Portfolio Manager Commentary Q1 '17

Dividend

The Dividend strategy produced a positive return during the first quarter, although it underperformed the broad market. This result is no surprise - we expect underperformance during times of a strongly rising market, while the resilience of our strategy should shine during weaker markets. To that end, we made several changes that we believe will improve our portfolio for the future. And, qualitatively, the strategy continues to hit its three portfolio goals:

· Safety: During the life of the strategy we have never suffered a dividend cut - and we remain vigilant in protecting against this.

· Significance: Our portfolio yield remains healthy at 3%, or 150% of the yield of our S&P 500 benchmark, and higher than the 2.3% yield on Treasury bonds.

· Growth: The businesses we own continue to be healthy and support rising dividend streams. During the first quarter, we had seven companies increase their annual dividends by an average of 5.6%.

The first quarter was a busy one. Most of our activity was the result of our largest holding, Spectra Energy, being acquired. Because the acquirer was a Canadian company, and we prefer to avoid the complexities of international dividend investments in this strategy, we sold our shares and had a lot of cash to put to work.

Finding great businesses that have attractive dividend policies remains a challenge - we already own the best ones we know. Accordingly, we chose to increase our ownership of nine companies already in the portfolio. Notably, we made tech giant Microsoft our largest position and significantly increased our stake in Paychex, a payroll and HR services firm. These are two very special businesses that generate a ton of cash, have healthy growth prospects, and deserved a spot at the top of our portfolio. The others we added to were Ventas, Crown Castle, Amgen, Walmart, Fastenal, Praxair, and Exxon Mobil.

We sold our small position in L Brands, the parent company of Victoria's Secret and Bath & Body Works. The company has been struggling to offset declining mall traffic and increasing online competition. We expected continued growth and a rising dividend - so far, we've been disappointed. We think there is better opportunity in Corning, which dominates its niche in the LCD display market. It has a reasonably stable business that throws off a lot of cash, and a recent divestiture prompted a massive commitment to new (smart) capital allocation priorities, including a meaningful dividend. We think this emerging dividend growth story is in its early innings.

Later in the quarter we found opportunities to potentially upgrade the quality and growth in our portfolio. We sold Verizon because of questionable capital allocation decisions and an emerging price war driven by unlimited cellular data packages. We sold Emerson Electric and General Mills because of deteriorating growth outlooks. We then happily deployed this capital into WEC Energy. WEC is a fully regulated utility that serves customers in Wisconsin, Illinois, Michigan, and Minnesota. Since the current management team came on board in 2003, WEC has been the gold standard in the utility world.

We also purchased CVS Health, a business committed to helping people improve their health. Through more than 9,700 retail locations (7,600 have a pharmacy), 1,100 walk-in clinics, and a long-term care dispensary, CVS fills prescriptions and acts as a patient touch point to encourage better health outcomes. Its pharmacy benefit management business negotiates drug pricing with pharma companies, provides formulary management, and looks for ways to lower healthcare costs for insurance/health plan/government customers. We believe CVS will remain a critical player in the large, growing, and cost-focused US Healthcare market.

Everlasting

The Everlasting strategy outperformed the S&P 500 by nearly 1 percentage point during the first quarter of 2017, for a total gain of 7.0%. After a difficult end to 2016, we are happy to see the strategy moving in the right direction against the market.

Let's run through some of the performance highlights for the quarter.

It's always nice when your best performing stock is your largest holding. After falling sharply at the end of 2016, Facebook's stock price rose just over 23% in the first 3 months of 2017. Because it accounted for more than 13% of the portfolio, Facebook contributed almost 2.5 points of benchmark outperformance. That's a strong showing from a strong company.

And it wasn't the only stock helping the portfolio gain ground on the market. Amazon.com, Priceline Group, Netflix, and Middleby round out the Top 5 performers in the portfolio to start 2017. We're not surprised by that list, as we consider those 5 companies to be some of the best in the world, run by very strong management teams.

As always, there were a few stocks that fell short of the S&P 500 benchmark. This quarter, TripAdvisor, Tractor Supply, and Under Armour were the biggest losers, contributing 2.3 points of underperformance for the portfolio.

