Insight SMA

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Commentary Insight SMA | 1st Quarter 2019 The philosophy underpinning the Insight portfolio is that few investors should possess better insight into the future prospects of a company than its executives and Board members. Just as lower valuations generally tilt the odds of investing success in investors’ favor, so too does insider buying. That thesis has been validated by academic studies from researchers at Harvard, Yale, Stanford, and the University of Michigan, which independently found that corporate insiders have achieved superior risk-adjusted returns. A peer-reviewed article published in the November 2011 edition of the International Review of Economics and Finance further validated those findings, concluding that, “Insider actions have positive predictive power for future returns. Managers know more about their companies than any outsider, including Wall Street analysts and as such investors could benefit from observing the behavior of insiders. Results are statistically significant.” The majority of the Insight portfolio is invested in companies in which there has been recent insider buying activity; we also retain the flexibility to own companies in which insiders own a substantial (5%+) stake of the company, whereby their incentives already are well-aligned with ours as shareholders, but where it would be less likely to expect insiders to take a further stake via additional purchases. Such flexibility also enables the portfolio to invest in overseas companies that trade on U.S. exchanges, where insider buying is not reported in real-time. Performance Summary U.S. stocks turned in their best quarterly performance since 2009, even as portions of the yield curve inverted, a signal that’s often interpreted as a precursor of slowing economic growth. All 11 S&P sectors generated positive quarterly returns, led by a near-20% showing for Technology, while Healthcare was worst with a 6.6% gain. Smaller stocks outperformed their larger brethren, growth outperformed value, and the stocks of unprofitable companies outperformed those that generate profits.

Source: JPMorgan

For the quarter, the Insight portfolio generated a +13.3% total return (after fees), which compares to 13.7% for the S&P 500, 14.0% for the Russell 1000, and 14.5% for the S&P Midcap 400. The quarter’s robust gain took market valuations from below average (at the start of the year) to average (at quarter end).

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Commentary Insight SMA | 1st Quarter 2019

Source: FactSet, FRB, Robert Shiller, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management.

Double-digit quarterly returns are certainly well in excess of the market’s historical averages. But following previous steep market declines (such as the drop U.S. markets experienced in the fourth quarter of 2018) stocks have averaged well above-average returns over the subsequent next 12 months (“NTM Return” in the table below). Perhaps that helps illustrate why it pays to be contrarian, and why we’re enthusiastic to be an incremental buyer when stock prices are declining.

Source: Bloomberg, Haver Analytics, CRSP, Bernstein Analysis

During the fourth quarter’s decline, in addition to being a net buyer of stocks, we specifically sought to add to stocks that had suffered disproportionately during the downturn – the proverbial babies thrown out with the bath water. For example, in the fourth quarter of 2018 we purchased home improvement retailer Lowe’s, and railroad Kansas City Southern, both of which have outperformed the S&P 500 since purchase. Meanwhile, we trimmed stocks that had held up relatively well, such as healthcare stalwart Johnson & Johnson, which underperformed the S&P 500 in the first quarter. As scientist Charles Darwin said, “It’s not the strongest who survive, nor the most intelligent, but the one[s] most responsive to change” (emphasis added is ours). We intend to respond to market conditions, by changing the composition of the Insight portfolio, such that it reflects our view of the best risk-adjusted investment opportunities in companies where insiders are sending a confirming signal through their own purchases.

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Commentary Insight SMA | 1st Quarter 2019 Winners and Losers For the quarter, all but one stock in the portfolio appreciated in value, the lone exception being Berkshire Hathaway, which slid 2%. (In a quarter in which it was hard to find much to be disappointed about, other laggards included Medtronic, Aramark, and Schwab, which turned in quarterly gains of “just” 1%, 2%, and 3%, respectively). To be clear, that’s as much a statement about the market’s overall buoyancy for the quarter as much as anything else. Just as we don’t expect the stock market to produce double-digit percentage gains each quarter, it’s a near-certainty that future intervals will feature a more “normal” ratio of winners to losers. Since the portfolio contained only a single loser for the quarter, we’ll devote a little extra attention to it. Two skeptical articles in the same week about Berkshire caught our attention. In early March, Barron’s ran a piece entitled: “It’s Time to Stop Betting on Warren Buffett.” That article cited Berkshire’s underperformance vs. the S&P 500 since the stock market’s March 2009 low. (To its credit, the article acknowledged that Berkshire gained 28% from March 2000 – March 2009, while the S&P 500 lost nearly half its value over the same period. Indeed, protecting capital during challenging market environments is a priority, both for Mr. Buffett and for us). The same week that Barron’s cast its dubious eye on Berkshire, Marketwatch ran a story with the following headline:

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” Source: Marketwatch.com

Really? They recommend to no longer bet on the greatest investor in our lifetime? To no longer bet on a wellrun company with a long track record of outperformance, paced by diverse, wide-moat businesses such as GEICO, Burlington Northern, Precision Cast Parts, Coca-Cola and Apple? Forgive our cynicism, but really? Barron’s ran a similar article about Mr. Buffett “losing his magic touch” in 1999, which nearly precisely marked the peak in crazy dot.com valuations and the trough in Berkshire’s share price.

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Source: Barrons.com

In other words, that article couldn’t have been more wrong – there was nothing wrong with Warren in 1999, he had simply avoided astronomically valued internet stocks, which were on the verge of imploding. Since that article was published nearly 20 years ago, Berkshire has increased in value nearly five-fold while the S&P 500 has generated a total return of just 94%.

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Commentary Insight SMA | 1st Quarter 2019 That’s not the only time Mr. Buffett proved prescient near a market inflection point. Recall, in October 2008, he penned a Wall Street Journal editorial entitled: “Buy American, I Am.” The stock market bottomed less than six months thereafter. Meanwhile, in this past month’s shareholders letter, Mr. Buffett sounded a note of caution about current stock valuations that likely merits more attention than it’s received. We believe it likely pays to be as contrarian now as it has in the past, with respect to Berkshire’s stock. Its valuation is near the lower end of its historic range, and the company itself has been buying back shares aggressively. In early May, we will again attend Berkshire Hathaway’s annual meeting in Omaha, and will assess Mr. Buffett’s “magic touch” first-hand; in years past, we’ve been impressed by his command of both big-picture trends and individual business details. Top performers for the quarter were paced by bubble wrap maker Sealed Air (+33%) and aluminum can maker Crown Holdings (+31%). Both recovered nicely from sub-par 2018 performances. Our recent meetings with the management of both companies revealed robust pricing opportunities amid strong demand for their products. With respect to Crown (and Ball, which we also own in the portfolio), Citi Research said the fourth quarter of 2018 was “the first time in nine quarters that alcoholic beverage can volumes were positive.” That bolstered growth for Crown and Ball, which already were seeing strength from other beverage categories, such as energy drinks and sparkling water. Meanwhile, amid a surge in demand for infinitely recyclable materials aluminum cans are gaining share from plastic bottles, with aluminum cans comprising 26% of all new beverage launches last year, up eight percentage points vs. three years ago.

Source: Nielsen, Morgan Stanley Research

Among our other notable gainers was real estate management company FirstService (+31%) which continues to produce steady mid- to upper-single digit organic growth in both its homeowners association management services and branded service operations (for painting, restoration, and custom closets). The rising age of the average home should remain a tailwind for services such as those FirstService offers, and products sold by home improvement retailers like Lowe’s. Genpact (+31%) reported excellent results in its most-recent quarter, which showed both a nice acceleration in revenue growth (+15% on a constant currency basis) and a very strong pipeline of new business that should flow through the P&L in 2019 and beyond.

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Commentary Insight SMA | 1st Quarter 2019

Source: ISG (left chart), Genpact (right chart)

Merrill Lynch opines that Genpact’s revenue growth should accelerate the next several years, and that the industry “has relatively high growth resiliency in a tough macro environment, given its value proposition of cost optimization for corporates.” One commonality among each of the top four performers for the quarter is their relatively small size, reflecting the fact that stocks of smaller and mid-sized companies outperformed their large-cap counterparts in the first quarter. Purchases and Sales During the quarter, we sold three companies that delivered solid contributions to the portfolio during our ownership: business services provider Ecolab as well as life science tools and diagnostics leaders Danaher and Thermo Fisher. In all three cases, we applaud management for terrific execution. Our sales reflected each of those stocks having achieved our price objective; sizable insider selling led us to follow those insiders to the sidelines. New purchases also shared a common element: Insight returned two previously owned positions – orthopedics leader Zimmer Biomet and video game publisher Activision – to the portfolio, amid fresh insider buying at both companies. In each company’s case, we believe two visuals tell the story well.

