Primecap Odyssey Funds' Semiannual 2024 Letter: A Look Back

Dear Fellow Shareholders,

For the six months ended April 30, 2024, the PRIMECAP Odyssey Stock Fund, PRIMECAP Odyssey Growth Fund, and PRIMECAP Odyssey Aggressive Growth Fund produced total returns of +21.35%, +18.83%, and +18.47%, respectively. The unmanaged S&P 500^® Index produced a total return of +20.98% during the period.

The torrid U.S. equity market started 2024 as it finished 2023, notching five consecutive months of positive performance on a steady rise to record-high levels at March-end. Growing optimism in a “soft landing” outcome for the U.S. economy pushed stocks higher. Indeed, bolstered by a firm labor market and steady consumer spending, the domestic economy delivered solid (albeit slowing) real growth. And the Federal Reserve seemed intent to lower its policy rate in the coming months. The market increasingly assessed this well-telegraphed maneuver – the resilient economy's controlled glide back into the orbit of a more supportive Fed – as likely to succeed.

But the period ended on a less rosy note, with April registering a 4 percent decline in the S&P 500^®. This landing maneuver was always data-dependent, and the data has not cooperated of late. The economy may be slowing more quickly than anticipated; real GDP in the first quarter missed expectations, and recent economic data has skewed somewhat softer. Meanwhile, inflation has proven intransigent at levels notably above the Fed's 2 percent target. Core CPI's +3.8% March reading barely budged from October's +4.0% print, and shorter-term pricing measures have worsened in recent months. The Fed has postponed its rate cuts, and investors have been forced to acknowledge a fraught path ahead.

The benchmark's large growth stocks again outperformed – a familiar refrain over the last decade – but the performance gap moderated. Equity strength was broad-based, and smaller-capitalization stocks nearly kept pace with their bigger brethren. Communication Services (+28%) and information technology (+25%), home to AI-fueled performances from mega-capitalization Meta (+43%) and NVIDIA (+112%), respectively, were among the sector leaders. Financials (+26%) and industrials (+25%) also spiked higher. Defensive sectors generated less lift, while flattish oil prices also limited upside in the energy sector (+12%).

The Funds' divergent relative performances mostly reflected stock-specific idiosyncrasies. All three Funds experienced comparable sector allocation headwinds, driven by significant health care exposure (+14% sector benchmark return) and modest cash positions amid the market upswing. The Stock Fund overcame this allocation hurdle via an eclectic collection of prominent holdings, including banks (Wells Fargo), European industrials (Siemens), and pharmaceuticals (Eli Lilly). But whereas growth stocks, both large and small, outperformed during the period, the two growth-oriented Odyssey Funds trailed the S&P 500^®. Neither the Growth Fund nor the Aggressive Growth Fund resemble conventional growth funds. Both have largely eschewed Big Tech, much to their historic detriment, preferring less orthodox alternatives. During the period, those alternative exposures' mixed results were unable to offset the Funds' allocation shortfalls.

All three Funds held an overweight position in the health care and industrials sectors, and an underweight position in the information technology, energy, financials, real estate, consumer staples, communication services, materials, and utilities sectors. The Stock Fund and Growth Fund were also underweight the consumer discretionary sector, whereas the Aggressive Growth Fund featured a modest overweight position.

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

PRIMECAP Odyssey Stock Fund

For the six months ended April 30, 2024, the Stock Fund's total return of +21.35% led the S&P 500^®'s total return of +20.98%. Relative to the S&P 500^®, favorable stock selection more than offset unfavorable sector allocation.

The Fund's sector positioning detracted from relative results. The Stock Fund's large overweight position in health care (27% of average assets versus a 13% benchmark weighting) and modest cash position were the primary culprits. The Fund was also underweight information technology (22% versus 29%), financials (10% versus 13%), and communication services (3% versus 9%), the three best-performing sectors. A large overweight position in industrials (19% versus 9%) and an underweight position in consumer staples (2% versus 6%) were partial offsets.

Favorable stock selection drove the Fund's outperformance during the period. Health care and financials were the bright spots. Within health care, Eli Lilly (LLY, Financial) (+41%), the Fund's largest position, extended its remarkable multi-year run, while animal health company Elanco (ELAN, Financial) (+49%), now five years removed from Lilly's ownership, recovered somewhat after enduring numerous setbacks as a separate company. These performances more than offset biotechnology laggards Biogen (BIIB, Financial) (-10%) and Amgen (AMGN, Financial) (+9%). Within financials, several large bank holdings, most notably Citigroup (C, Financial) (+59%) and Wells Fargo (WFC, Financial) (+52%), benefited from a resilient economy and the prospect of lower short-term interest rates, overcoming a modest headwind from derivatives exchange CME (CME, Financial) (+2%).

