Performance Investor Class SMVLX

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1 Performance Investor Class SMVLX Average Annualized Total Returns as of December 31, 2013 QTR YTD ONE YEAR THREE YEAR FIVE YEAR ANNUALIZED SINCE INCEPTION 1/2/2008 SMEAD VALUE FUND 9.04% 37.53% 37.53% 22.54% 22.02% 7.66% RUSSELL 1000 VALUE 10.01% 32.53% 32.53% 16.06% 16.67% 5.57% S&P 500 INDEX 10.51% 32.39% 32.39% 16.18% 17.94% 6.49% Gross Expense Ratio: 1.50% Net Expense Ratio: 1.40%* *The Adviser has contractually agreed to waive its fees and/or absorb expenses of the Fund to ensure that Total Annual Operating Expenses do not exceed 1.40% of the Fund s average net assets, through 3/30/14. Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor s shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling Investment performance reflects fee waivers. In the absence of such waivers, total returns would be reduced. Dear Shareholder For the first time in many years, we can honestly say that the optimism of the people around us is making us a little nervous. The year 2013 was a terrific year for the Smead Value Fund with a return of 37.53%. What makes us nervous is the fact that the indexes did extremely well with a gain of 32.39% on the S&P 500 Index and a gain of 32.53% for the Russell 1000 Value Index. Our return since inception on Jan. 2, 2008 is 7.66%. This compares to 6.49% for the S&P 500 Index and 5.57% for the Russell 1000 Value. We are pleased for our original shareholders from early 2008, who had to brave the worst decline in the S&P 500 Index in the last 70 years and now can look back at what we believe are acceptable returns including the difficulty. The vast majority of investors discovered in 2013 that there has been a huge bull market in place for the last five years and many have decided to get involved or more involved. This shows up in many sentiment indicators, which are telling us to be cautious, as well as in the trading of untested concept stocks. Frothy markets cause us to mentally prepare for the froth getting eliminated in the not too distant future. As we will discuss below, this is not the first time we have been in this situation and think we have a good plan for dealing with more volatile gyrations in the stock market. Once the froth gets clipped, we are very optimistic about the future of the companies which we have selected. The stocks which contributed the most to our returns for the year 2013 were Gannett (GCI), Cabela s (CAB), and Walgreen (WAG). This is representative of the steady improvement in the economy of the US during the year and the expectation by the end of the year that the kind of positive demographics and increased confidence will filter through to higher levels of Gross Domestic Product. Our poorest performers were Ebay (EBAY), McDonalds (MCD), and Abbott Labs (ABT). They either suffered the hangover of a great performance in 2012 or were the kind of staple business which this more frothy market wasn t interested in. We continue to over-weight what we call our staple consumer discretionary stocks, our financial service stocks and our Pharma/Biotech companies. We believe that interest rates will rise the next ten years. For this reason and others, we are avoiding capital intensive industries

2 and ones which carry high debt levels. This includes the energy, basic material, heavy industrial, utility and the telecom sector of the S&P 500 index. As you will see below, this is fitting with what we foresee for the next five years in a world economy dominated by the comeback in the US economy and strength in the US dollar. 2014: Once more for 84 Since our thinking is always dominated by owning businesses which meet our eight investment criteria in a long-duration time frame, we continue to remain vigilant of the circumstances around us. To that end, we thought it would be helpful to review a similar historical situation and glean a feel for what was wise behavior back then and what might be wise behavior as we look forward to the year The terrible US economy and high unemployment of was the closest thing to s economy in the last 50 years. Unemployment exceeded 10% and baby boomers were flooding the job market from high school and college. The price of money (interest rate) was so high that sensible people felt that there was no possibility of the economy being any good until those rates went down substantially. (Stocks traded at extremely depressed prices due to high discount rates and the way that inflation had ravaged investor sentiment and attitudes in the prior decade.) Gold, oil, real estate and fast growing, small-cap stocks were all the rage because of the belief that they were the best way to benefit from those circumstances. When the S&P bottomed at in August of 1982, there were few if any optimists. The Dow Jones Industrial Average had made no headway since 1966 s high around 1000 and stood below 800. The first leg up in the bull market which started on August 10th of 1982 took the S&P 500 to 173 and the Dow to 1200, peaking in June of Long-term interest rates bottomed around 11% and started a move to 14% in Bullishness was rampant and sentiment readings were some of the most optimistic that I ve seen in my 33 years in the industry. Small-cap US equities had been hot even before the bull market took off because of their perceived higher growth rates and their seeming ability to outperform inflation. The market got nutty in the spring of 1983 and the lowest quality securities and riskiest investments were at the top of everyone s list. Below is the chart of the Russell 2000 Index as compare to the S&P 500 Index from the end of 1978 to the end of June of 1983: 4 TH QUARTER 2