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Commentary Insight SMA | 1st Quarter 2019 Activision is an industry leader in the steadily growing video game software industry, with a library of wellknown titles, such as World of Warcraft, Call of Duty, Overwatch, Hearthstone, and Diablo. More casual games acquired through Activision’s purchase of King Digital – such as Candy Crush, Farm Heroes, and Pet Rescue – provided Activision with a broader menu and a foray into free-to-play gaming, where content is monetized through in-game transactions rather than the purchase of the game itself. In 2018, the industry and Activision encountered heightened competition from relative newcomers, as Fortnite and Apex achieved 50 million users within mere months. While such competitors are legitimate, we give Activision credit for deftly navigating the competitive environment in years past, and providing financial guidance that it has exceeded fairly consistently.

We presume long-tenured Board member Peter Nolan wouldn’t have purchased $4.3 million of Activision shares in March (the largest insider buy at the company since at least 2003), if he didn’t believe the company was on track to meet or exceed its financial objectives. Importantly, in our view, Mr. Nolan’s track record of previous insider purchases is encouraging. According to InsiderScore, “Nolan has a long history at ATVI and has made some smart buys in the past, so it stands out to see his conviction now. Insider selling has ceased as shares have faltered, adding to the compelling, positive sentiment. Nolan was on the board from 2003-08 and was re-appointed in 2013, when Leonard Green Partners, a private equity fund that Nolan advises, purchased a stake in ATVI. Nolan was also a buyer during his earlier stint at much lower prices that have clearly panned out well. Overall, shares have increased an average of 6%, 22%, and 67% over the three, six and 12 months following his three prior buys.” Zimmer may be providing an even stronger insider signal, insofar as 11 company insiders, including CEO Bryan Hansen, purchased shares in February and March. We believe those purchases demonstrate conviction that the company’s turnaround (from manufacturing snafus in years past, under previous management) is pointed in the right direction. Zimmer also scored FDA approval of its Rosa robotics platform in March, which may add a full point to organic growth in 2020. Wells Fargo says Rosa enables Zimmer to be able to “offer brain, spine [and knee surgeries] on a single platform, unlike its peers.” The company also is integrating its Walter bionic arm “that can hold instruments during procedures, eliminating the need for one additional

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Commentary Insight SMA | 1st Quarter 2019 helper in the operating room. It can be used across specialties and gives Zimmer the ability to bundle.” Improved outcomes with lower costs ought to be a successful healthcare formula. In addition to those opportunities, a restoration of full manufacturing capability, a new cementless knee offering, and a partnership with Apple for tracking patients post-operatively also should help drive a reacceleration in Zimmer’s organic growth.

Source: Stifel Estimates, Company Filings

Meanwhile, in large part because of the company’s trials and tribulations under previous management and as investors await the reacceleration, Zimmer trades at a sharp discount to peer medical device companies. We believe that the low valuation coupled with low expectations (consensus forecasts model slightly negative organic growth rates and year-over-year EPS for the first half of 2019) offers a reasonable margin of safety and upside potential if the company’s execution continues to improve.

Source: FactSet

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Commentary Insight SMA | 1st Quarter 2019 Company Developments Perhaps the most noteworthy occurrence during the quarter for our companies was an announcement by Fidelity National that it is acquiring global merchant acquirer (credit/debit card processor) WorldPay for $35 billion in a cash and stock transaction expected to close later this year. WorldPay over-indexes to the fastgrowing e-commerce market, and the combined company is expected to hold a high-single digit organic growth profile (vs. FIS’ standalone mid-single organic growth rate). That may help the stock’s valuation re-rate higher, closer to faster-growing peers. Meanwhile, both companies have demonstrated excellent execution on previous acquisitions, suggesting that synergy targets may again be exceeded.

Source: Fidelity National

A number of our companies announced dividend increases during the quarter: Fidelity National (+9% yearover-year), UMB Financial +9%, General Dynamics +10%, Comcast +11%, FirstSerivce +11%, and Genpact +13%. For its part, Schwab increased its dividend for the second time in six months, with the year-over-year growth checking in at a heady +70%. After completing previous share repurchase programs, Schwab authorized a new $4 billion plan, while Google announced a new $12.5 billion repurchase program. Neither comes as a huge surprise, as both companies are significantly over-capitalized (Google’s $115+ billion net cash balance shown in chart below).