Selection elsewhere was mixed. Within industrials, automation giant Siemens (XTER:SIE, Financial) (+46%) was a key contributor. But Big Tech generally outperformed, a recurring theme, creating a performance headwind for the Fund yet again. Even a sizable tailwind from avoiding Apple (AAPL, Financial) (flat) and Tesla (TSLA, Financial) (-9% ) failed to overcome the Fund's limited exposure to NVIDIA (NVDA, Financial) (+112%), Meta (META, Financial) (+43%), and Amazon (AMZN, Financial) (+31%). Within information technology, key holdings Flex (FLEX, Financial) (+50%) and KLA (KLAC, Financial) (+47%) offset underperformance from Intel (-16%), while Sony (SONY, Financial) (-1%) and Mattel (MAT) (-4%) weighed on results in consumer discretionary.

The top 10 holdings, which collectively represented 38.7% 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 Growth Fund

For the six months ended April 30, 2024, the Growth Fund returned +18.83%, trailing both the S&P 500^®'s +20.98% total return and the Russell 1000 Growth Index's total return of +23.56%. Relative to the S&P 500^®, sector allocation was unfavorable while stock selection had a neutral impact overall.

The Growth Fund's sector allocation headwind approximated that of the Stock Fund. An even larger overweight in health care (32%) detracted from Fund performance, but this was roughly offset by reduced cash and a less pronounced underweight position in communication services (6%).

Stock selection was broadly less favorable than the Stock Fund across most sectors. Within health care, Rhythm Pharmaceuticals (RYTM) (+72%) soared as its solutions for genetic obesity gained traction, but a smaller Eli Lilly position and greater biotechnology exposure, particularly BeiGene (BGNE) (-17%) and BioMarin (BMRN_ (-1%), provided a partial offset. Within information technology, Micron (MU) (+69%) was a major incremental contributor; the Growth Fund also had less exposure to Intel and more exposure to NVIDIA than the Stock Fund. And within consumer discretionary and communica-tion services, Chinese internet companies Alibaba (BABA) (-8%) and Baidu (BIDU) (-2%), respectively, detracted from results. Also, robot vacuum maker iRobot (IRBT) (-74%) plummeted after Amazon responded to regulatory pushback by walking away from its acquisition plans, exacerbating the Fund's consumer discretionary weakness.

The top 10 holdings, which collectively represented 34.1% 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, 2024, the Aggressive Growth Fund's total return of +18.47% trailed both the S&P 500^®'s total return of +20.98% and the Russell Midcap Growth Index's total return of +24.49%. Relative to the S&P 500^®, both sector allocation and stock selection were unfavorable.

As with its Odyssey Fund peers, sector allocation registered a headwind. Greater exposure to information technology (28%) helped, but the Fund's smaller overweight position in industrials (12%) and larger underweight in financials (5%) offset the benefit.

Stock selection was modestly unfavorable overall but featured varied performances by sector. Information technology, health care, and industrials contributed positively. The Fund's larger stakes in Micron (+69%) and Nutanix (NTNX) (+68%) bolstered information technology, even as Axcelis (ACLS) (-19%) detracted from results. Health care results were comparable to the Growth Fund, with a larger Rhythm position offsetting the Fund's BioNTech (BNTX) (-5%) exposure. And greater ownership of several airlines, most notably Delta (DAL) (+61%) and United (UAL) (+47%), propelled results within industrials.

But brisker headwinds elsewhere ultimately tipped the Fund's selection impact negative. Within consumer discretionary, despite Royal Caribbean's (RCL) (+65%) resurgence, bigger positions in Tesla and Sony, plus exposure to Chinese EV producer XPeng (XPEV) (-44%), weighed on results. MarketAxess (MKTX) (-6%) within financials and more exposure to Baidu in communication services were also incremental headwinds.

The top 10 holdings, which collectively represented 31.7% 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

Notwithstanding April's swoon, the equity market's posture still reflects a certain exuberance. Investors, underwriting not just a soft landing but a subsequent boom, as well, chased stocks higher ahead of the Fed's long-awaited pivot back to a dovish regime. The market may now be wrestling with the wisdom in that conviction, but the aggressive buying propelled the S&P 500^® Index's valuation into rarefied air (20.9x forward P/E at March-end before dropping modestly to 19.8x at period-end). Other than mid-pandemic, when earnings were artificially constrained, this multiple represented the Index's loftiest valuation in more than 20 years.

We have been skeptical of the consensus view that the economy's safe return to the warm embrace of a pliant Fed was a near certainty. More generally, we have been surprised at how hastily the market has reverted to its historic Fed-centric orientation. Indeed, we originally assessed 2022's equity weakness (the S&P 500^® dropped 18 percent) amid rising inflation and interest rates as indicative of a paradigm-shifting reset – the demise of the low growth, low inflation, low interest rate regime (and its implied “Fed put”) that had defined the prior decade, and which provided fertile conditions for Big Tech's ascendance. But our assessment proved incorrect, or at least premature. Last year the equity market soared – punctuated by the Magnificent Seven's concentrated dominance – as investors imagined the Fed solving post-pandemic imbalances and aggressively cutting rates. Fed theater was back in force, with meeting minutes and official speeches again serving as cue cards for Fed-obsessed market actors.

