Primecap Odyssey Funds' 2023 Semiannual Letter

Dear Fellow Shareholders,

For the six months ended April 30, 2023, the PRIMECAP Odyssey Stock Fund, PRIMECAP Odyssey Growth Fund, and PRIMECAP Odyssey Aggressive Growth Fund produced total returns of +7.39%, +8.53%, and +10.74%, respectively. The unmanaged S&P 500^® Index pro-duced a total return of +8.63% during the period.

U.S. equities rose during the period despite tumult in the banking sector. The abrupt collapse of Silicon Valley Bank highlighted the risks stemming from the Federal Reserve’s rapid tightening campaign. Regulatory actions thereafter partially contained the immediate fallout, but regional banks remained in crisis mode, and ongoing pressure led to subsequent bank failures.

The domestic economy was largely unfazed, however, grinding out real growth amid still-high inflation. Consumers were especially undeterred, as growth in Personal Consumption Expenditures (PCE) sustained at a robust pace despite lapping outsized growth in the prior year. Relatedly, labor market tightness compelled average hourly earnings considerably higher and anchored the economy’s historically low unemployment rate in the mid-3% band. Indeed, the economy’s enduring resilience coupled with stubborn core inflation prompted four additional interest rate hikes by the Fed through April – plus a tenth consecutive hike executed thereafter in May. And yet longer-term interest rates actually declined, with the 10-year Treasury yield sinking from 4.1% to 3.4% during the period.

Market optimism that the Fed’s rate-raising campaign was nearing an end fueled a resurgence in growth stocks, which had been weak last year. Likewise, enthusiasm surrounding ChatGPT and generative artificial intelligence (AI) propelled several Big Tech stocks higher. Communication services (+23%) and information technology (+19%) were the primary sector beneficiaries of these themes, while energy (-3%) and financials (-1%) were the sector laggards.

The Funds’ relative performance reflected, in part, the market’s recent growth skew; the Aggressive Growth Fund outpaced the benchmark, the Growth Fund was in line, and the Stock Fund lagged. But this omits a key plot line: the S&P 500^®’s rise was unduly reliant on just three mega-capitalization stocks; Meta (+158%), NVIDIA (+106%), and Microsoft (+33%) con-tributed nearly half of the market’s return. The Funds’ underweight position in all three stocks – just 1-3% total exposure by Fund, mostly via Microsoft, relative to the benchmark’s aggregate 8% weighting – thus posed a meaningful headwind. Within this less friendly context, each Fund delivering favorable stock selection overall was a particularly welcome outcome.

All three Funds held an overweight position in the health care and industrials sectors, and an underweight position in the energy, financials, real estate, consumer staples, communication serv-ices, materials, and utilities sectors. The Stock Fund was also underweight the consumer discre-tionary and information technology sectors; the Growth Fund was overweight consumer discretionary and underweight information technology; and the Aggressive Growth Fund was overweight both consumer discretionary and information technology.

A more detailed discussion of the results of each PRIMECAP Odyssey Fund follows.

PRIMECAP Odyssey Stock Fund

For the six months ended April 30, 2023, the Stock Fund’s total return of +7.39% trailed the S&P 500^®’s total return of +8.63%. Relative to the S&P 500^®, unfavorable sector allocation more than offset favorable stock selection.

The Fund’s sector positioning detracted from relative results. The Stock Fund featured substantial underweight positions in both communication services (3% of average assets versus an 8% benchmark weighting) and information technology (19% versus 24%), the two best-performing sectors. Likewise, a large overweight position in health care (27% versus 15%) similarly weighed on results, as health care (+1% benchmark return) lagged the market.

Positive stock selection nearly offset this allocation drag. Within health care, top holdings AstraZeneca (AZN, Financial) (+26%) and Eli Lilly (LLY, Financial) (+10%) provided a significant boost, more than compensating for weakness in Bristol-Myers Squibb (BMY, Financial) (-12%) and Amgen (AMGN, Financial) (-10%). Industrials featured Siemens (XTER:SIE, Financial) (+55%) and FedEx (FDX, Financial) (+44%), both rebounding from earlier company-specific struggles, while space technology firm Maxar (MAXR, Financial) (+136%) rocketed higher after announcing its planned acquisition by private equity firm Advent International.

Selection elsewhere provided a partial offset. Within information technology, NVIDIA (NVDA, Financial) (+106%) and Microsoft (MSFT, Financial) (+33%), both early beneficiaries of generative AI enthusiasm, weighed on results given the Stock Fund’s underweight position in both companies; similarly, limited exposure to Meta (META, Financial) (+158%) proved punitive within communication services. Within financials, avoiding the high-profile troubles of Silicon Valley Bank, Signature Bank, and First Republic Bank helped, but the Fund’s large stakes in Raymond James (RJF, Financial) (-23%) and Wells Fargo (WFC, Financial) (-12%) suffered in partial sympathy. Finally, within materials, Albemarle (ALB, Financial) (-34%) slid in tandem with falling lithium prices.

