Investment Strategy Letter

September 30, 2016
Madison Large Cap Value Fund
Investment Strategy Letter
INV ES T M EN TS ®
Our Approach to Investing
The Madison Large Cap Value Fund goal is to achieve long-term outperformance over a
full market cycle on a risk-adjusted basis. To achieve this goal, we employ a process to find
stocks with rising return on invested capital (ROIC), which is the most important metric for
evaluating stocks, in our view. We believe that owning companies with increasing ROIC
and an attractive valuation is the right strategy to generate outperformance. Common
characteristics of stocks with rising ROIC include expanding margins, accelerating earnings
growth and/or working capital improvement on the balance sheet. Stocks with improving
ROIC also tend to benefit from valuation multiple expansion, which helps drive superior
performance results. Additionally, our process attempts to manage risks by avoiding value
traps and dead money stocks, both of which can damage long-term performance.
John Brown, CFA
Portfolio Manager
Industry since 1983
This quarter we are highlighting airfreight and logistics company FedEx (FDX) as an
example of an Industrial stock with good prospects for rising ROIC. FDX owns and
operates the world’s premiere express delivery network and largest air cargo fleet.
Its capital intensive fleet of 660 aircraft, 52,000 vehicles, and operations in over 220
countries creates an express network with very high barriers to entry. FDX has global
brand recognition, density and scale advantages, and is #1 in express delivery in the U.S.,
Latin America and Canada, and #2 in Asia-Pacific and EMEA, behind DHL. In the U.S., it
operates in an attractive duopoly with UPS that allows for good pricing power. We believe
these factors provide its competitive advantage.
Our thesis on FDX is that its May 2016 acquisition of competitor TNT Express (TNT) will
provide meaningful cost reduction synergies and improve ROIC over the next 12-18
months. FDX paid $4.8 billion for TNT, a purchase price we believe was reasonable and
which was $2 billion less than UPS offered to pay for the company a few years earlier.
Importantly, TNT gives FDX significant size in Europe, an area the company had only
a small presence in previously. As a stand-alone company, TNT was barely profitable,
despite having high single-digit market share in Europe. We expect FDX will be able to
improve margins and reach its goal of $750 million in annual cost savings. To accomplish
this goal, FDX has four main sources of savings, including implementing new technology
used in pick-up and delivery operations, having one global express and air network,
reducing labor costs, and consolidating sales teams. If the integration goes well, the
acquisition of TNT should increase FDX’s global delivery cost advantages.
Drew Justman, CFA
Portfolio Manager
Industry since 2001
Outside of the TNT acquisition, we believe the FDX Ground segment is likely to continue
to take market share from UPS. FDX Ground is a high margin, high ROIC business that has
taken share from UPS consistently over the last decade. It generates 50% of the firm’s total
operating profit despite representing only 27% of total sales. FDX Ground benefits from
Past performance does not predict future results. Please refer to the final two pages of this piece
which contain current performance information for the fund, the risks of investing in the fund and a
complete list of the fund’s individual portfolio holdings as of quarter end. Individual portfolio holdings are identified to illustrate our approach to investing the fund’s portfolio and are not intended
to represent a recommendation to buy or sell any such security.
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an independent contractor model and a separate Ground network, which results in lower
labor costs and faster delivery times. UPS is the market leader with an estimated 65%
share, while FDX is #2 with approximately 33% share, up from 22% in 2010. We believe
there is further growth in Ground from e-commerce, a significant network expansion and
continued share gains.
The fund purchased FDX in the quarter after it reached an attractive valuation compared
to the overall market. Specifically, FDX traded for less than 0.8x the S&P 500® forward P/E
multiple, which is the lowest level it has been valued at in over a decade according to data
from research provider FactSet. We believe the combination of cost synergies from its
TNT acquisition, continued growth and market share gains in the Ground segment, and a
cheap valuation make FDX an attractive investment.
Risks to our thesis include a slowdown in global economic growth, a negative impact from
rising energy prices, integration risk that results in lower than expected costs savings, and
inefficiencies in the Ground segment due to staffing and delivery challenges associated
with e-commerce volumes over the holidays.