But no matter how important or effective the Fed has been since the Great Recession and through the pandemic – contestable, unresolved claims – it is worth remembering the Fed is not almighty. After all, just two years ago, the Fed got inflation completely wrong. The Fed reacts to data, and the data (broadly defined) is messy. Stubborn inflation, unsustainable deficit spending, worsening geopolitical strife – not to mention two key leading indicators (an inverted yield curve and M2 money supply contraction) sounding an alarm for more than a year.

To be clear, we are not predicting doom per se. We are ardent admirers of America's unique brand of creative destruction and free enterprise. We simply observe an underlying sanguinity in the equity market that we do not share. And this is true even as the market rally broadened beyond Big Tech to include smaller-capitalization stocks and, to a lesser degree, value stocks.

Our optimism is instead more tempered, and more targeted. From airlines to biotechnology to the Chinese internet, the Funds own many stocks where exuberance is non-existent, where expectations have withered, and where, admittedly, performance has generally been woeful. But these are also pockets of the market where, in our estimation, intrinsic values compare quite favorably to current prices.

The airlines logged a robust six months overall – of the largest Fund holdings, Delta (+61%) and United (+47%) were particularly strong, while American (+21%) and Southwest (+18%) tracked the benchmark – but have endured a very difficult five-year run. The Funds' ownership (3-5 percent by Fund at period-end) dwarfs the Index's weighting (0.2 percent). The Funds' industry exposure has been punitive, especially during the Covid era. Most airline stocks remain well below their pre-pandemic peaks even as the S&P 500^® sits 50 percent higher. Some of this degradation in equity value reflects higher debt burdens. But the equities are also heavy-laden with investor frustration and fatigue. Despite the negativity, demand for flying grows at a healthy clip; the industry is mission-critical for the modern economy; and a consolidated industry struc-ture should ultimately allow well-managed airlines to generate sufficient returns on invested capi-tal. Relative to still anemic valuations (the industry trades at 7.0x forward P/E), and despite Wall Street apathy, we believe our airline holdings can be high fliers yet.

Biotechnology is another portfolio staple that has struggled. Fund exposure to the industry ranges from roughly 5 percent (Stock Fund) to 15 percent (Aggressive Growth Fund), an order of magnitude greater than the Index (1.9 percent). Individual stock performance has been predict-ably varied and volatile, with some notable wins along the way, but the Funds' largest positions have generally fared poorly of late. Biogen, for instance, has declined one-half from its pre-pandemic high; as a frequent Top 10 holding across all three Funds over time, this relative weakness has been costly. But as with the Funds' other outsized biotechnology positions, our Biogen thesis is largely intact. Biogen sports an underrated collection of both commercial assets and pipeline opportunities. The company botched the 2021 launch of its landmark Alzheimer's drug, Aduhelm, souring the company's fundamental outlook (and its reputation). But the opportunity for its second such drug, Leqembi, despite a slow initial ramp, compares favorably to Bio-gen's relatively paltry market capitalization ($31 billion). When sentiment is decidedly negative, as it is with Biogen, small signs of progress can deliver outsized returns. The Funds' biotechnology portfolios are replete with such out-of-favor opportunities.

Lastly, the Chinese internet stocks have been doubly painful. Alibaba and Baidu, the so-called Amazon and Alphabet of China, respectively, have, as securities, behaved nothing like Amazon and Alphabet. The stocks have declined two-thirds or more from peak levels just over three years ago, a period when their US-based Big Tech peers have generally surged in value. Even zooming out and including earlier outperformance, both companies' five-year returns are bleak. The resultant performance drag for the Growth and Aggressive Growth Funds, where these stocks currently represent nearly 3 percent of the portfolio, has been stark. (Both Funds also have exposure to China biotech BeiGene, and the Aggressive Growth Fund has exposure to China automaker XPeng; all four companies have suffered from their association with China.) Our the-sis, battered but not broken, is that these giants, as market leaders in key technology verticals, are critical enablers of China's digital transformation. Alibaba, like Amazon, leads in e-commerce and cloud computing; Baidu, like Alphabet, leads in search and has even better competitive prospects in generative AI and autonomous driving. But their credentials have succumbed to their circum-stances; bad news has been constant, from regulatory pressure to macro weakness to geopolitical tension. The stocks, now nearly untouchable, trade at high-single digit P/E valuations (mid-single digit net of cash stockpiles) – multiples befitting dying businesses, not China's most important technology companies.

For several years now, the above “ABC” (airlines, biotechnology, and China) headwinds have been brisk and relentless. Combined with the gale force headwind stemming from the Funds' Big Tech underweight position, it is unsurprising that recent results have been challenging for the Funds. But over forty years as equity investors we have weathered several multi-year storms. We are optimistic this particular dynamic is at an inflection. And, particularly relative to an expensive benchmark, our aggregate underperformance only narrows and deepens our conviction in the Funds' unconventional holdings.

Sincerely,

PRIMECAP Management (Trades, Portfolio) Company

May 6, 2024

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.