This shareholder letter is part of the Bretton Fund 2017 Annual Report (pdf).

February 20, 2018

Dear Fellow Shareholders:

The Bretton Fund’s net asset value per share (NAV) as of December 31, 2017, was $30.87 and the total return for the year was 18.19%.

Returns as of December 31, 2017 (A)

4th Quarter1 YearAnnualized
3 Years
5 Years
Annualized Since
Inception (A)
Bretton Fund11.44%18.19%6.91%11.16%11.82%
S&P 500 Index (B)6.64%21.83%11.41%15.79%14.86%

Calendar Year Total Returns (A)

YearBretton FundS&P 500 Index
9/30/10 – 12/31/106.13%10.76%
Cumulative Since Inception124.83%173.07%

(A) All returns include change in share prices and, in each case, include reinvestment of any dividends and capital gain distributions. The inception date of the Bretton Fund was September 30, 2010.

(B) The S&P 500® Index is a stock market index based on the market capitalizations of 500 leading companies publicly traded in the US stock market, as determined by Standard & Poor’s, and captures approximately 80% coverage of available market capitalization.

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 may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901.

All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. The fund’s expense ratio is 1.50%.The fund’s principal underwriter is Rafferty Capital Markets, LLC.

4th Quarter

The fund returned 11.44% in the fourth quarter, versus 6.64% for the S&P 500. The retail sector, which had been hit hard by negative investor sentiment in the first half of the year, continued its rebound in the fourth quarter. Ross Stores added 1.2% to the fund, and Carter’s and AutoZone each added 0.9%. Bank of America continues to benefit from higher rates and contributed 1.0% to the fund. Union Pacific also added 1.0%.

In a rare occurrence, there were no detractors from the fund’s performance; all our stocks went up. If only every quarter were like this….

As longtime shareholders know, we’ve always admired Ross’s direct competitor TJX Companies (TJX), parent company of the T.J. Maxx and Marshalls stores, and the slump in retail shares allowed us to add TJX to the fund at a great price. In addition to T.J. Maxx and Marshalls, TJX runs a couple of furniture concepts (HomeGoods and HomeSense), an outdoor goods retailer (Sierra Trading Post), and stores in Australia and the UK (TK Maxx), all of which run the “treasure hunt” model of deeply discounted, name-brand goods that TJX was able to grab on the cheap. This model has grown steadily in popularity over decades, and we think that trend will continue for a very long time.

Contributors to Performance for 2017

For the year, the biggest contributor to performance was the fund’s largest holding, Alphabet (i.e., Google), which accounted for 2.5% of performance. Other significant contributors were Bank of America 2.0%, Mastercard 2.0%, Union Pacific 1.9%, Carter’s 1.7%, and American Express 1.7%.

MEDNAX was again one of the fund’s largest detractors, hurting the fund by 0.9%. And despite rebounds in their stock prices toward the end of the year, both Discovery Communications and AutoZone had negative impacts on the fund for the year, dragging down performance by 0.6% and 0.3%, respectively.

Tax Distributions

Despite the large returns this year, we managed to avoid making any tax distributions, thanks to the fund’s low holdings turnover. Generally speaking, the faster a fund changes its holdings, the more tax is generated for shareholders.


Security% of Net Assets
Alphabet, Inc.8.5%
Union Pacific Corp.6.7%
Bank of America Corp.6.6%
Wells Fargo & Company5.7%
Ross Stores, Inc.5.7%
American Express Co.5.4%
JPMorgan Chase & Co.5.4%
Mastercard, Inc.5.4%
Carter’s, Inc.5.4%
AutoZone, Inc.5.2%
Berkshire Hathaway, Inc.4.5%
Visa, Inc.4.3%
Continental Building Products, Inc.4.0%
PPG Industries, Inc.3.8%
HD Supply Holdings, Inc.3.8%
Canadian Pacific Railway Limited3.6%
TJX Companies Inc.3.0%
Discovery Communications, Inc.2.4%
Armanino Foods of Distinction, Inc.2.0%
MEDNAX, Inc.1.7%
Verisk Analytics, Inc.1.3%

* Cash represents cash equivalents less liabilities in excess of other assets.