Your team added one new investment to the portfolio during the quarter: Align Technologies.

Align Technologies may not be a household name, but it wants to be. The company designs and sells Invisalign retainers, which are used by orthodontists as an alternative to traditional braces. Business is booming all over the globe as the product continues to improve, making it easier and more cost effective for orthodontists to use the product on their patients. We think Align is an incredible franchise run by a very capable management. As such, we started an initial position at what we think is a reasonable price. As we get new information about the company, we'll look for opportunities to buy more shares over time.

Our only sell this quarter was Under Armour. Although we believe the company has a very strong brand and that founder and CEO Kevin Plank has done a wonderful job of driving sales growth over the years, Under Armour is just not run as efficiently as it should be. The company cannot generate enough cash flow to both drive its growth and justify its valuation. That's because it has not found a way to generate consistent economies of scale. The recent slowdown in North American retailing exposed those frailties. As such, we've exited the position, preferring to watch from the sidelines as management addresses its operational and financial issues.

It was a tough decision, especially considering that we prefer to buy and hold companies like Under Armour. But given that the Everlasting portion of your portfolio is very concentrated, we have to place strong demands on the companies in the portfolio. If they don't meet our requirements for quality, growth, and a reasonably attractive price, we have to move the capital to an investment opportunity that better meets our needs. That's why, in addition to buying Align, we purchased some additional shares of Tractor Supply and Costco.

As always, we value the trust you place with us to manage your money and look forward to communicating with you again next quarter.

International

Three months ago, we cheered the 8% returns the International strategy posted over the course of 2016. Well - that was nothing.

The international strategy just posted 8% returns for the first three months of 2017. Of course, the rest of the year will bring what it may, but we would wager it won't be identical to what we just saw. Regardless, the start of this year is far better than what we saw 12 months ago.

Our performance came from across the globe and across industries. MercadoLibre, often called the EBay of Latin America, was up 35%. A trio of companies, India's HDFC Bank, Japanese robotics company Fanuc, and Chinese online travel agent Ctrip.com, were all up more than 20%.

Our top and bottom five companies are presented below:

Of the 27 companies in the strategy, 15 - representing 54% of the strategy's value - beat the benchmark and 13 (38% by value) posted double digit returns. This was offset by seven companies (19% of the portfolio) posting negative returns.

Our biggest loser in the quarter, BRF, is one of the world's largest exporters of chicken, so it didn't help when Brazilian regulators revealed a major investigation (codename "Operation Weak Flesh") into the industry for food safety violations. News of the investigation resulted in major importers like China, South Korea, and Chile halting all orders from Brazil, and there is potential for serious reputational damage. The good news is China quickly lifted its ban and only one of BRF's facilities was closed down for further investigation. The shares have bottomed for now, and we're digging in to see if this is an opportunity or an exit point.

Across the Pacific, our Japanese fast-fashion company, Fast Retailing, stumbled out of the gate in 2017 following a strong close to 2016 which saw the shares hit 52-week highs in December. Since then, the shares have fallen 19%. There are a few possible explanations for the fall:

· We're seeing generally weak numbers coming out of the retail industry lately. Swedish competitor H&M reported its first monthly sales drop in nearly four years in mid-March, and industry star, Spain's Inditex (the owner of the Zara brand), reported the weakest margins they've seen in almost eight years.

· The yen has strengthened 5% against the dollar since the calendar turned. A weaker currency increases the value of Fast Retailing's large overseas operations and makes it easier for the company to compete on price.

· Concerns about a Border Adjustment Tax (a tax to increase the cost of imported goods) and founder Tadashi Yanai threatening to leave the US market if one is put in place.

Operationally, Fast Retailing looks to be on track, but if the US growth opportunity goes away, it would hurt our valuation of the company. Fortunately, Fast Retailing isn't the only company balking at the tax proposals (a certain company named Wal-Mart is also protesting loudly), and it doesn't seem likely a border tax - at least as outlined so far - will succeed. This is another one we're going to be watching, however.

