Madison Mid Cap Fund Investment Strategy Letter - Madison Funds
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September 30, 2018
I N V E S TME N TS ®
Madison Mid Cap Fund
Investment Strategy Letter
Review - 3rd Quarter 2018
For the third quarter of 2018, the Madison Mid Cap Fund (Class Y) returned 6.38%,
net of fees, versus a 5.00% return for the Russell Midcap® Index. For the nine months
ending September 30, 2018, the Fund (Class Y) returned 9.83%, net of fees, versus
7.46% for the Index.
Portfolio Review
Our top five contributors in the second quarter were O’Reilly Automotive, Arch
Rich Eisinger
Capital, TJX Companies, Henry Schein and Fastenal. Portfolio Manager
Industry since 1994
Sales growth for O’Reilly Automotive has continued to improve since it slowed down
to the 1% level in 2017. In the latest quarter ended in June, O’Reilly reported just over
4% growth in same-store sales, which would put it almost in-line with its historical
average. The stock price has followed this improvement in sales.
Arch Capital shares rebounded as fears of accelerating price competition in the
insurance industry, especially in mortgage insurance, subsided. The jury is still out on
whether pricing will deteriorate materially, but we feel sufficiently confident that Arch
will manage through any such period. It remains our largest position.
The story with TJX Companies is somewhat similar to O’Reilly: sales continued to
rebound from a 2017 slowdown, with the 6% same-stores sales posted in the quarter Haruki Toyama
ending July 2018 the best performance in two years. Its core value proposition to Portfolio Manager
customers was never in question; the improvement stems from better merchandising Industry since 1994
and store execution.
While recovering sales growth has helped the stocks of O’Reilly and TJX, there is also
no doubt that retail stocks have benefited this year from favorable investor sentiment.
The babies were being thrown out with the bathwater in the Amazon hysteria last
year, spurred by various news articles and Amazon’s acquisition of Whole Foods, but
the market has become more discriminating this year. The stocks of the four retailers
we have owned since the beginning of 2018 have averaged a 33% return through the
end of September.1 We have been very careful to select retailers that we think are
generally “Amazon-proof,” and believe we are reaping the benefits of that decision.
We added a fifth retailer to our ranks, which we discuss below.
1. The four are CarMax, O’Reilly Automotive, Ross Stores, and TJX Companies
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.
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.
888.971.7135 madisonfunds.com | madisonadv.com
Only a handful of our stocks were down in the quarter, and none by any meaningful amount. The five largest detractors to the portfolio were Omnicom, Copart, Axalta Coating Systems, Laboratory Corporation of America, and Dollar Tree. Omnicom shares continue to tread water despite reasonable profit growth – the share price is down 7% for the year, while per-share profits are up 12%, or perhaps mid-single digits after adjusting for the lower federal tax rate. Revenue growth in the U.S. has been weak, while international revenues have been strong. With the stock trading for a P/E of 12x there seem to be a lot of bad outcomes priced in. Copart shares are finally taking a breather after a multi-year run. Volume growth in its core business has been so strong that any slack capacity that the company had in its infrastructure, including its salvage yards, is now gone. Thus, the company is beginning to spend some money to alleviate these pressures. At the same time, it’s also starting to gain further traction in Germany and is stepping up spending there as well. Copart has opened two yards in Germany over the past year, but anticipates it will open several more in the coming months. All this spending is crimping margins, but the returns on the spending should be good and the outlook remains outstanding. Buys and Sells The fund was relatively active in the third quarter. We made three new investments in the quarter and exited three. Our three new investments were a full position in Dollar Tree, and smaller positions in Mohawk Industries and Alliance Data Systems. Our three exits were RPM International, DaVita, and Zoetis. Just several months after we made an investment in RPM earlier this year, the company announced that an activist investor had taken a stake and would work together with management to improve operational performance and enhance shareholder value. The share price spiked on the news and we thought a lot of the potential upside became priced in, so we sold our position. We’ve been selling down our DaVita holding for some time now as its shares have rebounded over the past year, and we decided to sell the remaining stake this past quarter. A growing number of regulatory and legal risks have developed and intensified, and despite our belief that the core business is worth