3 What were the biggest risks in the stock market by the mid-point of 1983? At the time, it appeared that the biggest risk was that the crowds agreement on the inflationary premises would get blown out of the water (it did). The second big risk seemed to be that all the air would come out of the small-cap enthusiasm and concept/risky stocks. See the chart below of the S&P 500 versus the Russell 2000: Where are we today? In the eyes of Smead Capital Management, we are in a similar situation. The real economic recovery started two years ago as housing and auto production began to ramp up to meet the needs of the 86 million echo-boomers. Interest rates appear to be rising like they did from June of 1983 to June of With the US population of 315 million people, echo-boomers are now a bigger economic factor than the baby-boom generation. The best performing domestic equity asset class in the last five to 15 years has been small-cap stocks, which were first boosted by owning most of the small energy companies in the US at the market lows of In the last five years small-cap equities have been boosted by institutional investors piling into them because of how well they had done in the prior years and the beauty of hindsight via rearview mirrors. Small-cap domesticity has also been a source of outperformance. Here is the chart of the Russell 2000 versus the S&P 500 since the low of the bear market: From the chart above, you can see that the US stock market corrected for 18 months. You can also see that small caps, as represented by the Russell 2000, suffered a bear market decline of greater than 20%. Worse than the bigger decline in the correction, small-caps lagged large-caps for the following three years, rubbing salt in the wound. The long-term picture only added to investor grief as the S&P 500 Index was on its way to at its peak in 1990 and 1469 by the end of The long-duration common stock investor would have been hood-winked by any urge to defend capital against the correction in large-cap stocks in June of 1983 to June of You can see that small caps have been a big winner and the outperformance spread is currently the highest during the entire time period. Today the Russell 2000 trades for 21.9 times First Call s 2014 earnings estimates and the S&P 500 trades at TH QUARTER 3

4 times 2014 s estimate. We suppose the board members of public companies, especially concept stocks, are so arrogant that they never split their stock prices to make them more affordable to individual investors. The Nobel Prize committee rained accolades on Eugene Fama for highlighting the long-term benefits of small-cap index investing. Money management firms emphasizing US small-cap stocks are being drowned in money. Price-to earnings ratios on today s popular glamour new era stocks are in the range of time earnings and some of that is reflected in the S&P 500 Index through companies like Amazon, Zillow and Netflix. It seems to us that one of the big differences between now and mid-1983 is that much of the mania associated with young, fast-growing concept companies resided in the smallcap Russell index, rather in large-cap companies. Today, the enthusiasm for futuristic and exciting concepts is a largecap phenomena right from the get-go! Facebook, LinkedIn, Twitter and other recent Initial Public Offerings have skipped over being part of the small-cap outperformance by having huge capitalizations on day one. They are joined by nearly uninterrupted new era excitement surrounding stocks like Zillow, Amazon, Netflix and the like. We believe that the huge spread from 1979 to June of 1983 in the small-cap versus large-cap indexes was magnified by it containing almost all of the nutty enthusiasm. Therefore, what was the right thing to do in and what is the right thing to do now? We believe the following makes for good sense. First, it was smart to avoid frothy common stocks, regardless of market cap. Second, form a positive vision of the next seven to ten years in the US economy. Great demographics, affordable housing, low interest rates, strong banks, a cleansed economy, terrific household income statements and the humility handed out in the financial meltdown are what we believe are exceptional ingredients for the future. Lastly, ignore the urge to time the market. Trading a 10-20% downside in the near-term for 100% upside potential over the next seven to ten years is a solid risk/reward relationship, in our opinion. Getting involved with the companies you want to own for the next ten years seemed to pay off back in late 1983 through mid-1984, why not now? William Smead Portfolio Manager Tony Scherrer, CFA Co-Portfolio Manager 4 TH QUARTER 4

5 The information contained herein represents the opinion of Smead Capital Management and is not intended to be a forecast of future events, a guarantee of future results, nor investment advice. The Smead Value Fund s investment objectives, risks, charges and expenses must be considered carefully before investing. The statutory and summary prospectuses contain this and other important information about the investment company, and it may be obtained by calling , or visiting Read it carefully before investing. Mutual fund investing involves risk. Principal loss is possible. As of 9/30/2013 the fund held 5.33% of Walgreen, 3.3% of Mylan, 3.1% Starbucks, 4.0% of Nordstrom, 1.5% of Abbott, 3.2% of H&R Block. Fund holdings are subject to change at any time and should not be considered recommendations to buy or sell any security. Current and future portfolio holdings are subject to risk. The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The Dow Jones Industrial Average is an unmanaged comprised of major industrial companies and assumes reinvestment of dividends. It is not possible to invest directly in an index. Diversification does not assure a profit nor protect against loss in a declining market. Standard Deviation is a statistical measure of the historical volatility of a mutual fund or portfolio, usually computed using 36 monthly returns. The Smead Value Fund is distributed by Quasar Distributors, LLC. SMEAD CAPITAL MANAGEMENT 600 University Street, Suite 2412 Seattle, WA Shareholder Services Sales Desk info@smeadcap.com