Rainier Investment Management

The financial services sector is unique. Unlike other sectors, it is essentially the lifeblood of the economy. When it’s healthy, it provides businesses and consumers with access to the credit, capital and investments that are vital to a healthy and growing U.S. economy. But when it’s sick, as we saw during the financial crisis in 2008, it can weaken the whole system. Severely damaged in 2008, the U.S. financial system - in particular banks - have been healing. Now is a good time to seek out investment opportunities in financial stocks.

The demand for higher yielding fixed income investments has never been greater. In the current environment of low yields, from the virtually non-existent rate offered on savings accounts and CDs to the declining, and in some cases negative, yields on global government debt securities, investors are searching for attractive income¬ generating alternatives.

While Europe abounds in world-class companies, macro concerns in 2014 obscured compelling opportunities for price appreciation and earnings power that we believe will surprise to the upside in 2015. Investors have woken up to the opportunity in the first two months of 2015 and many European exchanges are off to a fast start. We think more gains are ahead, particularly in small- to mid-size companies in Europe.

With cloud computing, mobile Internet, the “Internet of Things” and next-generation security, recent trends in technology are driving innovation and are creating attractive opportunities for investors.

Given recent strong performance and yields hovering at historic lows, a current topic of debate has been whether the high yield bond market has become an asset bubble and how much of a risk is the potential end to the Federal Reserve?s accommodative monetary policy to high yield investors. While we at Rainier acknowledge there are current risks in the fixed income market, we believe these concerns are not unique to high yield bonds.

After steadily rising in terms of market capitalization in the 1980s, the consumer staples sector shrank in the 90s as technology shares swelled in market value. Over the most recent decade, staples representation has crawled back to about 10% in the large growth and value indices, while inclusion in small-cap indices ranges between a mere 3-6%. The theme of consolidation within industries continues today and the sector is increasingly dominated by a small number of mega-cap corporations often seeking to acquire small- and mid-cap companies.

Our focus is on identifying companies that we believe are likely to grow earnings faster than their competitors, yet are priced at reasonable valuations. Health care is an interesting sector in that there is a fair amount of differentiation within the sector, so it is rare that companies within the sector move entirely in tandem with one another. Successful investments can typically be found within the sector even during times that the group is out of favor. Today we are much more attuned to the economic sensitivity of the group and the effects of reform on the broader landscape.

There has been a trend in the last decade for companies to increase in size through M&As, with a focus on removing competition, growing larger, and cutting costs to achieve economies of scale. In businesses that are commodity-oriented, scale is vital to success. This consolidation is occurring in part because it is becoming increasingly difficult to add economic value in this sector of the market. An agricultural revolution is underway, which is advantageous to many companies in the agricultural chain. Demand in the emerging world in particular is providing opportunities to grow revenues.

A major change that has occurred in technology in recent years is the way that software is delivered, specifically to the enterprise customer base. It used to be that large companies such as Oracle and SAP sold their database and application software on a ?perpetual license,? where there was a large sale that recognized revenue up front. The industry has recently moved to a ?software as a service? model (aka ?SaaS model?), where software is sold as a contract and revenue is recognized monthly. This has led to changes in the growth rates of many of the companies in this industry.

International growth is a consistent theme for companies in the consumer discretionary arena. ?Consumerism? is growing globally, and those companies that are able to grow in more than just one market have more growth opportunities. Another theme in this sector is the concept of reaching the consumer in more ways than the traditional method of just providing a physical store. Retail revolves around getting the product to the consumer right at the point they want to buy it, where and how they want to purchase it. Companies have invested heavily in building out their e-commerce capabilities.

There is a large opportunity set in the energy sector. There are 205 public US companies that have a market cap greater than $500 million. We seek to understand these companies from both a subjectively analytical point of view, as well as a quantitative angle. We have a proprietary database in which we track important characteristics of a broad range of companies. We also have another tool to track measures that are more specific to this sector. We utilize price to- cash flow ratios and net asset valuations as the principal tools for assessing the stock price targets.

The upheaval in the global financial system has made investing in financials quite challenging as of late, Rainier positioned itself well for the crisis. Because of our emphasis on financial strength and sustainability, we were able to avoid the major financial institutions that were most exposed to toxic assets and had taken on excessive credit risk. As the economy has moved into recovery mode, the financial sector hasn?t gotten any easier. Some of the biggest winners in the sector recently have been distressed institutions that aren?t projected to have positive earnings in the next year.

Growth and value labels tend to be fairly subjective, and over time opportunities for growth and value tend to migrate and shift as conditions change. The producer durables sector has not historically been viewed as a ?traditional growth? sector; however, there have typically been pockets of growth. Recently, this sector has begun to take on more consistent growth characteristics. We believe that the growth in producer durables could potentially be as good as other sectors of the market over the next few years. Much of this forecasted growth can be attributed to growth in the emerging world.