The top 10 holdings, which collectively represented 34.9% of the portfolio at the period end, are listed below:

PRIMECAP Odyssey Growth Fund

For the six months ended April 30, 2023, the Growth Fund returned +8.53%, roughly in line with the S&P 500^®’s +8.63% total return but behind the Russell 1000 Growth Index’s total return of +11.51%. Relative to the S&P 500^®, favorable stock selection approximately offset unfavorable sector allocation.

The Growth Fund’s sector allocation resembled the Stock Fund with a few notable differences. A less pronounced underweight position in communication services (5% average weighting) and information technology (22%) reduced those respective headwinds, while a larger underweight position in financials (8% versus 14%) also provided an incremental benefit. These factors more than offset the Fund’s even larger overweight position in health care (34%).

Stock selection was more favorable than that of the Stock Fund. Health care was the primary incremental driver, with several biotechnology holdings outperforming. Seagen (SGEN, Financial) (+57%) and ABIOMED (ABMD, Financial) (+51%) both spiked as acquisition targets; Pfizer is buying Seagen to enhance its cancer drug pipeline, while Johnson & Johnson acquired ABIOMED to bolster its medical tech-nology offerings. Chinese biotechnology company BeiGene (BGNE, Financial) (+51%) and medical device company Insulet (PODD) (+23%) also benefited results.

Weakness in the Growth Fund’s consumer discretionary portfolio created an incremental head-wind. Xometry (XMTR) (-77%), an on-demand industrial parts marketplace, declined after guiding to lower growth this year than expected, while iRobot (IRBT) (-30%) struggled as its planned acquisition by Amazon received additional regulatory scrutiny.

The top 10 holdings, which collectively represented 30.5% of the portfolio at the period end, are listed below:

• The percentage is calculated by using the ending market value of the security divided by the ending market value of the total investments of the Fund.

PRIMECAP Odyssey Aggressive Growth Fund

For the six months ended April 30, 2023, the Aggressive Growth Fund’s total return of +10.74% led both the S&P 500^®’s total return of +8.63% and the Russell Midcap Growth Index’s total return of +6.60%. Relative to the S&P 500^®, favorable stock selection was the primary driver of outperformance.

Sector allocation was better than each of its Odyssey Fund peers but remained a modest headwind overall. Relative to its Odyssey Fund peers, slightly larger positions in communication services (6%) and information technology (25%) – the latter indicating a slight overweight in the sector – and a smaller position in financials (6%) all benefited results. A more substantial underweight position in energy (1% versus 5%), the worst-performing sector, also helped.

Stock selection was broadly favorable. Larger positions in trading platform MarketAxess (MKTX) (+31%) within financials, offshore drilling company Transocean (RIG) (+60%) within energy, Chinese search engine Baidu (BIDU) (+58%) within communication services, and Japanese conglomerate Sony (SONY) (+33%) within consumer discretionary all contributed. Axcelis (ACLX) (+104%) and Universal Display (OLED) (+41%) outperformed within information technology, offsetting a sharp decline in Wolfspeed (WOLF) (-41%).

Within health care, selection was quite favorable, although it trailed the Growth Fund’s outsized strength. Larger positions in the Growth Fund’s outperformers (Seagen, ABIOMED, BeiGene, and Insulet) further boosted results. But other significant biotechnology holdings, most notably Rhythm (RYTM) (-20%) and BioNTech (BNTX) (-17%), served as a partial offset.

The top 10 holdings, which collectively represented 31.2% of the portfolio at the period end, are listed below:

• The percentage is calculated by using the ending market value of the security divided by the ending market value of the total investments of the Fund.

Outlook

Two recent developments have rightly piqued the market’s attention: the launch of a potent new technology, generative AI, and the abrupt collapse of several large regional banks. Of note, these developments seemingly foretell quite divergent stories. Mixing metaphors, if generative AI is a potential gold mine of the future, the bank failures are perhaps a canary in the coal mine of today.

Technologists have been designing and deploying elements of artificial intelligence and machine learning for years. But OpenAI’s release of ChatGPT, a large language model that generates original content, is different. The launch transfixed an awestruck public (ChatGPT surpassed 100 million users within two months), turbocharged an extant AI arms race, and spawned count-less derivative initiatives. It also invigorated some technologists’ AI-driven nightmares.

