Oakmark Global Fund: Third Quarter 2013
September 30, 2013
The September quarter produced strong equity outcomes across most world markets. The Oakmark Global Fund participated in this rally, gaining 11%. The MSCI World Index returned 8%, and the Lipper Global Fund Index returned 8%. The Fund’s return for the calendar nine months is 26%, compared to the 17% return for the MSCI World Index and the Lipper Global Fund Index. For the Global Fund’s fiscal year ended September 30 the returns are 40% for the Fund, 20% for the MSCI World Index, and 22% for the Lipper Global Fund Index. As always, we are most pleased to report the Fund’s 12% compound annualized rate of return since inception, which compares to 4% for the MSCI World Index and 5% for the Lipper Global Fund Index for the same period.
The countries that contributed most to the Fund’s quarter return were the U.S., Switzerland, and Japan. Australia was the only country to have equities that detracted from the Fund’s return in the quarter. The five largest contributors to the Fund’s return in the quarter were Daimler (Germany), Julius Baer (Switzerland), Cimarex Energy (U.S.), Credit Suisse (Switzerland) and MasterCard (U.S.). The Fund holdings that detracted most were Tenet Healthcare (U.S.), Incitec Pivot (Australia), Intel (U.S.), Bank of America (U.S. new purchase) and Canon (Japan).
For the calendar nine months the highest contributing countries were the U.S., Japan and Switzerland. Holdings in both Spain and Australia detracted from the nine-month return. Daiwa Securities Group (Japan), Daimler, Live Nation (U.S.), MasterCard and Julius Baer were the leading contributors. Incitec Pivot, Canon, Banco Santander (Spain), Bank of America and Apache (U.S.) detracted most from the nine-month return. For the Fund’s fiscal year the U.S., Japan and Switzerland were again the leading contributors to return while Australia was the only detractor. The five companies that led the contributors list were Daiwa Securities Group, Daimler, Tenet Healthcare, Credit Suisse and MasterCard. Detractors were Incitec Pivot, Square Enix (Japan), Apache, Bank of America and Franklin Resources (U.S. new purchase).
Although equity markets moved higher in the quarter, we found opportunities to make new additions to the Fund, adding three U.S. and two European holdings. The first name alphabetically is Bank of America. For years, Bank of America was the poster child for all that was troubling about banks. But like the industry as a whole, we believe Bank of America has made tremendous progress simplifying and “de-risking” its business. For instance, in just the past few quarters it has gone from being one of the worst capitalized big banks to one of the best. (For perspective, the company’s tangible common equity ratio is 64% higher than it was in 2006, which was before the crisis). Management also took advantage of lowered investor expectations as an opportunity to invest heavily in systems technology and rationalization. Investors have rewarded the company for its progress and brought the stock up from its lows. However, it is still being valued at a sizeable discount to its peers. In our view, the discount derives both from stale perceptions of the relative risk profile, but also because Bank of America’s near-term earnings are more depressed than its peers. We expect this discount to close with time, as investors reevaluate the “new” Bank of America and its profitability catches up.
Our second new purchase is Franklin Resources, an investment firm that manages a family of more than 300 mutual funds under the names Franklin, Templeton and Fiduciary Trust, among others. The funds invest internationally and domestically in equities, fixed income and money market instruments. Franklin Resources also offers separately managed accounts and insurance product funds. Franklin Resources has an excellent brand name and a well-established global network, with a presence in over 17 international markets. The company has deliberately built this international presence over decades, and we believe this provides, and will continue to provide, a distinct competitive advantage. In addition, management has historically returned capital to shareholders through stock buybacks and dividends, and we expect Franklin Resources to continue to be good stewards of shareholders’ capital.
Next is Fugro, a Netherlands-domiciled geological engineering company that primarily serves the off-shore oil market. Much of Fugro’s value—about 85%--comes from businesses that are tied to construction or production related to the off-shore oil market. Investors are attracted to this market because it is growing at nearly a double-digit rate, and Fugro controls very high market shares in many of its businesses. That said, the other 15% of Fugro’s value comes from Geoscience, which is not nearly as attractive. Fugro essentially operates ships that take seismic pictures of the ocean floor. This business is capital intensive (ships and cameras), and its returns are erratic, like a commodity’s (because it depends on exploration demand). While this “lumpiness” can cause short-term earnings to fluctuate greatly, in our view, it does not affect long-term business value. We have taken advantage of this volatility—and other investors’ shortsightedness—and initiated a position during the quarter when Fugro’s share price fell after missing Street guidance.
Long-term holders of the Global Fund may remember us buying Holcim (Switzerland) in late 2010. We sold it only one year later, an unusually short holding period relative to our normal three- to five-year holding period. We did not sell because of a change in our investment thesis about Holcim. Instead, our other holdings were not doing as well. Many Japanese names were hurt by the earthquake and tsunami in March 2011 and the Thai floods in the Fall of 2011. In addition, many of our European names also fared poorly in the third and fourth quarters of 2011 as markets feared the break-up of the Euro. We sold Holcim so that we could purchase other positions that offered greater share appreciation potential.
Looking back, these trades worked in our favor. Since the sale of Holcim, the Global Fund appreciated almost 50%, while Holcim appreciated less than 30%. During the past quarter we started buying Holcim at a price that was only 7% higher than our previous average cost, while our estimate of intrinsic value increased more than 10%. This makes Holcim absolutely and relatively more attractive now than when we purchased it in 2010.