Performance Review
For the third quarter, the Madison Large Cap Value Fund (Class Y) returned +1.1%
compared to the Russell 1000® Value Index, which gained +3.5%. Sector allocation was
positive while stock selection detracted from performance. In terms of sector allocation,
underweight positions in Utilities and Consumer Discretionary favorably impacted results.
For stock selection, there were positive contributions from Telecom and Energy that were
more than offset with negative results in Financials, Industrials and Technology. Within
Telecom, mobile phone carrier T-Mobile US (TMUS) was the most additive stock in the
portfolio. It continues to take subscriber market share with innovative marketing programs
and an improved cellular network. Within Energy, exploration and production firm Apache
(APA) and oilfield service company Baker Hughes (BHI) contributed nicely to results. APA
made a significant discovery of oil and gas that we believe will drive production growth
for the next several years. Within Financials, insurance firm American International Group
(AIG) was another notable outperforming stock.
On the negative side, three stocks that performed well earlier in the year trailed the
market in the quarter. Within Real Estate, data center real estate investment trust
(REIT) Digital Realty (DLR) was the most detractive stock in the portfolio, while specialty
insurance company Markel (MKL) negatively impacted performance in Financials. Within
Industrials, garbage disposal firm Republic Services (RSG) lagged the index. Another
notable underperforming stock was software provider Oracle (ORCL) in Technology. The
fund continues to hold all stocks mentioned above.
On a year-to-date basis, the fund returned +6.8% compared to the Russell 1000 Value
Index, which gained +10.0%. Sector allocation and stock selection detracted from
performance. For sector allocation, underweight positions in the Energy, Utilities and
Materials negatively impacted results. In terms of stock selection, there were positive
results in Consumer Staples, Consumer Discretionary, Real Estate and Health Care, while
there were negative results in Technology, Financials and Industrials. Within Consumer
Staples, global meat processor Tyson Foods (TSN) and cereal maker General Mills (GIS)
performed well. TSN was the most additive stock in the portfolio. Both TSN and GIS were
sold after reaching what we believe were full valuations.
In Consumer Discretionary, toy manufacturer Mattel (MAT) performed well after its
Barbie® toy line showed a return to growth. Within Real Estate, DLR contributed
nicely to results as it benefits from strong demand for its data centers. Another notable
outperforming stock was engineering and construction firm Jacobs Engineering (JEC)
in Industrials. On the negative side, within Technology, three names detracted from
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results including ORCL, software peer Microsoft (MSFT) and defense technology firm
FLIR Systems (FLIR). FLIR reported a disappointing earnings report that showed lack
of margin expansion. The fund sold the stock as this impaired our thesis. In Industrials,
conglomerate General Electric (GE) and engineering and construction firm Fluor (FLR)
lagged the index. Both stocks have significant exposure to depressed energy end
markets. As those end markets recover, we believe GE and FLR will stand to benefit.
Another notable underperforming stock was snack food manufacturer Mondelez
(MDLZ), which was sold.
John Brown
Drew Justman
Russell Investment Group is the source and owner of the trademarks, service marks and copyrights
related to the Russell Indexes. Russell® is a trademark of Russell Investment Group.
Although the information in this report has been obtained from sources that the firm believes to
be reliable, we do not guarantee its accuracy, and any such information may be incomplete or
condensed. All opinions included in the report constitute the authors’ judgment as of the date of
this report and are subject to change without notice. This report is for informational purposes only
and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
Madison Funds are distributed by MFD Distributor, LLC. Madison Asset Management, LLC.