more than its current enterprise value, the “tail” risk of a negative regulatory or legal event became too great to ignore. Zoetis’s profits grew nicely during our holding period but its multiple grew even more. We hate to sell wonderful companies, but with its P/E multiple approaching 30x we decided to take our gains. We welcome back our old friend Mohawk Industries to our portfolio after an absence of some years. The company is the largest manufacturer of flooring products in the world. Concerns over rising input costs, foreign exchange volatility and a slowing U.S. housing market have all conspired to bring its share price down by one-third since the start of the year to an attractive level. CEO and owner-operator Jeff Lorberbaum has engineered a series of acquisitions over the past two decades that give the company an unassailable lead in its global scale, breadth of product and broad distribution capabilities. We are delighted to be fellow shareholders with him once again. We also welcome a new friend, Alliance Data Systems, one of the largest 888.971.7135 madisonfunds.com | madisonadv.com
managers of private label credit cards for retailers in the country. Private label cards are a wonderful tool to drive customer loyalty and spending for retailers. Mature retailers have long known this to be true, but more recently, high growth retailers and e-tailers such as Ulta Beauty and Wayfair are finding out for themselves by signing with Alliance Data for card management and marketing expertise. The key to future growth for Alliance is to sign up enough of these newer customers to offset the decline in its mature customer base, and we think its success in this regard over the past few years will continue. We were able to purchase shares at less than 10x earnings. Money does grow on trees Dollar Tree, Inc. is the operator of the Dollar Tree chain of stores, which is the only one of the so-called national “dollar” store chains that still sells everything for one dollar. Due to the difficulty in maintaining a profitable business at that price point, most other dollar stores have either gone out of business, been acquired, or have long since abandoned the single price point. Meanwhile, Dollar Tree’s superb management created an enviable record of strong sales and earnings growth sticking to the single price point, with returns on capital above 20% for many years. While the Dollar Tree chain continues to perform well, the company’s shares are down approximately 30% from its highs because of weakness in the Family Dollar chain which Dollar Tree acquired in 2015 for around $9 billion and which presently accounts for about a quarter of its profits. We think the market is overly focused on this smaller piece of the pie, and at the current market valuation we are paying a conservative valuation for the Dollar Tree chain and getting the Family Dollar piece for free. We like free. Our investment should do well under multiple scenarios. Dollar Tree could turn around Family Dollar. This would be a big success for us. Dollar Tree could continue to struggle with Family Dollar and seek to divest it sometime in the next few years, either voluntarily or involuntarily, with an active push from shareholders. This would probably result in a successful outcome for us as well. And finally, Dollar Tree could continue to struggle with Family Dollar but decide to keep it. We don’t think this last scenario is likely, but even in this case, we are paying such a low valuation that our investment could work out reasonably well. As always, thank you for your investment with us. Respectfully, Rich Eisinger Haruki Toyama The Russell Midcap® Index is a mid-cap market index which measures the performance of the mid-cap segment of the U.S. equity universe. 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 Asset Management, LLC does not provide investment advice directly to shareholders of the Madison Funds. Opinions stated are informational only and should not be taken as investment recommendation or advice of any kind whatsoever (whether impartial or otherwise). Madison Funds are distributed by MFD Distributor, LLC. ©Madison Asset Management, LLC. October 3, 2018. 888.971.7135 madisonfunds.com | madisonadv.com
Time Period: 10/1/2008 to 9/30/2018 Time Period: 10/1/2008 to 9/30/2018
Madison Investors Y 27,674 Madison Large Cap Value A
September 30, $2018
30,000 $ 25,000
Time Period: 10/1/2008 to 9/30/2018 Time Period: 10/1/2008 to 9/30/2018
$ 25,000
$ 30,000 $$ 20,000
30,000
$ 20,000
$ 25,000 $$ 15,000
25,000
Madison Mid Cap Fund $ 15,000
$ 20,000 $ 20,000
$ 10,000 $ 10,000 FUNDS®
$ 15,000 $ 15,000
$ 5,000 $ 5,000
$ 10,000 2010 2012 2014 2016 2018 $ 10,000 2010 2012
$ 5,000 $ 5,000
Madison Investors Y 2010 2012 2014 2016 2018
27,674 Madison Large Cap Value A 2010 2012
The Value10/1/2008
Time Period: of Long-Term
to 9/30/2018 Investing Experienced Management
Time Period: 10/1/2008 to 9/30/2018
Madison Mid Cap Y 29,098 Madison Small Cap Y
$ 30,000 $ 30,000
Growth of $10,0001