Tainted chicken and a bit of a fashion faux pas aside, it was a very strong quarter for your international investments. While it may be unreasonable to expect this pace to continue, your investment team is focused on creating a portfolio of high quality companies capable of delivering market-beating returns over a multi-year period.

Acquisitions will take a few names from us in the next couple of quarters (we closed our Syngenta position shortly after quarter-end and we expect the Qualcomm/NXP deal to close by year end), so your team has been busy scouring the globe for high quality companies to reinforce what we believe is a solid long-term portfolio.

Large Cap Core

The Large Cap Core strategy outperformed the S&P 500 by 2.1 points during the first quarter of 2017, rising 8.2%. After a difficult end to 2016, it's good to see the portfolio back on the right track.

We have crafted the Large Cap Core strategy to have a good balance of value, growth, and dividend income. As such, we expect it to do fairly well as the market rises and experience less volatility when the market falls. Over the past 12 months, the portfolio performed as well as the market on up days and slightly better than the market on down days. During the first quarter of 2017, the Large Cap Core SMA outperformed the market on up days and significantly outperformed the market on down days, leading the strong results so far.

Looking deeper into the portfolio, strong results from IPG Photonics, Panera Bread, and Amazon.com more than made up for the losses from TripAdvisor, Devon Energy, and Under Armour. In fact, the Top 5 performers contributed 4 percentage points (or about half) of the portfolio return compared to the -1.6 points the Bottom 5 detracted from the portfolio.

Uncharacteristically, we were very busy in the first quarter, making a number of buys and sells. We sold our stakes in Intel, Verizon, Level 3, Devon Energy, and Under Armour. We purchased additional shares of American Tower, Starbucks, Corning, and PayPal, as those are all high-quality companies with attractive share prices. We also added three new names to the portfolio: Crown Castle (a cellphone tower owner and operator like American Tower), Microsoft, and Amgen. All three of the new purchases have strong businesses and reasonable share prices. They also have attractive dividend yields, which we believe will provide additional stability to the portfolio.

Let us provide some additional information about the sale of Under Armour. We are big fans of the brand, and founder and CEO Kevin Plank has done a wonderful job of driving sales growth over the years. Unfortunately, the business is not run as efficiently as it should be. The company has difficulty generating significant amounts of cash flow, as it cannot generate economies of scale. The recent slowdown in North American retailing exposed those frailties. As such, we've exited the position, preferring to watch from the sidelines as management addresses its operational and financial issues.

Selling was a difficult decision, but facts are facts and our analysis shows that, right now, Under Armour does not have the right mix of quality and value to be a part of the Large Cap Core strategy. Quality and value are what your team focuses on when managing the portfolio. That's because if we pay good prices for great businesses, especially if they have room to grow, history has shown that's one way to outperform the market over the long haul.

Hedged Equity

The Hedged Equity strategy had an excellent first quarter, rising each month and soundly outpacing its benchmark. The market provided a healthy tailwind, rising more than 6% and buoyed by steady global economic data and uninspiring investing alternatives.

Four investments returned greater than 20% during the quarter:

· Atlassian and Cerner (both software providers) are small positions that we initiated last year. We're fans of both business models: asset-light, full of recurring revenue, cash generative, and founder-led. For a variety of reasons, both stocks lost more than 20% of their value over the course of 2016, which gave us the opportunity to establish our toe-hold positions.

· The other two were large, long-standing positions: Apple and Facebook. Apple's surge seemed to be sentiment driven. The stock (which had languished) caught up to the business (which continues to be strong) last quarter. Facebook is relentlessly demonstrating the relevance of its social platforms to users and advertisers. Although expectations are high, the company has found the right balance of delivering on its near-term promises and investing for the sustainability of its growth and profitability. It remains the Hedged Equity strategy's largest core long holding.