Source: Company Data, Jefferies

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Commentary Insight SMA | 1st Quarter 2019 During the quarter, we saw incremental insider buying at Abbott, Aramark, AT&T, Constellation Brands, Medtronic, Sealed Air and UMB Financial. Conclusion Perhaps one reason cynics think Warren Buffett has lost his “magic touch” is because investors have been focused on hyper-growth businesses. According to the Financial Times, more than 300 companies are ready to go public and want to raise as much as $50 billion. On the last day of the quarter, ride-sharing service Lyft launched its initial public offering (IPO) at a valuation of more than $25 billion. Two days later, its stock was trading below its IPO price. Other “unicorn” companies, such as Uber, Airbnb, Pinterest, and others are in the pipeline. There’s nothing necessarily wrong with hyper-growth businesses. In fact, creative destruction is one of capitalism’s greatest attributes. But many of these unicorns have pursued growth without regard for a sustainable business model, i.e. one that can generate sufficient free cash flow to support itself. Or, as a Marketwatch.com article opined, “Today’s IPO companies seem to be competing to see how much money they can lose.” Crunchbase recently described unicorn WeWork, which provides shared workspaces for office workers, as a company “that converts hard currency into negative net worth, losing money at a pace greater than 100% of its revenue.” Remember, IPOs reflect a form of insider selling, as the shares being offered to the public are typically being sold by company founders and initial backers, such as venture capital firms. By contrast, we will continue to populate the Insight portfolio with companies where insiders are increasing, rather than decreasing, their ownership. Thank you for your interest in our thoughts and entrusting us with the mission of growing your wealth. Adam Bergman, CFA® Portfolio Manager

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Commentary Insight SMA | 1st Quarter 2019 Performance is preliminary and is annualized for periods longer than one year. Net of fees performance returns are presented net of the investment management fees and trading expenses. Investment management fees are described in Sterling’s Form ADV 2A. Performance reflects the reinvestment of interest income and dividends and realized capital gains. The performance presented represents past performance and is no guarantee of future results. Performance is compared to an index, however, the volatility of an index varies greatly and investments cannot be made directly in an index. Market conditions vary from year to year and can result in a decline in market value due to material market or economic conditions. The Performance is considered Supplemental Information to the Composite Disclosure Presentation which is attached. The Chartered Financial Analyst® (CFA) charter is a graduate-level investment credential awarded by the CFA Institute — the largest global association of investment professionals. To earn the CFA charter, candidates must: 1) pass three sequential, six-hour examinations; 2) have at least four years of qualified professional investment experience; 3) join CFA Institute as members; and 4) commit to abide by, and annually reaffirm, their adherence to the CFA Institute Code of Ethics and Standards of Professional Conduct. Specific securities identified and described do not represent all of the securities purchased, sold or recommended to clients. There are no assurances that securities identified will be profitable investments. The securities described are neither a recommendation nor a solicitation. Security information is being obtained from resources the firm believes to be accurate, but no warrant is made as to the accuracy or completeness of the information. The opinions contained in the preceding commentary reflect those of Sterling Capital Management LLC, and not those of BB&T Corporation or its executives. The stated opinions are for general information only and are not meant to be predictions or an offer of individual or personalized investment advice. They also are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. Any type of investing involves risk and there are no guarantees. Sterling Capital Management LLC does not assume liability for any loss which may result from the reliance by any person upon any such information or opinions. Investment advisory services are available through Sterling Capital Management LLC, a separate subsidiary of BB&T Corporation. Sterling Capital Management LLC manages customized investment portfolios, provides asset allocation analysis and offers other investment-related services to affluent individuals and businesses. Securities and other investments held in investment management or investment advisory accounts at Sterling Capital Management LLC are not deposits or other obligations of BB&T Corporation, Branch Banking and Trust Company or any affiliate, are not guaranteed by Branch Banking and Trust Company or any other bank, are not insured by the FDIC or any other government agency, and are subject to investment risk, including possible loss of principal invested.

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Sterling Capital Management – Insight SMA Composite August 31, 2011 – December 31, 2017 Description: Consists of all discretionary separately managed wrap Insight portfolios. Sterling’s Insight equity portfolios invest primarily in companies where there has been recent insider buying activity; we also retain the flexibility to own companies in which insiders own a substantial stake.

