smaller, less-liquid
markets.
Though not a clear bargain, we are generally optimistic about the potential for
reasonably good returns from foreign stocks going forward. Moreover, the
pressure to restructure and become more profit oriented is going to continue to
result in a number of exciting individual stock-picking opportunities. So, at a
stock-picking level we believe that there is excellent potential. We believe
that this plays to the strength of Masters' Select International with its
primary emphasis on bottom-up stock picking.
As we move into a new decade your fund continues to have a material weighting to
technology (29%) and the telecom (22%) sector. In terms of country weightings it
looks a bit different than the average international fund with significant
holdings in Canada (9.6%) and Israel (7.7%). Exposure to Japan has increased
though it is still underweighted relative to the index.
Please see the introduction to this report for a detailed discussion and review
of the Masters' Select concept and a detailed review of performance.
- ----------
Please note that with the replacement of Bee and Associates as a sub-advisor
last September, after the death of Bruce Bee, the fund no longer has a dedicated
small-cap manager. We are therefore dropping the Custom International Index
because it included a 10% allocation to a small-cap benchmark. By dropping the
Custom Index we are creating a tougher historical comparison during the fund's
first 22 months, given that international small companies underperformed over
that time span. We will no longer include the performance of the Custom Index
after this report, and are considering adding a second index in the future that
includes some emerging markets representaion.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
[PHOTO OF TED TYSON]
AN INTERVIEW WITH
TED TYSON
.........
Ted Tyson manages
approximately 10% of the
Masters' Select International Fund.
WHAT FIRST ATTRACTED YOU TO THE BUSINESS OF STOCK PICKING?
Basically starvation. I was a journalist for several years in San Francisco in
the early 1980s and decided to go out on my own and sell articles on a freelance
basis. I was slowly going bankrupt when I met a guy who was starting up a
brokerage operation. Even though I didn't have a great familiarity with the
stock market, I was more or less the entire research operation. So I pretty much
got dropped in head first. From the first day, I couldn't believe how
interesting the whole business of stock picking was--I just never looked back.
HOW DID YOUR INVESTMENT PHILOSOPHY DEVELOP?
The advantage of starting out on the brokerage side of the business was that it
allowed me to talk to a wide variety of investment managers. I realized fairly
quickly that I had a strong bias toward growth investing. It just seemed to me
common sense that markets were fairly efficient pricing mechanisms and that the
greatest opportunity was likely to be in those stocks that had achieved a
sustainable advantage in their industry and whose growth rates were likely to
surprise on the upside over time.
CAN YOU DESCRIBE THE KEY ELEMENTS OF YOUR STOCK-PICKING DISCIPLINE?
We survey on a daily basis the earnings of every company worldwide that has
reported in the previous 24 hours, looking for companies where earnings growth
is significantly higher than historic levels and, preferably, higher than
anticipated by any analysts who follow the company. We then narrowly focus in on
one and only one question: What is the catalyst for the higher level of growth
and to what degree is it sustainable? It's a pure bottom-up process, company by
company.
You've built a great long-term record at American Century and most recently with
your own firm, Mastholm Asset Management.
WHAT FACTORS CONTRIBUTE THE MOST TO YOUR SUCCESS?
Money management attracts a lot of really smart, hardworking people--it's a
difficult industry in which to be at the head of the class. Most of the people
I've known who have been successful over time have the same characteristics in
common: they find an investment philosophy they believe in and stick with it
regardless of market conditions. And they realize that very few managers succeed
based on inspiration as opposed to simple, relentless focus and application.
30
<PAGE>
It's hard work, so you better love what you're doing. And I do. I genuinely
can't imagine a more interesting job.
AS YOU RESEARCH COMPANIES, TYPICALLY, WHAT ARE YOUR MOST IMPORTANT SOURCES OF
INFORMATION?
First, we use a quantitative screen to isolate companies showing higher than
anticipated rates of growth. The advantage of a "quant" screen is that it forces
you to look at areas of the market where earnings momentum is less
obvious--often because it is just beginning to emerge. After that, it's a pure
process of meeting the managements--every member of the team travels
extensively--and using a wide variety of industry contacts to cross-reference
and put into context what we're hearing from the companies themselves.
HOW DOES THE TEAM WORK TOGETHER?
Each member of the team has certain industry specialties and specific country or
region responsibilities. We meet daily to discuss our individual research; and
decision making, as far as possible, is based on group consensus.
ARE THERE MARKETS OR REGIONS WHERE YOU ARE PRESENTLY FINDING ABUNDANT
OPPORTUNITIES AT A STOCK-PICKING LEVEL, OR ARE OPPORTUNITIES WELL DISPERSED?
PLEASE ELABORATE.
Global growth in 1999 is likely to come in around 2.5% to 2.75%, accelerating to
perhaps 4% or even higher in 2000. A lot of management I speak with throughout
the world are more optimistic than they've been for some time, and growth
opportunities are reasonably well dispersed. And, of course, to the extent that
markets and to some degree general economic growth are being driven by a
revolution in technology and communications, that is a worldwide phenomenon, not
one restricted to any particular country.
HOW ATTRACTIVE ARE TODAY'S OPPORTUNITIES, AT A STOCK-PICKING LEVEL, COMPARED
WITH OTHER TIMES IN YOUR CAREER?