The bottom performers came in two flavors:

• Shorts:
  • As we might expect in a strongly positive market, our short positions hurt performance. Four of our short positions moved greater than 10%. Our position sizes remain small, so none of these moves hurt too much. Our analysis leads us to believe the business performance of these companies didn't drive the stock increases and we remain short.
• Adverse business developments:
  • Online broker TD Ameritrade suffered an 11% decline as its long-stable industry entered a price war. Charles Schwab reduced its trading commission rate twice(!) in February, which sparked competitive responses across the industry. Low price isn't everything for online brokers, but a race to the bottom has eviscerated the industry profit pool (to the benefit of investors with online brokerage accounts). We owned TD Ameritrade for more than just its brokerage business, but this unexpected move changes our thesis. We're digging deeper.
  • Rural retailer Tractor Supply was another loser. More accurately, all brick and mortar retailers had a tough quarter. Investors are opening their eyes to Amazon's dominance and are reducing their willingness to pay up for any retailer who might stand in its path. We think Tractor Supply is reasonably insulated, but it will have to put up the proof to allay fears.

The Hedged Equity strategy remains about 70% net long, which is a normal positioning. Despite persistently low volatility (as measured by the CBOE Volatility Index), we have found attractive put writing opportunities. This strategy allows us to hold a cash cushion, secure any potential obligations in companies we might want to purchase cheaper, and earn a bit of income to boost our returns. Volatility helps determine how worthwhile this activity is, so with prices low we must remain hyper-disciplined in how we execute this strategy. Entering the second quarter, we're pleased with the portfolio's balanced makeup consisting of core longs, shorts, a hedge, and options.

Large Cap Aggressive Growth

The Large Cap Aggressive Growth strategy outperformed the S&P 500 by 2.7 points during the first quarter of 2017, rising 8.8%. We are glad to start the year off on the right foot, but we know there's still plenty of work left to close the performance gap with the benchmark.

Coming out of 2016, your team has been upgrading the portfolio by selling companies that no longer meet our high standards for quality and growth and buying ones that do at what we believe are reasonable to attractive prices. One notable example of a company we've sold is Under Armour, which has had an incredible journey since its IPO in 2005.

We are big fans of the brand, which has become a global powerhouse. And we think founder and CEO Kevin Plank has done an amazing job of driving sales growth over the years. Unfortunately, the business is not run as efficiently as it should be. The company has difficulty generating significant amounts of cash flow, as it cannot generate economies of scale. The recent slowdown in North American retailing exposed those frailties. As such, we've exited the position, preferring to watch from the sidelines as management addresses its operational and financial issues.

It was a tough decision, but our job is to put your hard-earned capital to the best uses possible in the portfolio. As such, we purchased additional shares of Salesforce.com, Align Technologies, and Facebook. So far, those decisions have worked out well for the portfolio, as those three stocks were squarely in our Top 10 performers for the quarter, while Under Armour continued to decline after we sold.

As mentioned above, your team has a renewed discipline in making sure that all of our companies have strong, growing businesses. Over time, if we pay reasonable prices for those stocks, we are confident we can outperform the market over the long haul. And if a business is not meeting those standards, we will reallocate the capital sooner rather than later.

In December 2016, we purchased shares of internet security company Palo Alto Networks. Our research showed that it had a strong business with lots of growth potential and a good management team leading the way. The stock started to move higher following our purchase, until it reported year-end results in February. Management revealed that it had made a mistake reorganizing its salesforce, resulting in reduced guidance for growth. Assessing the new information, we made the decision to sell our shares, despite the recent purchase, as the quality of the company had diminished and the price was no longer attractive.

The lesson coming out of 2016 can be best summed up as "invest in your winners and sell your losers quickly". That can help protect a concentrated portfolio of fast-growing companies like the Large Cap Aggressive Growth strategy. We've had a number of big winners in the portfolio so far. Unfortunately, we've also had some big losers. Since we know we're not going to get every stock pick correct, we want to limit the impact of loses in order to enable the portfolio to grow at a faster rate. So far in 2017, those changes have started to pay off.

Thank you again for choosing to invest with us. We look forward to providing you with further results over a more extended time frame in the future.

U.S. Small & Mid-Cap

During the first quarter, the SMID strategy had a net return of 1.5% compared to a gain of 3.9% for the benchmark index, the S&P MidCap 400. The biggest drag on our performance was some of our consumer discretionary holdings, including Horizon Global which was down 42%.