Year 2017 2016 2015 2014 2013 2012 2011 (Inception 8/31/11) Annualized Since Inception

Total Return "Pure" Gross of Fees 25.37 10.39 5.14 7.41 28.48 17.74 4.86 15.41

Total Return Net of Fees 23.78 8.88 3.69 5.88 26.64 16.17 4.62 13.87

No. of Portfolios 57 146 116 134 121 74 2

Composite Assets End of Period ($MM) 18 33 29 29 27 14 0

Percent of Firm Assets 0.0 0.1 0.1 0.1 0.1 0.3 0.0

Total Firm Assets ($MM) 55,908 51,603 51,155 47,540 45,638 4,422 3,932

Composite Dispersion (%) 0.35 0.30 0.25 0.24 0.24 0.08

Russell 1000 21.69 12.05 0.92 13.24 33.11 16.42 3.50 15.56

Composite 3-yr St Dev (%) 9.18 9.92 9.35 9.42

Benchmark 3-yr St Dev (%) 9.97 10.69 10.48 9.12

Sterling Capital Management LLC claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Sterling Capital Management LLC has been independently verified for the periods 01/01/01 to 12/31/16. The verification report(s) is/are available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. Notes: 1. Sterling Capital Management LLC (SCM) is a registered investment advisor with the SEC. Registration does not imply a certain level of skill or training. Sterling manages a variety of equity, fixed income and balanced assets. Prior to January 2001, Sterling was a wholly owned subsidiary of United Asset Management (UAM). In January 2001, Sterling Capital Management LLC purchased all the assets and business of Sterling Capital Management Company from UAM to become an employee owned firm. There were no changes in personnel. In April 2005, BB&T Corporation purchased a majority equity ownership stake in Sterling Capital Management LLC. There were no changes in personnel. In October 2010, the management group of Sterling Capital entered into an agreement with BB&T Corporation that reduced and restructured management's interest in Sterling Capital Management. Additionally, BB&T Asset Management merged into Sterling Capital Management. There were no material changes in personnel. In January 2013, CHOICE Asset Management firm merged into Sterling Capital Management. There were no changes in personnel. “Percent of Firm Assets” and “Total Firm Assets” prior to 2013 are for CHOICE Asset Management. In August 2015, 8 new employees joined Sterling Capital management via Stratton Management Company following the close of BB&T’s purchase of Susquehanna Bancshares. There were no changes to personnel. 2. Adam B. Bergman, CFA, has managed the portfolio since inception. No alterations of composites, as presented herein, have occurred due to changes in personnel or other reasons at any time. 3. Inception date of composite: August 31, 2011. Creation date: August 31, 2011. The appropriate index is the Russell 1000 Index which measures the performance of the largest 1,000 US companies, representing over 90% of the investable US market. The index is reconstituted annually. Total return includes price appreciation/depreciation and income as a percent of the original investment. A complete list of all of SCM’s composites and their descriptions is available upon request. Policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request. 4. Performance reflects reinvested interest income and dividends and realized and unrealized capital gains and losses. All portfolios are valued monthly as of calendar month-end and utilize trade-date and accrued income accounting. Valuations and performance are reported in US dollars. Portfolio returns are calculated monthly using the Modified Dietz method. Portfolios are revalued for cash flows greater than 10%. Composite returns are calculated by weighting the individual portfolio returns using beginning of period market value plus weighted cash flows. Periodic time weighted returns are geometrically linked. Returns are not calculated net of non-reclaimable withholding taxes due to immaterial dollar amounts. 5. “Pure” gross of fees returns do not reflect the deduction of any fees including trading costs. The net of fee return reflects the actual SMA fee of the individual account. The SMA fee includes all charges for trading costs, portfolio management, custody and other administrative fees. 6. The annual composite dispersion presented is measured by an asset-weighted standard deviation calculation method of all portfolios in the composite for the entire year. It is not meaningful when there are less than six portfolios in the composite for the entire year. The three year annualized standard deviation measures the variability of the composite and benchmark returns over the preceding 36 month period. It is not required to be presented for annual periods prior to 2011 or when a full three years of composite performance is not yet available. 7. The performance presented represents past performance and is no guarantee of future results. Stock market conditions vary from year to year and can result in a decline in market value due to material market or economic conditions.