The market was quick to identify and crown specific AI winners, or at least first-order beneficia-ries. NVIDIA, which sells best-in-class GPUs for AI applications, doubled; the resultant $350B surge in valuation spiked its already lofty multiple to 21x price-to-sales. Microsoft, which has explicit ties to OpenAI and benefits from ChatGPT’s Azure-based footprint, jumped 33%, add-ing a staggering $500B to its market capitalization; Microsoft also expects generative AI to aug-ment Office and even revive Bing. Two stocks, $850B of incremental value – a proverbial gold mine, and the rough equivalent of the entire materials sector (which, coincidentally, houses the actual gold mines). In the vernacular of the Gartner hype cycle, we are perhaps at the peak of inflated expectations – with the trough of disillusionment ahead.

That said, we subscribe to the idea that AI will be transformative, and we expect generative AI to unlock significant productivity benefits in the mid-term. We also acknowledge NVIDIA and Microsoft are both well-positioned. But this nascent AI ecosystem is incredibly dynamic, and winners will materialize across multiple layers: model makers, cloud providers, application devel-opers, and physical infrastructure suppliers, among others. The Funds’ outsized semiconductor and memory ownership should ultimately profit from the requisite increase in computing, for instance. And we continue to assess other second-order impacts, particularly within the applica-tion layer, where generative AI’s influence is likely to reverberate well beyond the information technology sector.

In the meantime, we are also contending with the second recent development, an ongoing bank-ing crisis, and the substantial unease it signals about the broader economic moment. Rising rates tend to break things, and a few big banks proved shockingly fragile. The confluence of asset-liability mismanagement, concentrated deposits, social media contagion, and one-click with-drawals dismantled Silicon Valley Bank overnight. Bank runs are now bank sprints.

The Funds avoided Silicon Valley and its failed peers. We are underweight financials in each Fund, though we do have material bank exposure in the Stock and Growth Funds. But not all banks are created equal. The values of our bank and bank-adjacent holdings, including Wells Fargo and Raymond James, declined as collateral damage, but we believe their differentiated franchises will emerge post-crisis on even stronger footing.

Even as the banking crisis ebbs, its acute phase may persist; past crises have often lasted months or years. As importantly, the banking crisis “canary” portends a wider set of interest rate-driven concerns. Residential real estate, already undermined by higher mortgage rates, may yet crack. Commercial real estate is at particular risk; owners of half-empty office buildings may need to refinance loans at unforgiving rates in a tight credit environment. And the federal government – even ignoring the latest iteration of default gamesmanship – may see its fiscal position over-whelmed by an escalating interest expense.

The market’s latest move higher has thus only reinforced our earlier cautious tilt. The S&P 500^® Index’s valuation is now somewhat elevated at 18.2x forward P/E. Yet this calendar year’s expected earnings show negligible growth from 2022 levels – a stark shortfall relative to the double-digit growth forecasted a year ago. Meanwhile, as noted, many economic indicators are flashing warning signs. The yield curve is persistently and substantially inverted. Money supply as measured by M2 has been declining for several months – an exceedingly rare phenomenon that implies weakness ahead given M2’s lagged impact. The market nonetheless appears confident in the Fed’s ability to engineer a soft landing; we assess that confidence as overdone.

Amid this unease, our significant health care position – approximately twice the index’s 15% weighting in each Fund – is particularly attractive. The sector features reduced macroeconomic sensitivity and a more idiosyncratic set of industry drivers, especially R&D-driven innovation. And this defensive posture is still on sale; the sector (17.5x forward P/E) is less expensive than both the market and its defensive-oriented peers (consumer staples 20.8x, utilities 18.2x).

Our Funds largely kept pace during the period even as several technology titans reclaimed the equity market throne. This concentrated benchmark performance seemingly undermines our belief that last year ushered in a new market paradigm, one less conducive to Big Tech’s domi-nance. But we continue to believe this decade will be different than the last – and the market will not simply re-anoint last decade’s runaway winners. We instead own (smaller) companies with individual potential far greater than their current valuations. And this is what gives us confidence that our portfolio is well-positioned to outperform over the long term.

Sincerely,

PRIMECAP Management (Trades, Portfolio) Company

May 15, 2023

Past performance is not a guarantee of future results.

The funds invest in smaller companies, which involve additional risks such as limited liquidity and greater volatility. All funds may invest in foreign securities, which involves: 1) greater vola-tility; 2) political, economic, and currency risks; and 3) differences in accounting methods. Mutual fund investing involves risk, and loss of principal is possible. Growth stocks typically are more volatile than value stocks; however, value stocks have a lower expected growth rate in earnings and sales.

Please refer to the Schedule of Investments for details of fund holdings. Fund holdings and sector allocations are subject to change at any time and are not recommendations to buy or sell any security.