Q&A Masters’ Select Focused Opportunities Fund

To download the fund's prospectus click here.

On June 30, 2006, Litman/Gregory Fund Advisors, LLC launched Masters’ Select Focused Opportunities, the fifth Masters’ Select Fund. What follows is a question and answer session discussing various aspects and attributes of the fund.

What differentiates Masters’ Select Focused Opportunities?

Focused Opportunities differentiates itself from the other Masters’ Select funds by its greater concentration in the highest-conviction ideas of each sub-advisor. Specifically, the fund (initially) will be run by only three sub-advisors and each will run a portfolio of only five to seven stocks. This means that the overall fund will be far more concentrated than any other Masters’ Select fund. The key idea behind the fund though, is not its overall level of concentration, but rather each sub-advisor’s concentration in even fewer stocks than in the other Masters’ Select funds.

At the overall portfolio level, we expect the fund to be style-neutral with a primary emphasis on mid- and large-cap stocks. The managers may also invest in the securities of non-U.S. companies, which at times may make up a meaningful portion of the overall portfolio—though probably never over 50%.

What is the fund’s objective?

The objective of the fund as stated in the prospectus, is long-term growth of capital; that is, the increase in the value of your investment over the long term. Beyond this general objective, it is our belief that the higher level of concentration will result in higher returns over the long run than would otherwise be the case. This objective may or may not be achieved.

What is the fund’s primary benchmark?

The Standard & Poor’s 500 is the fund's primary benchmark. The S&P 500 Index is a capitalization-weighted index of the stocks of 500 leading U.S. companies.

Why is Litman/Gregory launching the fund?

We created this fund because we believe it has the potential to deliver strong long-run returns relative to large-cap stock benchmarks and peer groups. Our confidence stems from the Masters’ Select concept, which is based on the belief that a skilled stock picker’s best ideas are likely to deliver higher long-term returns than a more diversified portfolio run by the same stock picker. Focused Opportunities takes this idea to another level, with even more concentrated sub-portfolios than those found in the other Masters’ Select funds. We believe this higher level of concentration is likely to result in higher returns over the long run (than if the same stock pickers were running more-diversified portfolios—even ones as concentrated as the traditional 15-stock Masters’ Select portfolio). Importantly, the fund’s three sub-advisors have had success running concentrated portfolios and believe that more concentration is likely to result in higher long-run returns.

How does Masters’ Select Focused Opportunities fit into a broader fund portfolio?

The fund could serve as a core large-cap holding for long-term investors. However, its concentrated portfolio could make it more volatile than its benchmark and for this reason, some investors may want to use it as a complement to a core fund. As is true with all Masters’ Select funds, this fund is only appropriate for long-term investors with an investment time horizon of five years or longer.

Who Should Invest?

The fund may be appropriate for investors who:

• Expect to hold the fund for a minimum of five years
• Desire exposure to mostly mid- and large-cap stocks
• Understand that concentrated investing can result in higher volatility than more typically diversified funds and benchmarks
• Understand that the fund’s sector and industry exposure is likely to deviate significantly from that of its benchmark
• Understand that at times foreign stocks could account for a significant portion of the fund’s portfolio

Will the fund be considered diversified?

The Masters’ Select Focused Opportunities Fund is registered with the Securities and Exchange Commission as a “non-diversified” fund. In contrast, to be classified as “diversified” requires that no more than 25% of a fund’s portfolio be composed of individual holdings that represent 5% or more of the fund’s total assets. As mentioned above, we don’t specifically seek a high level of concentration for Focused Opportunities at the fund level. But it is our goal to allow each sub-advisor to own only those few stocks in which they have exceptionally high confidence—the true “fat-pitch” opportunities. With only three sub-advisors, the fund itself will be concentrated and therefore classified as non-diversified. It is possible that in future years we may add sub-advisors to the fund resulting in it meeting the criteria to be classified as a diversified fund. (See the question below that addresses this possibility.)

With fewer managers selecting fewer stocks, will the fund be more volatile than its benchmark and the other Masters’ Select funds?

It is hard to say for sure but it most definitely has the potential to be more volatile than its benchmark and a more diversified fund. Relative to the other Masters’ Select funds, it is likely that Focused Opportunities will be more volatile than Equity and Value by virtue of its greater concentration. (However, if the fund adds more sub-advisors in the future, that may not be the case.) Compared to Smaller Companies and International, it is harder to know if the fund will be more volatile. Those asset classes have tended to be more volatile than the large-cap domestic stock asset class. So, it is possible that the greater asset-class volatility inherent in Smaller Companies and International could match or exceed the potential volatility that Focused Opportunities may have, given its greater concentration.

In terms of bottom-line expectations, investors in Focused Opportunities should expect more volatility. This expectation may or may not play out in reality.

Who are the three sub-advisors?

three managers, along with the name of their firm, their investment style, and the percentage of the fund they will be managing, are listed in the following table:

All three are managers on other Masters’ Select Funds; Craig Blum/Steve Burlingame and Chris Davis/Ken Feinberg on Masters’ Select Equity and Michael Embler/Peter Langerman on Masters’ Select Value.