Markets in the United States and Europe are clearly expensive by historic
standards, but the rate of economic and technological change is so great that
the outlook for individual companies and industries is the most fluid in my
lifetime. That uncertainty in outlook makes stock picking--trying to pick the
winners in a very volatile economic scene--more difficult that it's ever been,
but potentially more lucrative. Never in my career has the market paid you so
well for being right or punished you so severely for making errors. Japan, I
believe, is in a multiyear bull market. Simple returns to historic corporate
earnings levels would indicate a market two to three times higher than the
current level.
WHAT ARE YOUR PRIMARY CONCERNS WITH RESPECT TO TODAY'S INVESTMENT CLIMATE?
I have the heretical belief that inflation is being severely underestimated as a
potential problem for markets, especially in the United States. If anything
keeps me up at night it's a change in inflation expectation that increases the
risk premium on U.S. equities. I don't think any of us know what would follow a
30% to 40% decline in the United States, especially if the dollar went south at
the same time.
HOW DOES RUNNING A VERY CONCENTRATED PORTFOLIO (THAT IS ALSO PART OF A BROADLY
DIVERSIFIED FUND) DIFFER FROM A MORE BROADLY DIVERSIFIED PORTFOLIO?
Very little, in practice. Historically, our top 10 holdings represent 30% to 40%
of our diversified portfolios, so we already practice a high degree of
concentration. It does allow us to be less concerned with sector and country
considerations and to focus purely on total return, knowing that we are not
responsible for overall diversification that flows from the multimanager format.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
MASTERS' SELECT INTERNATIONAL FUND STOCK HIGHLIGHTS
...........
Quilmes--David Herro
...........
Quilmes is the largest brewing company in the southern cone of South America. It
has commanding market shares in Argentina, Uruguay, Paraguay and Bolivia. It is
also involved in bottled water in these regions and has recently purchased the
Argentinean Pepsi bottler, BAESA. Not only is this region expected to experience
economic growth faster than the developed West over the next decade, but
per-capita beer and soft drink consumption is low and advancing rapidly. This
means excellent business opportunity for Quilmes.
Though its main markets are developing, Quilmes is a very developed company. It
has an extremely experienced and competent management team and is partially
owned by Heineken, which also provides technical support. The company's
operational results have been stunning. It has an operating margin of close to
20%, has maintained or grown its high market shares, and has wisely deployed
free cash. Though it operates in somewhat volatile markets, its results have
been consistently strong, and, the company has grown mostly through its own
internal resources.
In view of all of the positives, one would expect Quilmes to be richly priced.
Instead, it sells at a P/E of 13.5 times and a price-to-cash flow ratio of well
under 10. Given the high quality of the company, its low valuation and good
growth prospects, we think Quilmes is an excellent long-term investment.
...........
Samsung Electronics--Dan Jaworski
...........
Samsung Electronics, headquartered in South Korea, is Korea's largest
manufacturing company. Its product offerings include semiconductors, mobile
phones, home electronics, and flat-panel displays for notebook PCs and desktop
monitors. The company is the world's largest supplier of flat-panel displays,
CDMA handsets, and color monitors and is the world's second-largest producer of
semiconductor memory chips. Samsung has strong business momentum in all of its
primary business segments and has been restructuring non-core segments to focus
its resources where it has competitive advantages. The company has excess
operating cash flow, which has recently been used to pay down a substantial
portion of long-term debt. The company also recently sold some non-core
businesses and liquidated money-losing subsidiaries.
In the past, Samsung's profits have been cyclical due to its high exposure to
the semiconductor cycle. Due to this cyclicality, investors have discounted
Samsung's valuation relative to other technology companies. However, as other
business segments have grown, the portion of Samsung's earnings derived from
semiconductors has declined from 90% in 1995 to less than 50% currently. Also,
Samsung remains at the forefront of the technology curve by introducing
next-generation semiconductor products earlier than its competitors. By doing
this, the company is able to capture the profitability attached to premium
pricing of new products while dispensing of lower-margin, mature products.
32
<PAGE>
We believe that Samsung Electronics should trade at valuations more similar to
other high-growth technology companies. Currently trading at under 13 times
estimated calendar year 2000 earnings and under 7 times estimated year 2000 cash
flow, a revaluation of the company to industry peer levels would generate
significant gains for shareholders.
TELEFONICA DE ESPANA--HELEN YOUNG HAYES
...........
At Janus, we've found that polling a firm's customers, competitors and suppliers
is a great way to cross-check what we know about a company. So when we began
looking at Telefonica de Espana, Spain's premier telecommunications operator, we
sent one of our analysts packing to uncover everything he could about the
company.
We started with the basics. Our analyst developed detailed models of the
company's earnings and cash flows, visited top executives and toured Telefonica
facilities on two continents. But it was only after discussing Spain's wireless
market with a builder of cellular antenna towers that he began to understand
exactly how much potential the company had. The tower builder told him that the
antenna-building business was accelerating rapidly and that Telefonica accounted
for more than 50% of that growth. Another infrastructure supplier confirmed that
sentiment, reporting that Telefonica was the most aggressive of Spain's three
competing cellular providers in adding new capacity. Meanwhile, a client of the
company's TEF Mobile subsidiary in Madrid gave glowing reviews of the company's
service, describing it as "first class," and "the best service offering
available" for corporate clients.