Portfolio Discussion

Tax Cuts
Generally speaking, we are focused on microeconomics: we own a small portfolio of companies that we would like to think we know well and make investments that we think will do well over various macroeconomic climates. We try to avoid investment theses that rely too much on government action; hard experience has taught us that while the government may eventually do the right thing, it will only be after exhausting all other alternatives.

That said, the Internal Revenue Service is our partner in each of our investments, with a priority claim on all cash flows. Most of our investments have relatively conservative balance sheets, and all are profitable in the US. Historically, this meant that our investments paid more in taxes than they might have given different geographic and financing arrangements. The corporate tax cuts that were passed in December should disproportionately benefit our companies.

The corporate tax rate dropping from 35% to 21% mathematically results in an immediate 22% increase in after-tax income for our companies’ US operations. But how much they eventually benefit over time remains to be seen and will depend in part on each company’s competitive advantage. In highly competitive industries with undifferentiated products, a reduction in everyone’s costs—taxes being a universal cost—typically gets passed through to customers. E.g., if every grocery store in your city saw wholesale milk prices fall by half, they’d be forced to drop their retail prices by a similar amount. But if, say, Visa and Mastercard saw a drop in their computing or rent costs, that probably wouldn’t lead to a reduction in how much they charge retailers and banks for clearing payments. Given most businesses in the fund have strong competitive advantages, we expect our companies to capture most of the gains.

The change in tax law caused a lot of non-cash, accounting charges for companies’ earnings in the fourth quarter, so for comparability purposes, we are adjusting our companies’ earnings growth for those charges.

Union Pacific, now our second largest holding, returned 32.3%, which is on top of a 34.0% return in 2016. Traffic ticked up, pricing firmed, costs were managed, and in general investors were more sanguine about the economy’s—and rail’s—prospects. Earnings per share increased 14%.

Berkshire Hathaway’s property insurance division suffered significant losses from the string of natural disasters in the back half of the year (Hurricanes Harvey, Irma, and Maria; California’s multiple wildfires). The year will likely end up as the largest loss year for insurers in history. But this won’t happen every year, and Berkshire, like much of the industry, was more than properly reserved for these incidents. A diversified conglomerate, Berkshire’s industrial and retail businesses, as well as its investments, performed well. Overall, we estimate Berkshire’s earnings per share declined 12% last year; the stock’s total return was 21.9%.

Wallboard maker Continental Building Products saw a nice uptick in demand due to rising home construction, and we estimate earnings per share increased 5% last year. The US significantly overbuilt houses in the mid-2000s, and in the subsequent recession, new home construction hit a low in 2009 that was a fraction of the level just a few years prior. Home construction has been climbing back ever since. Despite being almost 10 years into a recovery, the number of new homes being built each year is still well under the long-term average, despite an increasing population. Households are being formed, and people need places to live. The growth of home construction is likely to persist for many more years. We think Continental will thrive as this trend continues. The stock returned 21.9% last year.

Despite a weak environment for paint and coatings, PPG increased its earnings per share by 4%, and its stock returned 25.2%. It initiated a bid for Dutch paint company AkzoNobel, which would have been a sizable acquisition, but was rebuffed by management, partially on nationalistic grounds of keeping a Dutch company Dutch. We loved the deal at the original price, and we think PPG walked away at the right point. We remain confident PPG will use its cash wisely.

HD Supply continued its transformation. It sold off its water infrastructure division, which didn’t complement the core business, used the proceeds to pay down excess debt, refinanced some remaining debt at a lower rate, and most important, ironed out the operational hiccups that hurt results last year. Management estimates its operating earnings before depreciation and amortization increased 6%, yet the stock performed poorly, declining 5.8%, which we mostly attribute to the stock getting ahead of itself at the end of 2016 when it surged 43% on inflated investor optimism about the potential for federal infrastructure spending. We think the business will continue to grow at a healthy rate while returning significant capital to shareholders.