As a refresher, Switzerland-based Holcim is one of the world’s largest cement makers. The company has a broad geographic spread, with more than 70% of its pre-tax profits originating in emerging markets such as India, Indonesia and Africa. We think the company will thrive in these emerging economies and will gain from development in these areas. In addition, recent consolidations in the cement sector have strengthened the company’s market position. Holcim’s cost-reduction plan, which includes a restructuring plan in India to improve the cost base, is on track for 2014, and we believe its expected benefits have not yet been reflected in the stock price and that demand for cement will increase over the medium term.
Returning to the U.S., our last new purchase was shares of Itron, a global supplier of metering products and services for electric, natural gas and water utilities. Its product portfolio includes traditional, standard (manual-read) meters as well as radio- and telephone-based automatic meter-reading systems, handheld meter-reading computers, smart meters and meter data acquisition and analysis software. Approximately 8,000 customers in more than 100 countries use its products and services. We believe that Itron is poised to benefit from a wave of spending in the coming years, as utilities around the globe continue to upgrade approximately 2.5 billion outdated meters to more advanced meters, which are capable of automated readings and two-way communication. The company generates strong free cash flow given the minimal capital needed to run the business, and we think its leading market position is protected by large R&D investments, customer switching costs and solid brand value.
There were two full eliminations from the portfolio. The first was Rohm, a Japanese semiconductor company, which was sold to help fund more attractive holdings. The second was International Flavors & Fragrances, which, despite its name, is a U.S.-domiciled concern. As IFF’s shares approached our sell target, we sold it in order to help fund new purchases. We salute IFF management for their excellent stewardship of the company during the Fund’s three-and-a-half years of ownership.
Applied Materials/Tokyo Electron
Late in the quarter Applied Materials, one of our holdings, announced that it would merge with Tokyo Electron in an all-stock transaction. Mergers of American and Japanese firms are quite unusual, but this one developed in part because of the two CEO’s long-term friendship. Applied’s CEO will become the combined company’s leader and will move to Japan to help the deal progress. Both companies make semiconductor manufacturing equipment, but their products primarily overlap rather than directly compete. The deal also offers cost synergies and tax management possibilities.
If the merger takes place and semiconductor demand begins to pick up, the combined company should be very well positioned to benefit. Alternatively, should sales remain sluggish, we believe that Applied’s management team can introduce productive cost-reduction measures at Tokyo Electron to boost profits. But perhaps most importantly, we think this transaction suggests ever greater possibilities for worldwide economic consolidation and integration, which can enhance productive economic growth and expansion.
Global currencies were relatively stable during the quarter, but we continue to believe some currencies are overvalued. As a result, we defensively hedge a portion of the Fund’s currency exposure. Approximately 38% of the Australian dollar, 25% of the Swiss franc and 15% of the Japanese yen were hedged at quarter-end.
As always, we thank you for being our shareholders and partners in the Oakmark Global Fund. We look forward to your questions and comments.
Clyde S. McGregor, CFA
Robert A. Taylor, CFA
As of 9/30/13, Daimler AG represented 4.0%, Julius Baer Group, Ltd. 4.8%, Cimarex Energy Co. 1.6%, Credit Suisse Group 3.4%, MasterCard, Inc. Class A 3.9%, Tenet Healthcare Corp. 2.7%, Incitec Pivot, Ltd. 3.2%, Intel Corp. 1.9%, Bank of America Corp. 1.4%, Canon, Inc. 2.9%, Daiwa Securities Group, Inc. 2.4%, Live Nation, Inc. 1.9%, Banco Santander SA 0%, Apache Corp. 0%, Square Enix Holdings Co., Ltd. 0.2%, Franklin Resources, Inc. 2.0%, Fugro NV 2.0%, Holcim, Ltd. 3.0%, Itron, Inc. 0.4%, International Flavors & Fragrances, Inc. 0%, Applied Materials, Inc. 2.1%, and Tokyo Electron Limited 0%, of the Oakmark Global Fund’s total net assets. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
Click here to access the full list of holdings for The Oakmark Global Fund as of the most recent quarter-end.
The MSCI World Index (Net) is a free float-adjusted market capitalization weighted index that is designed to measure the global equity market performance of developed markets. This benchmark calculates reinvested dividends net of withholding taxes using Luxembourg tax rates. This index is unmanaged and investors cannot invest directly in this index.
The Lipper Global Fund Index measures the performance of the 30 largest mutual funds that invest in securities throughout the world. This index is unmanaged and investors cannot invest directly in this index.
The Fund’s portfolio tends to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.
Investing in foreign securities presents risks that in some ways may be greater than in U.S. investments. Those risks include: currency fluctuation; different regulation, accounting standards, trading practices and levels of available information; generally higher transaction costs; and political risks.
The percentages of hedge exposure for each foreign currency are calculated by dividing the market value of all same-currency forward contracts by the market value of the underlying equity exposure to that currency.
The discussion of the Fund’s investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Fund’s investments and the views of the portfolio managers and Harris Associates L.P., the Fund’s investment adviser, at the time of this letter, and are subject to change without notice.