Fellow Shareholders,
After an extremely unstable and frightening first six months of our fiscal year, equity markets around the globe have stabilized, and in our view, recovered. Your International Funds have performed well over this period - both in absolute terms and in comparison with their peers. Please see specific Fund write-ups for the details.
The Year in Review
I believe this wild ride had its roots in a U.S. Federal Reserve policy that kept interest rates too low for too long. As such, economic agents (consumers, banks and even government entities) around the world adapted to artificially low rates by altering their economic behavior. Most noticeably, they increased their debt levels, and found new ways to package and spread debt obligations globally. Unfortunately, the build-up of debt raised consumption and caused home prices to rise to unsustainable levels. It took the extraordinary economic crisis of last fall to finally stop spending growth. Consumer spending is now declining. This “new” change in behavior has led to widespread weakness in consumer goods purchases and the housing sector in many countries. Keep in mind that U.S. consumer spending has traditionally comprised 66-68% of GDP. Just before the crisis, it had risen to over 73% of GDP. Today, consumption makes up slightly less than 70% of GDP. Where has the money gone? Well, the U.S. savings rate, which was flat before the economic downturn, has now reached 6%.
The impact of these exuberant behavioral changes were felt everywhere because financial institutions around the world owned this weak credit. Additionally, some places, like the U.K. and Ireland, experienced real estate bubbles similar to the United States. This mountain of leverage caused numerous well-known financial firms to collapse. Fears of a global financial meltdown severely damaged consumer sentiment in highly-leveraged countries, like the U.S. and the U.K., and also in developing nations including those with high savings rates. Consumer spending dried up, throwing the entire global economy into recession, and the fear of financial calamity prompted businesses and consumers to adopt a new mantra: “cash is king.”
Aggressive policy by the U.S. Federal Reserve, the U.S. Treasury and other global financial institutions brought relief by March. Led by improvements in the credit markets, equity markets began to recover. Since the equity markets hit lows in March, many pundits and traders have tried to anticipate the “precise bottom” of the market and have parked their assets in T-bills and money market deposits. Despite their reticence (or hubris), global equity markets rallied as fears of a financial collapse passed. Recent predictions for stronger economic growth, such as the IMF’s projection of 3.1% global growth in 2010, indicate a cautious optimism. I believe that the global economic recovery will be uneven. The nations that overspent and were overleveraged will need to repair their balance sheets before spending can recover there. Nations with high savings rates, however, will not.
Given this unstable environment, you may wonder how we achieved our returns. First, we stuck to our philosophy by analyzing the underlying intrinsic value of our holdings and of our prospective investments. For instance, in late 2008, the conventional wisdom urged people to exit financial and consumer stocks, so the herd moved out of these sectors. We, however, remained focused on specific company valuation, and we ended up increasing our positions in these sectors. We bought companies that we thought had the financial strength to survive the crisis and even flourish once it ended, including Signet (retail), Credit Suisse and Julius Baer (financial). As usual, “the market” appeared to be distracted by short-term turmoil and ignored long-term value. Again, we believe that if we focus on companies’ valuations and strengths, instead of broader price volatility, then we are more likely to succeed. Tumultuous times especially require discipline. Rather than running to what appears to be safe ground, we must value businesses as accurately as possible and have the determination to act on opportunities.
The future….
No one can predict what will happen in the markets. That is why we use the macro environment, whether it is stable or unstable, to find the best investment opportunities, according to our value philosophy. We are extremely grateful to our shareholders who have weathered a remarkable storm and stuck with us through this memorable period of financial market history. We will continue to work hard to achieve satisfactory results through the investment cycle.
David G. Herro, CFA
Portfolio Manager
oakix@oakmark.com
oakex@oakmark.com
The performance data quoted represents past performance. The above performance information for the Funds does not reflect the imposition of a 2% redemption fee on shares of all Funds, other than The Oakmark Equity & Income Fund, redeemed within 90 days. If reflected, the fee would reduce the performance quoted. Past performance does not guarantee future results. The investment return and principal value 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. Average annual total return measures annualized change, while total return measures aggregate change. To obtain most recent month-end performance data, view it here.
As of 9/30/09, Signet Jewelers Ltd. represented 3.0% of The Oakmark International Fund’s total net assets, Credit Suisse Group 2.7%, and Julius Baer Holding Ltd. 0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
As of 9/30/09, Signet Jewelers Ltd. represented 0% of The Oakmark International Small Cap Fund’s total net assets, Credit Suisse Group 0%, and Julius Baer Holding Ltd. 3.5%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.
Investing in foreign securities presents risks that in some way may be greater than 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 stocks of smaller companies often involve more risk than the stocks of larger companies. Stocks of small companies tend to be more volatile and have a smaller public market than stocks of larger companies. Small companies may have a shorter history of operations than larger companies, may not have as great an ability to raise additional capital and may have a less diversified product line, making them more susceptible to market pressure.
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.