Rail volume in Canada rebounded in 2017 after an off year, and Canadian Pacific’s earnings per share increased 11% on stronger volume and pricing. Our total return since our August 2017 purchase is 20.5%.

The retail sector went for a bit of a roller-coaster ride in 2017. Mainline department stores Macy’s, JCPenney, Sears, et al., have major, structural challenges that could well be fatal. Durable goods, such as TVs and dishwashers, lend themselves well to e-commerce, to the point that Best Buy has been forced to reinvent itself as an art gallery, charging consumer electronics manufacturers for display rights and not moving anything to the cash register. Apparel has seen some of this showrooming effect, plus the logical conclusion of decades of variable pricing: as customers have gotten used to seeing clothes at wildly different prices between Thanksgiving and the Super Bowl, they have come to value them only at the lowest price. We think there are reasons why our retail holdings are comparatively well positioned for the changing environment, and when investor sentiment turned sharply negative in the middle of the year, we were able to add to our positions at Ross, Carter’s, and AutoZone, and initiate a position in TJX.

Ross Stores’ stock price started the year at $65, dipped to a low of $53, and ended the year at $80. To put that in perspective, that’s a swing of $10.5 billion of value—in an otherwise calm market—for a steady, thriving business. Ross operates the lowest cost business model in apparel retail—it is what Amazon would look like if customers picked up their clothing at the distribution centers—and we believe they are well positioned for a more price-competitive future. We had not bought shares of Ross since 2014, but the sharp (we say irrational) swoon in the share price gave us an opportunity to bulk up the position, buying some at $55, just above the year’s low and just before the sharp run-up through the end of the year. From start to finish, Ross’s total return for the year was 23.5%, and we estimate earnings per share increased 17%.

Carter’s continues to perform. The children’s apparel maker acquired Skip Hop, a niche- yet-popular baby-products brand, and increased its distribution with Amazon, leading to an estimated 10% earnings-per-share growth. Despite some clear differences from the adult apparel market, investor concern has focused on Carter’s exposure to mall foot traffic. This is a serious concern, but we felt that it was significantly overstated in the spring downturn. Carter’s total return was 38.3%

As we discussed in the semiannual report, AutoZone’s stock price has been under pressure from weak sales due to the lack of inclement weather last winter (cars fail more often in harsher weather), but more so from the perception that the auto-parts retail business will move to Amazon. Some of it already has—and more of it will—but we think the bulk of the business will remain with the incumbents. Mechanics need parts delivered on a same-day basis, and the large majority of AutoZone’s retail customers ask for help in finding the right part, with employees often installing parts for customers. Despite investors’ concerns, there hasn’t been a material impact to date from online competition, and after falling almost 40%, the stock rebounded to end the year down only 9.9%. Earnings per share increased 6%.

Operationally, Discovery Communications had a good 2017, on track to grow free cash flow by double digits and making a significant, accretive acquisition (Scripps Network Interactive, operator of HGTV, Food Network, and other channels). But in the battle for the hearts and minds of investors, Discovery continued to lose ground, its share price declining by 18.4% as the market remains spooked about Discovery’s prospects in a world where viewers choose programs (e.g., via Netflix) rather than have the programs served to them according to a master schedule (“linear programming”). The concern is that Discovery’s massive content library of human interest and reality shows may be better suited to background viewing than appointment television. We think the traditional pay TV market in the US will continue to shrink, but we also believe Discovery’s overseas operations (where half its earnings come from) and other distribution agreements will maintain Discovery’s cash flows at attractive levels. With the valuation so low now (seven times free cash flow), we believe the odds are in our favor, but this is a rapidly shifting environment.