©October 6, 2016
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Sep 30, 2016
Madison Large Cap
Value Fund
Class A Shares
Growth of $10,0001
The Value of Long-Term Investing
Experienced Management
$15,319
$10,000
2007
2008
2009
2010
2011
2012
2013
2014
2015
John Brown,
Drew Justman,
CFA Portfolio Manager CFA, Portfolio
Industry since 1983
Manager
Industry since 2001
2016
Fund Features
Average Annual Total Returns2 (%)
YTD
1 Yr
3 Yr
5 Yr
1.11
6.83
13.19
8.12
13.72
4.62
5.16
1.05
6.62
12.97
7.84
13.44
4.36
4.93
• High conviction of approx. 50 holdings
-4.74
0.45
6.45
5.74
12.10
3.74
4.60
• Seek companies with rising return on
0.87
6.04
12.13
7.04
12.59
3.75
4.60
with sales charge
-3.63
1.54
7.66
6.07
12.34
3.75
4.60
Russell 1000® Value Index
3.48
10.00
16.20
9.70
16.15
5.85
-
Class A
without sales charge
with sales charge
Class B
without sales charge
10 yr Since Inception
• Fund seeks long-term capital growth with
Three Months
Class Y
an opportunity for income
invested captial (ROIC)
• Focus on risk management
Ticker
Inception
Date
Exp. Ratio3
A
MGWAX
12/29/97
1.16%
B
MGWBX
12/29/97
1.91%
Y
MYLVX
6/30/06
0.91%
Class
Calendar Year Returns2 (%)
2008
2009
2010
2011
2012
2013
2014
2015
Class A
-35.98
15.94
7.98
6.80
11.21
29.37
11.72
-3.27
Russell 1000® Value Index
-36.85
19.69
15.51
0.39
17.51
32.53
13.45
-3.83
Distribution Frequency
Annual
Characteristics
Risk Measure (10-year) Class A
TTM P/E
16.8x
P/B
2.0x
3yr EPS Growth
-4.1%
ROE
10.0%
Active Share
74.7%
Standard Deviation
14.7%
Downside Capture
90.9%
Upside Capture
86.8%
Total Net Assets
$106.1 Million
1 Growth of $10,000 is calculated at NAV and assumes all dividends and capital gain distributions were reinvested. It
does not take into account sales charges (see Note 2 below) or the effect of taxes.
2 Average annual total returns and calendar year returns assume all distributions are reinvested and reflect applicable
fees and expenses. Class A share returns without sales charge would be lower if sales charge were included. Class A
share returns with sales charge reflect the deduction of the maximum applicable sales charge of 5.75%. Class B shares
have no up-front sales charge. If redeemed within six years, however, B shares are subject to a maximum contingent
deferred sales charge of 4.5%. Index returns reflect broad measures of market performance compared the fund and
reflect no deduction for sales charges, account fees, expenses or taxes. You cannot invest directly in an index.
Wtd. Average Market Cap
3 Expense ratios are based on the fund’s most recent prospectus.
$112.6 Billion
Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the
Russell Indexes. Russell® is a trademark of Russell Investment Group.
Performance data shown represents past performance. Investment returns and principal value will fluctuate, so
that fund shares, when redeemed, may be worth more or less than the original cost. Past performance does not
guarantee future results and current performance may be lower or higher than the performance data shown.
Visit madisonfunds.com or call 800.877.6089 to obtain performance data current to the most recent month-end.
madisonfunds.com
Portfolio Turnover
97%
Total Number of Holdings
34
Sector Allocation (%)
Shareholder Services
Madison Funds
Post Office Box 8390
Boston, MA 02266-8390
800.877.6089
24.7 24.2
25
Russell 1000® Value Index
20
15.1
15
5
0
13.4
8.9
10
Consultant and
Advisor Services
550 Science Drive
Madison, WI 53711
888.971.7135
Large Cap Value Fund
2.8
4.9
9.2
11.5
13.7
12.2
9.4
10.0
6.6
3.3
Consumer Consumer
Discretionary Staples
Energy
Financials
Health Care Industrials Information
Technology
4.5 4.0
4.2
3.5 2.9
3.3
Materials
Real Estate
4.2
Telecom
3.6
Utilities
Cash/Other
Sector allocation is rounded to the nearest 0.1%.