Class Y Shares, Trailing 10-yrs
Time Period: 10/31/2009 to 9/30/2018
$ 25,000 $ 25,000
$ 20,000
$ 20,000 $ 20,000
$ 18,000
$ 15,000
$ 16,000 $ 15,000
$ 10,000
$ 14,000 $ 10,000
$ 12,000
$ 5,000 $ 5,000
2010 2012 2014 2016 2018 Rich Eisinger 2010Haruki Toyama 2012
$ 10,000 Portfolio Manager Portfolio Manager
$ 8,000 Industry since 1994 Industry since 1994
Madison Mid Cap Y 29,098 Madison Small Cap Y
Average Annual 2010 Total Returns2 (%)
Time Period: 10/31/2009 to 9/30/2018
2012 2014 2016 2018
$ 20,000
Madison Covered Call & Equity Income Y Three Since
18,546
Source: Morningstar Direct
$ 18,000 Months YTD 1 Yr 3 Yr 5 Yr 10 yr Inception Fund Features
Class Y $ 16,000 6.38 9.83 15.50 14.28 11.44 11.27 10.27 • Fund seeks long-term capital appreciation
Class R6$ 14,000 6.45 9.94 15.74 14.56 11.79 - 12.81 • High conviction; 25-40 holdings
Class A $ 12,000
without sales charge 6.26 9.41 15.06 13.82 11.06 - 11.73
• Holdings have elements of growth and
$ 10,000with sales charge 0.19 3.09 8.44 11.61 9.74 - 10.53 value companies
Class B $ 8,000
without sales charge 6.14 8.87 14.24 13.00 10.25 - 10.90 • Focus on risk management
2010 2012 2014 2016 2018
with sales charge 1.64 4.37 9.74 12.07 9.98 - 10.78
Russell Midcap® Index
Madison Covered Call & Equity Income Y 5.00 7.46 13.98 14.52 11.65 12.31 18,546 - Inception
Class Ticker Exp. Ratio3
Source: Morningstar Direct Date
A MERAX 9/23/13 1.40%
Calendar Year Returns2 (%) B MERBX 4/19/13 2.15%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Y GTSGX 7/21/83 0.98%
Class Y -36.61 24.51 21.15 5.10 15.69 28.96 9.42 0.87 12.06 15.63 R6 MMCRX 2/29/12 0.77%
Russell Midcap®
-41.43 40.48 25.48 -1.55 17.28 34.76 13.22 -2.44 13.80 18.52
Index Distribution Frequency
Annual
Risk Metrics (%) 3 Yr 5 Yr 10 yr Characteristics
Class Y Upside Capture 93.91 98.38 87.72 Total Number of holdings 30 Total Net Assets
Downside Capture 84.43 98.58 85.16 Active Share 95.5%
$447.0 Million
Beta 0.89 0.93 0.85 % Assets in Top 10 stocks 43.0%
Portfolio Turnover 22%
Wtd. Average Maket Cap $19.2 B
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 (if applicable) 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. Class B
shares may not be purchased or acquired, except for exchange from Class B shares of another Madison fund, please see
the most recent prospectus for details.
3 Expense ratios are based on the fund’s most recent prospectus.
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.Sector Allocation (%)
30.00
Shareholder Services 26.3 Mid Cap Fund
25.00
Madison Funds 22.5
Russell Midcap® Index
P.O. Box 219083 20.00 18.5
Kansas City, MO 64121-9083 15.00
15.0
14.2
13.1
800.877.6089
12.6
10.0
10.00 8.8 8.3
7.2 6.7 6.6 6.2
5.2 5.2
5.00 4.0
2.6 2.5 2.6
Consultant and --
0.9 1.2
0.0 0.0
Advisor Services Communication Consumer
Services Discretionary
Consumer
Staples
Energy Financials Health
Care
Industrials IT Materials Real Estate Utilities Cash
550 Science Drive
Madison, WI 53711 Sector allocation is rounded to the nearest 0.1%.
888.971.7135
Complete Stock Holdings (%)
ARCH CAPITAL GROUP LTD 5.2 AXALTA COATING SYSTEMS LTD 3.0
CDW CORP/DE 4.9 FASTENAL CO 2.7
MARKEL CORP 4.7 CROWN CASTLE INTL CORP 2.6
LIBERTY BROADBAND C 4.7 OMNICOM GROUP 2.6
DOLLAR TREE INC 4.0 WR BERKLEY CORP 2.5
O REILLY AUTOMOTIVE INC 4.0 GLACIER BANCORP INC 2.2
BROWN + BROWN INC 3.9 ROSS STORES INC 2.2
CARMAX INC 3.9 LIBERTY GLOBAL PLC C 2.2
EXPEDITORS INTL WASH INC 3.9 CROWN HOLDINGS INC 2.1
BROOKFIELD ASSET MANAGE CL A 3.8 ALLIANCE DATA SYSTEMS CORP 2.0
HENRY SCHEIN INC 3.8 AMPHENOL CORP CL A 1.9
IHS MARKIT LTD 3.5 MOHAWK INDUSTRIES INC 1.8
TJX COMPANIES INC 3.5 NEWMARKET CORP 1.6
LABORATORY CRP OF AMER HLDGS 3.4 OCEANEERING INTL INC 1.2
COPART INC 3.0 BROWN FORMAN CORP CLASS B 0.9
F U ND S ®
Madison Asset Management, LLC does not provide investment advice directly to shareholders of the Madison Funds. Materials on this document are informational only
and should not be taken as investment recommendation or advice of any kind whatsoever (whether impartial or otherwise).
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. 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 10/31/2017. Avg. Market Cap: the size of the companies in which the fund invests. Market capitalization is calculated by number of a company’s shares outstand-
ing times its price per share. Beta: a measure of the fund’s sensitivity to market movements. A portfolio with a beta greater than 1 is more volatile than the market, and a
portfolio with a beta less than 1 is less volatile than the market.
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, mid cap risk, growth and value investing
risk, ETF 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.
Investing in small, mid-size or emerging growth companies involves greater risks not associated with investing in more established companies, such as business risk,
significant stock price fluctuations and illiquity.
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
MSM140572
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