Interestingly, Horizon Global was one of the strategy's biggest winners of 2016, when shares were up 131%. It was unfortunate that the shares fell so sharply in the first quarter, giving back much of last year's gains. After the company reported 2016 earnings in March, it became clear that the profitability of the business was going to be lower than we originally expected, so we decided to sell all of our shares.

The best performing stocks for the quarter were Varex Imaging, up 23%, American Woodmark, up 22%, and Infinera, up 20%. Varex Imaging entered the portfolio in January when it was spun off from one of our other holdings, Varian Medical Systems. Varex is a leading provider of components used in X-ray machines in hospitals. American Woodmark and Infinera shares were up strongly after the companies released positive earnings reports.

During the quarter we also sold out of our positions in Aceto, Horizon Global, and Natus Medical - three companies for which we felt that business performance was not meeting the expectations we had when we first purchased our shares. We decided the time was right to move on.

We used the proceeds from those sales to open a new position in aftermarket auto parts manufacturer Dorman Products. We also added to existing positions in Church & Dwight, Compass Minerals, Cooper Companies, Jones Lang LaSalle, ResMed, Sabre, and XPO Logistics.

Part of our process every time we decide whether or not to make a trade is asking ourselves whether the transaction will result in a better portfolio. The trades we made in Q1 were held to that standard - the strategy improvements included an increase in the weighted average operating and net profit margins by 40 basis points. Profit margins are an important measure of business quality for us because they reflect how much of a company's sales it gets to keep after all of its expenses are paid.

We are looking forward to the Q1 earnings season that gets underway towards the end of April. Of particular interest for us are companies in the consumer discretionary and industrials sectors, since over 40% of our assets are invested in those sectors. We expect good earnings reports because the performance of these companies is tied to the performance of the overall U.S. economy - and we have a favorable opinion of the country's economic prospects.

U.S. Small & Mid-Cap Dividend

During the first quarter of the year, the SMID Dividend strategy returned 2.6% versus a gain of 3.9% for the benchmark index, the S&P MidCap 400. (Since inception, the strategy has seen annualized returns of 25.6%, compared to 27.7% for the benchmark.) At quarter end, the strategy had a dividend yield of 2.4% compared to 1.5% for the benchmark.

The top performing company in the portfolio for the quarter was Hasbro, whose shares gained 29.1%. Hasbro is the second largest toy company in the world and they have an enviable product portfolio full of toys, games, and characters that kids love, including Transformers, My Little Pony, Disney Princesses, Star Wars and Sesame Street. Hasbro's reputation for brand stewardship allows it to secure licensing agreements to sell products under these premier brand names.

At the bottom of the strategy's performance for the quarter is Sabre, whose shares fell 14.5%. Sabre is one of the key tech companies supporting global travel. Their software provides the connection between airline seat inventory and the consumer facing websites we all use to book our reservations. In December 2016, Sabre promoted Sean Menke to the CEO role. Sean is increasing the company's investment in hotel property management software, addressing complexity in legacy airline IT systems, and providing data and analytic services to airlines. All of these investments should improve Sabre's product offerings in the future - but they will depress profits in 2017. Still, we're excited about Sabre's long-term prospects, despite the recent sell off.

During the quarter we sold out of National Instruments and trimmed our position in Huntington Bancshares. Both of those decisions were made because we found the valuations less attractive than some alternatives. We used the proceeds from those sales to add to existing positions in Agree Realty, Compass Minerals, Church & Dwight, DSW, Polaris, and Sabre.

The SMID strategy had a dividend yield of 2.4% during the first quarter of the year, compared to 1.5% for the benchmark. Over the past year, companies in the portfolio have increased their dividends per share, on average, by 1.8%, while the per share dividend for the benchmark declined 0.3%. Over the past three years, the annualized dividend growth rate for the portfolio is 10.5%, compared to 4.8% for the benchmark.

It is a core part of our portfolio management approach to seek out what we believe are high quality businesses that have the ability to increase their dividends over time. As this is an income generating strategy, it is important for us to deliver a higher yield than the benchmark and, ideally, to have stronger dividend growth metrics as well.