But discussions with the company's customers and suppliers weren't enough. Our
analyst actively sought out contacts within a competing company and was able to
deduce that Telefonica's profit margins were expanding faster than those of its
competitors. More importantly, he discovered that at least one of the company's
two rivals was overwhelmed by growth and not at all interested in building
market share--a golden opportunity for an aggressively expanding company like
Telefonica. Everything he learned suggested that Telefonica was a good
investment on the verge of becoming even better. We bought in, and the stock has
been one of our best performers.
Jenoptik--Ted Tyson
...........
Jenoptik is a technology company located in Dresden in the former East Germany.
It is one of the companies spun out of Zeiss, the main technology conglomerate
during the Communist era. While that's not much of a potential advertisement per
se, Jenoptik has been extremely aggressive about restructuring, having sold off
over the prior three years almost 10 loss-making divisions.
The remaining divisions focus in three main areas. The first, clean systems
technologies, builds and finances specialized rooms that eliminate all dust and
other similar particles. They are sold to companies whose products, such as
semiconductors, can be destroyed by the slightest contamination. The business
has contracted globally to a relative handful of players, of which Jenoptik is
the technological leader. Most new semiconductor capacity, especially in
commodity areas, is coming on stream in Taiwan and South Korea, while Japan is
increasingly shutting low-end semiconductor manufacturing facilities. As
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
production shifts towards Asia (ex Japan), Jenoptik's main competitors, all of
which are Japanese, should find themselves at a significant disadvantage.
Jenoptik also makes photonic etching systems for semiconductors, an area growing
over 70% on an industry-wide basis, and has a large venture capital portfolio in
such areas as laser eye surgery and advanced plasma systems used in a wide
number of technologies.
Jenoptik will bring these companies to the stock market over the next several
years.
With a three-year projected annual growth rate of well over 35% and a market
value of less than 10 times net profits, Jenoptik seems set to achieve
significant upside.
DBS Group Holdings--Mark Yockey
...........
DBS (Development Bank of Singapore) has a combined asset base of about $65
billion, which makes it significantly larger than any other non Hong Kong based
Asian bank. And, with one of the largest capital bases of any bank in Asia, DBS
is committed to proactively managing this capital, freeing it up from businesses
where the returns are poor and putting it toward businesses with superior
returns. Its acquisition of POSBank illustrates this commitment to leveraging
its huge capital base. POSBank strengthens its already dominant consumer banking
franchise by providing DBS with a new low-cost funding platform, an effective
distribution and delivery network and a recognizable brand name. In an
environment where deregulation is opening up opportunities across the region,
DBS's acquisition strategy is likely to be a key element of its growth strategy
over the next few years.
Led by a highly regarded management team, DBS is becoming a leaner, more focused
organization placing greater emphasis on risk management, international banking
and consumer banking. Moreover, the breadth and depth of its management should
be a competitive advantage for DBS as it makes further acquisition inroads in
Asia and penetrates its growing customer base.
Finally, at 2.8X price-to-book, we believe that the stock price does not
adequately reflect DBS's current profitability or potential.
- --------------------------------------------------------------------------------
Neither the information contained herein nor any opinion expressed shall be
construed to constitute an offer to sell or a solicitation to buy any securities
mentioned herein. The views expressed herein are those of the portfolio managers
at the time commentaries are made and may not be reflective of current opinions.
34
<PAGE>
MASTERS' SELECT INTERNATIONAL FUND PORTFOLIO SUMMARY
PORTFOLIO COMPOSITION BY REGION
(12/31/99)
Cash and Other Investments 6.8%
Europe 49.2%
Japan 11.0%
Middle East 7.6%
Canada 9.6%
Latin America 4.7%
Asia (exJapan) 9.7%
Australia/New Zealand 1.4%
PORTFOLIO COMPOSITION BY ASSET CLASS
(12/31/99)
Cash and Other Investments 6.8%
Emerging Markets 14.1%(1)
Developed Country Small-Caps 13.6 (1)
Developed Country Large-Caps 65.5 (2)
(1) Market capitalization < $800 million
(2) Market capitalization > $800 million
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1999
<TABLE>
<CAPTION>
SECTOR/INDUSTRY SHARES HELD MARKET VALUE PORTFOLIO %
--------------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
COMMON STOCKS (93.23%)
Argentina
Quilmes Industrial Quinsa
Sponsored ADR Consumer Products 272,400 $ 3,251,775 1.48%
Brazil
Uniao De Bancos Brasileiros
S.A. GDR Finance 127,500 3,840,938 1.75%
Canada
* AT & T Canada, Inc. ADR
Class B Telecommunications 163,000 6,550,563 2.98%
BCE Inc. Telecommunications 40,000 3,607,500 1.64%
* Clearnet Communications Telecommunications 90,000 3,099,375 1.41%
Nortel Networks Technology 33,000 3,333,000 1.52%
Quebecor Printing Business Services 43,000 960,686 0.44%
* Rogers Communications, Inc. Telecommunications 113,177 2,801,131 1.28%
Royal Group Technologies Ltd. Basic Industries 33,600 715,760 0.33%
---------- -----
21,068,015 9.60%
Finland
* Metso OYJ Capital Goods 254,500 3,307,179 1.51%
Nokia Corp AB OY Technology 36,000 6,527,626 2.98%
Nokia Corp Sponsored ADR Technology 48,650 9,243,500 4.21%
---------- -----
19,078,305 8.70%
France
AXA UAP Finance 15,000 2,091,258 0.95%