Why were these three managers selected?

There were three reasons for selecting these specific stock pickers. First, we have an exceptionally high level of confidence in these managers. Our confidence stems from the extensive contact (which has included initial and ongoing due diligence) we have had with them and their firms over the years. Our exposure to their investment process, execution discipline, thorough research, intelligence and team quality has resulted in our high confidence in their investment edge and the sustainability of that edge. This confidence has been reinforced by each sub-advisor’s success in running concentrated portfolios for Masters’ Select, and in the case of Blum and Burlingame, also for another private entity. Second, each manager was enthusiastic about being part of Focused Opportunities and confident in their ability to add incremental returns by holding fewer stocks. Lastly, over the years each of these sub-advisors has demonstrated that they greatly value their relationship with Masters’ Select and, as a result, show a strong commitment to executing their portfolio management duties in a highly thoughtful and diligent way.

What due-diligence process did Litman/Gregory Fund Advisors use to identify and select the managers?

We use the same due-diligence process in evaluating all potential sub-advisors (click here to read the detailed discussion of our process). In this case, because each manager already sub-advises a Masters’ Select fund, it was not necessary to complete new due diligence. However, we did have detailed discussions with each manager regarding the concept of a more concentrated portfolio and their belief in their ability to generate higher long-term returns by holding even fewer stocks (than they hold in their existing Masters’ Select portfolios and in other portfolios they run).

Will you add more managers to the fund or increase the number of holdings allowed per manager?

We will consider adding additional sub-advisors to the Fund in the future if we find stock pickers who we believe are highly skilled and can add incremental returns by running a highly concentrated portfolio. We would have to believe that any stock picker added to the fund would have skills that are at least on par with the current group of sub-advisors. If we find stock pickers we believe are up to the task, the overall fund portfolio will benefit by virtue of greater diversification without giving up the long-term return potential that we believe we get from the high level of concentration at the individual sub-advisor level.

We don’t expect to increase the maximum number of securities held per manager. Under normal conditions, each investment manager’s portfolio segment is allowed a maximum of seven securities.

When will a sub-advisor be allowed to hold more than seven stocks?

We will allow the sub-advisors to temporarily hold more than seven stocks for tax reasons. For example, if a manager is selling a position that includes one or more lots that are short-term holdings, the manager would have the option (based on their judgment) of keeping the short-term lots until they qualify for long-term capital gain treatment. The sub-advisor could reinvest the proceeds of the other lots sold in a new holding, temporarily resulting in a portfolio of eight stocks.

How similar is Focused Opportunities to Masters’ Select Equity?

The funds have two managers in common. The Chris Davis/Ken Feinberg team and the Craig Blum/Steve Burlingame team combined run 40% of Equity and will run two-thirds of Focused Opportunities. However, Focused Opportunities will be far more concentrated in terms of stocks and less diversified by market-cap (Equity has two dedicated small-cap stock pickers). Because of its concentration, Focused Opportunities has the potential to be more volatile than Equity. Masters’ Select Equity was designed to be a core equity holding—one that could theoretically be the sole equity holding for a portfolio. That is not the intent of Focused Opportunities.

What is the expected expense ratio?

Through December 31, 2007, the expenses will be capped at 1.50%. However, as with all our funds, there are economies of scale that kick in as assets grow. For example, at $100 million of assets we estimate that Focused Opportunities’ overall expenses would be around 1.26%. At $500 million of assets we estimate expenses would be around 1.15%. These are only estimates.

What are the fund's investment minimums and availability?

The minimums are the same as other Masters’ Select funds—$5,000 for a regular account ($2,500 if an automatic investment plan is initiated) and $1,000 for retirement accounts. The fund is available on the same platforms and fund supermarkets as the other Masters’ Select Funds.

At what point do you expect to close the fund to new shareholders?

Based on discussions we have had with the current sub-advisors, we believe the fund’s current capacity is around $1 billion. However, if we add sub-advisors or if the fund takes many years to get to the $1 billion mark (and during that time the overall market capitalization of the stock market increases), it could close at a higher level of assets. This is something we will monitor as the fund grows and market conditions change.

The fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the investment company, and it may be obtained by calling 1-800-656-8864, or visiting www.mastersfunds.com. Read it carefully before investing.

Automatic Investment Plans do not assure a profit and do not protect against a loss in declining markets.

Mutual Fund investing involves risk; loss of principal is possible. The Fund may invest in foreign securities. Investing in foreign securities exposes investors to economic, political and market risks and fluctuations in foreign currencies. The fund may invest in the securities of small companies. Small-company investing subjects investors to additional risks, including security price volatility and less liquidity than investing in larger companies. The Fund is a non-diversified fund, which means that it may concentrate more of its assets in fewer individual holdings than a diversified fund. The Fund may invest a portion of its assets in securities of distressed companies, including debt obligations. Debt obligations of distressed companies typically are unrated, lower rated, in default or close to default and may become worthless.

You cannot invest directly in an index.

The Masters’ Select Funds are distributed by Quasar Distributors.