Armanino Foods of Distinction, our little Hayward, California–based maker of frozen pesto sauce, keeps on chugging away. Its stock returned 18.4% in 2017, and the company is on pace to increase its earnings per share 12%. First purchased in 2013, our overall total return is now close to 200%.

We expect TJX’s 2017 earnings per share to come in 11% higher than 2016’s levels. We acquired our shares at a price-to-earnings ratio of 16 times earnings, the company’s lowest level in almost five years, which we think is a bargain (especially in this market) for such a great business. Our return to date is 9.2%.

As interest rates rose and loans grew, the banking sector continued its rebound. Through strong cost-cutting and higher interest revenue, Bank of America increased its earnings per share 22% and its stock returned 35.7%. JPMorgan Chase also saw a surge in interest income, which led to earnings per share growth of 11% and a total return on the stock of 26.8%.

Historically, particularly leading into and through the financial crisis, Wells Fargo consistently outperformed its rivals by producing stronger deposit and loan growth, with better credit quality, while keeping costs lower, which earned it a long-running and well-deserved reputation as the best-run large bank. But in recent years, not only has earnings growth lagged, the company has also stumbled badly in treating its customers properly (ignoring the opening of fake accounts by aggressive bankers, overcharging its auto-loan and foreign-exchange customers) and complying with regulation (having its “living will” filing rejected by regulators). We’ve done okay on the investment so far with an annualized 14% return to date, but the missteps have been disappointing. We are cautiously optimistic that the new management team can improve operations and the low valuation will lead to outperformance. The stock returned 13.2% last year, and earnings per share were roughly flat from 2016.

American Express, after a couple rough years adjusting to the loss of its largest partner, Costco, increased its earnings per share 4% on growing card usage and a large share buyback. The economics of high-end co-branded credit cards are not what they once were, but the company prospects for growth are still strong. Despite a 36.2% return last year, the shares remain much cheaper than the rest of the market.

Information Technology
Alphabet, already one of the largest companies on the planet, seems to be defying the laws of physics by continuing to grow like a startup. Despite being over $100 billion, revenue is still growing at a rate of over 20% per year. And that’s not just the developing world catching up to mature markets; the US continues to grow at a rate of 20%. Despite this absurd growth rate, which looks to persist for a while, the company trades at only a small premium to the rest of the market. We think the likelihood of someone displacing Google in search anytime soon, or growth suddenly slowing down, are fairly remote, which is why it’s our top holding. The total return on the stock last year was 32.9%, and earnings per share grew an estimated 22%.

It was a great year for Visa and Mastercard, whose stocks returned 47.7%, and 47.2%, respectively. Mastercard increased its earnings per share an estimated 21%, while Visa increased 23% and is starting to see significant benefits from its Visa Europe acquisition. The world is moving to card payments, and the economics of their card ecosystems remains intact and durable.

MEDNAX’s struggles continued, with earnings per share declining an estimated 17% and the stock dropping 19.8%. The doctor-staffing company is facing some ephemeral issues—2017 was an off-year for births in the US, its nascent radiology business had growing pains—that will work themselves out soon enough, but it also faces structural challenges: it hasn’t been able to pass on its increasing physician costs to its customer base, comprised of consolidating commercial insurers and, increasingly, government health programs that pay lower rates. We sold half our shares in June. In November, an activist investor, Elliott Associates, took an ownership stake of 7% in MEDNAX and indicated it would urge management to review its “strategic options…to maximize shareholder value,” standard hedge fund euphemisms for seeking a sale of the company. We hold our remaining shares in the expectation this comes to fruition to our benefit.

Investments Initiated in 2017
Canadian Pacific Railway
TJX Companies

Investments Exited During 2017

InvestmentInternal Rate of Return
Whole Foods Market-13.4%

Despite an expensive market, we maintain our family office mindset of preserving wealth and compounding capital. As always, thank you for investing.

Stephen Dodson            Raphael de Balmann
Portfolio Manager         Portfolio Manager