Bouygues Telecommunications 2,000 1,271,276 0.58%
Cap Gemini S.A. Business Services 16,553 4,202,014 1.92%
Chargeurs Consumer Products 47,400 2,669,134 1.22%
Groupe Danone Consumer Services 9,400 2,215,766 1.01%
ST Microelectronics Technology 55,600 8,419,925 3.84%
Thomson Multimedia Technology 50,000 2,694,660 1.23%
Total Fina Energy 7,000 934,317 0.43%
---------- ------
24,498,350 11.18%
</TABLE>
*Non-income producing securities
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
Schedule of Investments as of December 31, 1999--(continued)
<TABLE>
<CAPTION>
SECTOR/INDUSTRY SHARES HELD MARKET VALUE PORTFOLIO %
--------------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Germany
Jenoptik AG Technology 60,300 $1,014,411 0.46%
Krones AG Capital Goods 40,386 1,139,119 0.52%
Mannesman AG Basic Industries/
Telecommunications 58,272 14,058,716 6.41%
Porsche AG Preferred Transportation 791 2,167,333 0.99%
---------- -----
18,379,579 8.38%
Hong Kong
* China Telecom Ltd
Sponsored ADR Telecommunications 61,300 7,880,881 3.59%
JCG Holdings Limited Finance 4,593,000 2,584,984 1.18%
Legend Holdings Technology 244,000 604,232 0.28%
---------- -----
11,070,097 5.05%
Israel
* Check Point Software
Technologies, Ltd Technology 37,300 7,413,375 3.38%
* Comverse Technology Technology 50,250 7,272,117 3.31%
* Orbotech Ltd. Technology 27,000 2,097,563 0.96%
---------- -----
16,783,055 7.65%
Italy
* FILA Holdings SpA
Sponsored ADR Consumer Products 356,000 3,916,000 1.78%
Japan
Belluna Co. Ltd Consumer Services 33,000 852,697 0.39%
CSK Corporation Technology 10,000 1,624,743 0.74%
DDI Corp Telecommunications 100 1,370,265 0.62%
Kyocera Corporation Technology 15,500 4,020,260 1.83%
Matsushita Consumer Products 10,000 2,642,654 1.21%
Nippon Telephone & Telegraph Telecommunications 166 2,843,300 1.30%
NTT Mobile Communications Telecommunications 203 7,808,457 3.56%
Tokyo Broadcasting Media & Publishing 87,000 2,946,266 1.34%
---------- ------
24,108,642 10.99%
Korea
Samsung Electronics Consumer Products 17,000 3,982,387 1.82%
Netherlands
* Exact Holdings Technology 23,000 1,225,642 0.56%
ICT Automastering Business Services 28,700 1,127,526 0.51%
Koninklijke Philips
Electronics NV Technology 6,286 848,610 0.39%
Philips Electronics NV Technology 16,876 2,295,004 1.05%
* United Globalcom Inc.
Class B Telecommunications 53,760 3,790,080 1.73%
VNU Media & Publishing 77,000 4,047,390 1.84%
---------- -----
13,334,252 6.08%
New Zealand
Fernz Corp Basic Industries 1,345,000 3,057,016 1.39%
Panama
Banco Latinoamericano Class E Finance 133,100 3,127,850 1.43%
Singapore
DBS Group Holdings Finance 234,560 3,844,784 1.75%
Mandarin Oriental
International Ltd Hotels 3,489,000 2,442,300 1.11%
--------- -----
6,287,084 2.86%
</TABLE>
*Non-income producing securities
36
<PAGE>
Schedule of Investments as of December 31, 1999--(continued)
<TABLE>
<CAPTION>
SECTOR/INDUSTRY SHARES HELD MARKET VALUE PORTFOLIO %
--------------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Spain
Telefonica S.A Telecommunications 190,695 $4,763,994 2.17%
Sweden
Assa Abloy Basic Industries 182,666 2,565,353 1.17%
Switzerland
* Synthes Stratec Holding AG Health Care 4,350 1,991,553 0.91%
United Kingdom
Capita Group Plc Business Services 195,057 3,544,600 1.62%
Cordiant Communications Group Business Services 351,000 1,649,884 0.75%
House of Fraser Consumer Services 3,515,000 4,315,113 1.97%
P & O Transportation 54,000 895,813 0.41%
* Royal Doulton Plc Consumer Products 2,643,000 5,123,086 2.33%
Scottish & Newcastle Consumer Services 94,000 652,905 0.30%
Tomkins Plc Business Services 984,971 3,213,868 1.46%
---------- -----
19,395,269 8.84%
Total Common Stocks (cost $122,796,430) 204,499,514 93.23%
Short Term Investments (6.17%)
Repurchase Agreements Par Value
- --------------------- ---------
State Street Bank & Trust Co. $11,344,000 @ 2.5% $11,344,000 $11,344,000 5.17%
(agreement dated 12/31/99; to be repurchased at
$11,346,363 on 1/3/2000; collateralized by $9,530,000
In US Treasury Notes due 1/3/2000; value $11,578,950)
(cost $11,344,000)
Government Agency Obligations
Federal Home Loan Bank Mortgage Discount Note 2,200,000 2,199,817 1.00%
1.5%, 1/3/2000 (cost $2,199,817)
Total Short Term Investments (cost $13,543,817) 13,543,817 6.17%
Total Investments (cost $136,340,247) 218,043,331 99.40%
Cash and Other Assets in Excess of Liabilities 1,314,092 0.60%
------------ ------
Total Net Assets $219,357,423 100.00%
============ ======
</TABLE>
*Non-income producing securities
See Notes to Financial Statements.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
Report of Independent Accountants
To the Board of Trustees and Shareholders of Masters' Select Funds Trust:
In our opinion, the accompanying statements of assets and liabilities, including
the schedules of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of the Masters' Select Equity Fund and
Masters' Select International Fund, separate series of Masters' Select Funds
Trust (the "Trust") as of December 31, 1999, the results of each of their
operations, the changes in each of their net assets, and the financial
highlights for the year then ended, in conformity with accounting principles
generally accepted in the United States. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Trust's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these financial statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit, which included confirmation of securities at December 31, 1999 by
correspondence with the custodian and brokers, provides a reasonable basis for
the opinion expressed above. The financial statements for the year ended
December 31, 1998, including the financial highlights for each of the periods
prior to December 31, 1999, were audited by other independent accountants whose
report dated February 12, 1999 expressed an unqualified opinion on those
financial statements.