Complete Stock Holdings
BAXTER INTERNATIONAL INC
4.8
P G + E CORP
2.7
JPMORGAN CHASE + CO
4.7
OCCIDENTAL PETROLEUM CORP
2.5
CISCO SYSTEMS INC
4.6
REPUBLIC SERVICES INC
2.3
T MOBILE US INC
4.5
CHEVRON CORP
2.2
BAKER HUGHES INC
4.4
BANK OF NEW YORK MELLON CORP
2.1
JACOBS ENGINEERING GROUP INC
4.3
BERKSHIRE HATHAWAY INC CL B
2.1
APACHE CORP
4.0
EXXON MOBIL CORP
2.1
MARKEL CORP
3.6
GENERAL ELECTRIC CO
2.0
AMERICAN INTERNATIONAL GROUP
3.6
FEDEX CORP
2.0
ORACLE CORP
3.5
DOW CHEMICAL CO/THE
1.9
DIGITAL REALTY TRUST INC
3.4
CATERPILLAR INC
1.9
PROCTER + GAMBLE CO WHEN DIS
3.3
PFIZER INC
1.7
NASDAQ INC
3.3
BALL CORP
1.6
MICROSOFT CORP
3.0
NEXTERA ENERGY INC
1.6
MATTEL INC
2.8
FLUOR CORP
1.2
AFLAC INC
2.8
TE CONNECTIVITY LTD
1.2
JOHNSON + JOHNSON
2.7
US BANCORP
2.7
Standard Deviation: the dispersion from an average, which, for a mutual fund, depicts how widely the returns varied over a certain period of time. Higher deviation
represents higher volatility. Downside Capture Ratio: a fund’s performance in down markets relative to its benchmark. The security’s downside capture return is divided
it by the benchmark’s downside capture return over the time period. Upside Capture Ratio: a fund’s performance in up markets relative to its benchmark. The security’s
upside capture return is divided by the benchmark’s upside capture return over the time period. TTM P/E (Price-to-Earnings Ratio): measures how expensive a stock is.
It is calculated by the weighted average of a stock’s current price divided by the company’s trailing 12-month (TTM) earnings per share of the stocks in a fund’s portfolio.
P/B (Price-to-Book Ratio): measures a company’s stock price in relation to its book value (the total amount raised if its assets were liquidated and paid back all its liabilities). EPS Growth: the annual rate at which a company’s earnings are expected to grow. ROE (Return on Equity): a profitability ratio that measures the amount of net
income returned as a percentage of shareholders equity. Active Share: the percentage of a portfolio that differs from its benchmark index. Active Share can range from 0%
for an index fund that perfectly mirrors its benchmark to 100% for a portfolio with no overlap with an index. Portfolio Turnover: a measure of the trading activity in
an investment portfolio—how often securities are bought and sold by a portfolio. It is calculated at the fund level and represents the entire fiscal year ending 10/31/2015.
Avg. Market Cap: the size of the companies in which the fund invests. Market capitalization is calculated by number of a company’s shares outstanding times its price
per share.
An investment in the fund is subject to risk and there can be no assurance the fund will achieve its investment objective. The risks associated with an investment in the
fund can increase during times of significant market volatility. The principal risks of investing in the fund include: equity risk, growth and value investing risk, special
risks associated with dividend paying stocks, option risk, interest rate risk, capital gain realization risks to taxpaying shareholders, and foreign security and emerging
market risk. More detailed information regarding these risks can be found in the fund’s prospectus.
For more complete information about Madison Funds®, including charges and expenses, obtain a prospectus from your financial adviser, by calling
800.877.6089 or by visiting madisonfunds.com and clicking on prospectus and reports to view or download a copy. Before investing in the funds, consider the
investment objectives, risks, charges and expenses. The prospectus contains this and other information about funds and should be read carefully before investing.
Madison Funds are distributed by MFD Distributor, LLC and may be purchased directly from the fund or through your investment professional. Portfolio data is as of
the date of this piece unless otherwise noted and holdings are subject to change.
Not FDIC Insured | No Financial Institution Guarantee | May Lose Value
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