PricewaterhouseCoopers LLP
New York, New York
January 28, 2000
38
<PAGE>
Statements of Assets and Liabilities as of December 31, 1999
Assets Equity Fund International Fund
----------- ------------------
Investments in securities, at value
(cost of $377,939,296 and $136,340,247) $448,009,304 $218,043,331
Cash, including foreign currencies
at value (cost of $92,813 and $172,840 92,813 172,803
Receivables:
Fund shares sold 492,558 1,549,647
Investment income 211,049 10,175
Investment securities sold 4,253,977 --
Foreign taxes withheld 8,644 128,326
Unrealized gain on forward exchange contracts -- 74,808
Deferred organizational costs 41,127 22,156
Prepaid expenses 17,254 13,503
------------ ------------
Total assets 453,126,726 220,014,749
Liabilities
Payables:
Fund shares redeemed 165,611 114,171
Investment securities purchased 3,200,089 318,953
Investment advisory fees 397,319 155,681
Other accrued expenses 117,132 68,521
------------ ------------
Total liabilities 3,880,151 657,326
Net Assets $449,246,575 $219,357,423
============ ============
Composition of Net Assets
Paid-in capital $354,447,102 $137,322,331
Undistributed net investment income -- 53,757
Undistributed net realized gains 24,729,906 211,700
Net unrealized appreciation 70,069,567 81,769,635
------------ ------------
Net Assets $449,246,575 $219,357,423
============ ============
Number of shares, $0.01 par value, issued
and outstanding (unlimited shares
authorized) 31,237,745 11,746,806
------------ ------------
Net Asset Value and Offering Price per Share $14.38 $18.67
------------ ------------
See Notes to Financial Statements.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
Statements of Operations for the year ended December 31, 1999
Investment Income Equity Fund International Fund
----------- ------------------
Income
Dividend income
(net of foreign taxes of $33,859 and
$144,300) $3,876,837 $1,302,308
Interest income 880,610 346,004
----------- -----------
Total income 4,757,447 1,648,312
Expenses
Advisory fees 4,594,816 1,399.695
Transfer agent fees 182,017 45,646
Accounting fees 82,981 77,581
Custodian fees 63,620 106,426
Administration fees 191,150 57,889
Registration fees 49,901 30,428
Shareholder reporting 57,547 10,937
Professional fees 45,395 25,267
Trustees' fees 14,965 14,965
Insurance 17,358 3,930
Amortization of deferred organizational costs 21,316 7,552
Miscellaneous 27,404 15,172
----------- -----------
Total expenses 5,348,470 1,795,488
Less
Advisory fees waived 83,807 151,859
Expenses paid indirectly 16,786 10,680
----------- -----------
Net expenses 5,247,877 1,632,949
----------- -----------
Net investment income (loss) (490,430) 15,363
Realized and Unrealized Gains (Losses
Net realized gain (loss):
Investments 91,751,133 10,529,523
Foreign currency transactions (895,815) 345,156
----------- -----------
Net realized gain 90,855,318 10,874,679
Net unrealized appreciation on:
Investments 6,658,117 72,261,423
Foreign currency transactions 901,555 111,958
Net unrealized appreciation 7,559,672 72,373,381
----------- -----------
Net realized and unrealized gains 98,414,990 83,248,060
----------- -----------
Net Increase in Net Assets Resulting
from Operations $97,924,560 $83,263,423
=========== ===========
See Notes to Financial Statements.
40
<PAGE>
Statements of Changes in Net Assets Equity Fund
For the year ended For the year ended
December 31, 1999 December 31, 1998
----------------- -----------------
Increase in Net Assets
Operations:
Net investment income (loss) $(490,430) $1,110,694
Net realized gain (loss) 90,855,318 7,401,690
Net unrealized appreciation 7,559,672 38,717,985
------------ -------------
Net increase in net assets from operations 97,924,560 47,230,369
Distributions to shareholders:
From net investment income (453,126) (716,884)
From net realized gains (72,845,649) (257,199)
------------ -------------
Total distributions (73,298,775) (974,083)
Fund share transactions:
Proceeds from shares sold 73,906,691 152,586,067
Net asset value of shares issued on
reinvestment of distributions 71,775,849 963,287
Cost of shares redeemed (126,519,637) (91,223,564)
------------ -------------
Net increase from Fund share transactions 19,162,903 62,325,790
------------ -------------
Net Increase in Net Assets 43,788,688 108,582,076
Net Assets
Beginning of year 405,457,887 296,875,811
------------ -------------
End of year $449,246,575 $ 405,457,887
============ =============
Change in Fund Shares
Shares sold 4,970,856 12,130,365
Shares issued on reinvestment of distributions 5,062,626 76,118
Shares redeemed (8,668,083) (7,397,559)
------------ -------------
Net Increase 1,365,399 4,808,924
============ =============
See Notes to Financial Statements.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
Statements of Changes in Net Assets--International Fund
For the year ended For the year ended
December 31, 1999 December 31, 1998
----------------- -----------------
Increase in Net Assets
Operations:
Net investment income (loss) $15,363 $763,812
Net realized gain (loss) 10,874,679 (6,214,611)
Net unrealized appreciation 72,373,381 9,823,019
------------ -----------
Net increase in net assets from operations 83,263,423 4,372,220
Distributions to shareholders
From net investment income (353,934 (769,458)
From net realized gains (4,038,447) --
------------ -----------
Total distributions (4,392,381) (769,458)
Fund share transactions:
Proceeds from shares sold 110,540,261 72,841,892
Net asset value of shares issued on
reinvestment of distributions 4,296,677 737,560
Cost of shares redeemed (69,570,835) (27,896,100)
------------ -----------
Net increase from Fund share transactions 45,266,103 45,683,352
------------ -----------
Net Increase in Net Assets 124,137,145 49,286,114
Net Assets
Beginning of year 95,220,278 45,934,164
------------ -----------
End of year $219,357,423 $95,220,278
Change in Fund Shares
Shares sold 7,886,341 6,729,487
Shares issued on reinvestment of distributions 274,383 68,609
Shares redeemed (5,108,427 (2,751,817)
------------ -----------
Net Increase 3,052,297 4,046,279
============ ===========
See Notes to Financial Statements.
42
<PAGE>
Financial Highlights--For a share outstanding throughout the period
<TABLE>
<CAPTION>
Equity Fund International Fund
------------------------------------- ---------------------------------------
Year ended Year ended Year ended** Year ended Year ended Period ended***
12/31/99 12/31/98 12/31/97 12/31/99 12/31/98 12/31/97
---------- ---------- ------------ ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of period $ 13.57 $ 11.84 $ 10.00 $ 10.95 $ 9.88 $ 10.00
-------- -------- -------- ------- ------- -------
Income from investment
operations
Net investment income (loss) (0.01) 0.03 0.03 0.00# 0.08 0.00
Net realized and unrealized
gain (loss) 3.52 1.73 2.90 8.13 1.08 (0.12)
-------- -------- -------- ------- ------- -------
Total from investment operations 3.51 1.76 2.93 8.13 1.16 (0.12)
-------- -------- -------- ------- ------- -------
Less distributions
From net investment income (0.02) (0.02) (0.03) (0.03) (0.09) (0.00)
From net realized gains (2.68) (0.01) (1.06) (0.38) (0.00) (0.00)
-------- -------- -------- ------- ------- -------
Total distributions (2.70) (0.03) (1.09) (0.41) (0.09) (0.00)
-------- -------- -------- ------- ------- -------
Net asset value, end of period $ 14.38 $ 13.57 $ 11.84 $ 18.67 $ 10.95 $ 9.88
-------- -------- -------- ------- ------- -------
Total return 26.45% 14.90% 29.11% 75.01% 11.74% (1.20%)
Net assets at end of period
(in 000's) $449,247 $405,458 $296,876 $219,35 $95,222 $45,934
-------- -------- -------- ------- ------- -------
Ratio of expenses to average
net assets, before custody
fee credits 1.26%+ 1.38%+ 1.47%+ 1.29%++ 1.55%++ 1.83%*++
-------- -------- -------- ------- ------- -------
Ratio of net investment income
(loss) to average net assets (0.12%) 0.30% 0.12% 0.01% 0.87% 0.42%*
-------- -------- -------- ------- ------- -------
Portfolio turnover rate 116.42% 135.41% 145.11% 100.00% 73.59% 0.00%
-------- -------- -------- ------- ------- -------
</TABLE>
- ----------
* Annualized
** Operations commenced December 31, 1996.
*** Operations commenced December 1, 1997.
# Amount represents less than $.01 per share.
+ Ratio of espenses to average net assets before management fee waiver and
custody credits for December 31, 1999, 1998, and 1997, respectively, were
1.28%, 1.38%, and 1.47%
++ Ratio of espenses to average net assets before management fee waiver and
custody credits for December 31, 1999, 1998, and 1997, respectively, were
1.41%, 1.63%, and 1.83%
See Notes to Financial Statements.
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
Notes to Financial Statements
1. Organization
The Masters' Select Funds Trust (the "Trust") was organized as a Delaware
business trust on August 1, 1996 and is registered under the Investment Company
Act of 1940 (the "1940 Act") as an open-end management investment company. The
Trust consists of two separate series: the Masters' Select Equity Fund and the
Masters' Select International Fund (each a "Fund" and collectively the "Funds").
The Masters' Select Equity Fund is a growth fund that seeks to increase the
value of your investment over the long-term by using the combined talents and
favorite stock picking ideas of six highly regarded portfolio managers.
The Masters' Select International Fund invests primarily in foreign companies.
It seeks to increase the value of your investment over the long-term by using
the combined talents and favorite stock-picking ideas of five highly regarded
international portfolio managers.
2. Significant Accounting Policies
The following is a summary of the significant accounting policies followed by
the Funds.
Security Valuation--Securities that trade on an exchange or Nasdaq are valued at
their last sale price. Securities traded on an exchange or Nasdaq for which
there have been no sales and other over-the-counter securities are valued at the
mean between the closing bid and asked prices. Securities for which market
prices are not readily available are valued at fair value as determined in good
faith by the Board of Trustees. Debt securities with remaining maturities of 60
days or less are valued at amortized cost unless the Board of Trustees
determines that amortized cost does not represent fair value.
Foreign Currency Translation--The Funds' records are maintained in U.S. dollars.
The value of securities, currencies and other assets and liabilities denominated
in currencies other than U.S. dollars are translated into U.S. dollars based
upon foreign exchange rates prevailing at the end of the reporting period.
Purchases and sales of investment securities, income and expenses are translated
on the respective dates of such transactions.
The Funds do not isolate that portion of their net realized and unrealized gains
and losses on investments resulting from changes in foreign exchange rates from
the impact arising from changes in market prices. Such fluctuations are included
with net realized and unrealized gain or loss from investments.
Net realized foreign exchange gains and losses arise from sales of foreign
currencies, currency gains or losses realized between the trade and settlement
dates on securities transactions, and the differences between the amounts of
dividends, interest, and foreign withholding taxes recorded on the Funds' books
and the U.S. dollar equivalent of the amounts actually received or paid. Net
unrealized foreign exchange gains and losses arise from changes in the value of
assets and liabilities, other than investments in securities, resulting from
changes in the exchange rates.
Forward Foreign Currency Exchange Contracts--The Funds may utilize forward
foreign currency exchange contracts ("forward contracts") under which they are
obligated to exchange currencies on specified future dates at specified rates,
and are subject to the risks of foreign exchange fluctuations. All commitments
are "marked-to-market" daily and any resulting unrealized gains or losses are
included as unrealized appreciation or depreciation on foreign currency
denominated assets and liabilities. The Funds record realized gains or losses at
the time the forward contract is settled. Counter parties to these forward
contracts are major U.S. financial institutions.
Federal Income Taxes--The Funds intend to comply with the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute all of their taxable income to their shareholders. Accordingly, no
provisions for federal income taxes are required.
Security Transactions and Related Income--Security transactions are accounted
for on the date the security is purchased or sold (trade date). Realized gains
and losses on securities sold are determined under the identified cost method.
Dividend income is recognized on the ex-dividend date and interest income is
recognized on the accrual basis. Purchase discounts and premiums on securities
held by the Funds are accreted and amortized to maturity using the effective
interest method.
Repurchase Agreements--It is the Trust's policy to take possession of securities
as collateral under repurchase agreements and to determine on a daily basis that
the value of such securities, including recorded interest, is sufficient to
cover the value of the repurchase agreements.
Deferred Organization Costs--Organization costs are amortized on a straight-line
basis over a period of sixty months commencing with the inception of each Fund's
operations.
44
<PAGE>
Distributions--Distributions to shareholders are recorded on the ex-dividend
date.
Accounting Estimates--The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities on
the date of the financial statements and the amounts of income and expense
during the reporting period. Actual results could differ from those estimates.
Other--Under terms of the Trust's Custodial Agreement, the Funds earn credits on
cash balances which are applied against custodian fees. For the year ended
December 31, 1999, these credits totaled $16,786 and $10,680 for Masters' Select
Equity Fund and Masters' Select International Fund, respectively.
Reclassification of Capital Accounts--The Funds account for and report
distributions to shareholders in accordance with the American Institute of
Certified Public Accountants' Statement of Position 93-2: Determination,
Disclosure, and Financial Statement Presentation of Income, Capital Gains, and
Return of Capital Distributions by Investment Companies. For the year ended
December 31, 1999, the Masters' Select Equity Fund decreased undistributed net
realized gains and increased undistributed net investment income by $511,378 for
the net investment loss which for tax purposes will be used to offset net short
term capital gain, and for foreign currency gains which are taxed as ordinary
income. For the year ended December 31, 1999, the Masters' Select International
Fund increased undistributed net investment income and decreased undistributed
net realized gains by $392,328 as result of foreign currency gains which are
taxed as ordinary income.
3. Management Fees and Transactions with Affiliates
The Trust, on behalf of the Funds, entered into an Investment Advisory Agreement
(the "Agreement") with Litman/Gregory Fund Advisors, LLC (the "Advisor"). Under
the terms of the Agreement, the Funds pay a fee to the Advisor equal to 1.10% of
the average daily net assets of each Fund. For the year ended December 31, 1999,
the Advisor contractually agreed to waive 0.02% from its fee applicable to the
Masters' Select Equity Fund and 0.10% from its fee applicable to the Masters'
Select International Fund. Additionally, effective September 24, 1999, the
Advisor voluntarily waived an additional 0.055% from its fee applicable to the
Masters' Select International Fund. The Advisor has contractually agreed to
continue the 0.02% and the 0.155% waiver through December 31, 2000 for the
Masters' Select Equity Fund and the Masters' Select International Fund,
respectively. While under certain circumstances the Advisor has the right to
seek recoupment of expenses they have reimbursed to the Fund, the Advisor has
agreed not to seek recoupment of the expenses waived for the Funds.
The Trust, on behalf of the Funds, has also entered into an Administration
Agreement with Investment Company Administration, L.L.C. (the "Administrator").
Under its terms, the Funds pay monthly a fee based on the value of the total
average net assets of the Trust at an annual rate of 0.10% of the first $100
million of such net assets, 0.050% of the next $150 million, 0.025% of the next
$250 million and 0.0125% thereafter, subject to a minimum fee of $40,000 per
Fund.
Affiliated entities of the Trust received net commissions on sales of the Funds'
securities for the year ended December 31, 1999 of $87,620 and $6,594 for the
Masters' Select Equity Fund and Masters' Select International Fund,
respectively.
Each unaffiliated Trustee is compensated by the Trust at the rate of $10,000 per
year.
4. Purchases and Sales of Securities
The cost of securities purchased and the proceeds from securities sold,
excluding short-term investments, for the year ended December 31, 1999 were as
follows
EQUITY INTERNATIONAL
FUND FUND
---- ----
Purchased $462,700,374 $150,189,253
Sales 532,584,258 121,779,766
At December 31, 1999, the aggregate unrealized appreciation and depreciation of
securities based on their cost for federal income tax purposes was as follows:
EQUITY INTERNATIONAL
FUND FUND
---- ----
Total Tax Cost $378,946,635 $137,150,392
Gross Unrealized Appreciation 98,669,744 84,181,553
Gross Unrealized Depreaciation (29,607,075) (3,288,614)
Net Unrealized Appreciation 69,062,669 80,892,939
The Masters' Select Funds Annual Report December 31, 1999
<PAGE>
5. Off-Balance-Sheet Risk
The Funds are parties to financial instruments with off-balance-sheet risk,
primarily forward contracts, in order to minimize the impact of adverse changes
in the relationship between the U.S. dollar and various foreign currencies.
These instruments involve market risk in excess of the amount recognized in the
Statement of Assets and Liabilities. Risks arise from the possible inability of
counter parties to meet the terms of their contracts, future adverse movement in
currency values and contract positions that are not exact offsets. The contract
amount indicates the extent of the Funds' involvement in such currencies.
A forward exchange contract is an agreement between two parties to exchange
different currencies at a specified rate at an agreed future date. Forward
contracts are reported in the financial statements at the Funds' net equity as
measured by the difference between the forward exchange rate at the reporting
date and the forward exchange rate on the date the contract is entered into. At
December 31, 1999, the Funds had the following forward contracts outstanding:
6. Line of Credit
The Trust has an unsecured $15,000,000 line of credit with its custodian.
Borrowings under this arrangement bear interest at the federal funds rate plus
0.50% per annum. At December 31, 1999, the Trust has no outstanding borrowings.
As compensation for holding available the lending commitment, the Trust pays a
0.08% per annum fee on the unused portion of the commitment which is allocated
among the Funds based on their relative net assets. The fee is payable quarterly
in arrears. For the year ended December 31, 1999, the commitment fees were
$9,516 and $2,486 for the Masters' Select Equity Fund and the Masters' Select
International Fund, respectively.
Masters' Select International Fund
In Exchange for Settlement Unrealized
date gain
--------------- ---------- ----------
Contracts to Buy
113,501 Euros U.S.$114,182 01/03/00 $178
34,989 Euros 35,182 01/04/00 75
----
253
Contracts to Sell
1,811,102 British Pound Sterling U.S.$3,000,000 04/10/00 74,555
Net unrealized gain on
forward contracts $74,808
46
<PAGE>
Change in Independent Accountants
On August 27, 1999, McGladrey & Pullen, LLP (McGladrey) resigned as independent
auditors of the Masters' Select Equity Fund and Masters' Select International
Fund, (hearafter referred to as the Funds) pursuant to an agreement by
PricewaterhouseCoopers LLP (PwC) to acquire McGladrey's investment company
practice. The McGladrey partners and professionals serving the Funds at the time
of the acquisition joined PwC. The reports of McGladrey on the financial
statements of the Funds during the past two fiscal years contained no adverse
opinion or disclaimer of opinion, and were not qualified or modified as to
uncertainty, audit scope or accounting principles. In connection with its audits
for the two most recent fiscal years and through August 27, 1999, there were no
disagreements with McGladrey on any matter of accounting principle or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of McGladrey would have
caused it to make reference to the subject matter of disagreement in connection
with its report. On September 9, 1999, the Funds, with the approval of its Board
of Trustees and its Audit Committee, engaged PwC as its independent auditor.
The Masters' Select Funds Annual Report December 31, 1999
