The Oakmark Select Fund
Report from Bill Nygren, Portfolio Manager
The Oakmark Select FundReport from Bill Nygren, Portfolio Manager |
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| THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK SELECT FUND FROM ITS INCEPTION (11/1/96) TO PRESENT (3/31/98) AS COMPARED TO THE STANDARD & POOR'S 500 INDEX | ||
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| 3/31/98 NAV $19.87 | Total Return Last 3 mos. |
Average Annual Total Return* Through 3/31/98 From Fund Inception 11/1/96 |
| The Oakmark Select Fund | 13.4% | 63.7% |
| Standard & Poor's 500 Stock Index w/inc** | 14.0% | 39.6% |
| Standard & Poor's MidCap 400 Index w/inc** | 11.0% | 36.5% |
| Value Line Composite Index** | 10.0% | 26.9% |
| *Total return includes change in share prices and in each case includes reinvestment of any dividends and capital gain distributions. | **Each of the three indexes or averages is an unmanaged group of stocks whose composition is different from the Fund. The S&P 500 is a broad market-weighted average dominated by blue-chip stocks. The S&P 400 consists of 400 domestic stocks chosen for market size, liquidity, and industry group representation. The Value Line Index is an unweighted average of more than 1,000 stocks. Past performance is no guarantee of future results. | |
UP, UP AND AWAY
The Oakmark Select Fund increased in value by 13.4% in the quarter ended March 31. That increase nicely exceeded the 11% gain in the S&P 400, the midcap index that compares most closely to our portfolio, but slightly trailed the increase in the S&P 500. Our six-month increase of 22.9% was well above the market, regardless of which index one chooses. Strong gains achieved by cable TV stocks again helped our performance.
Your Fund has now doubled in value since its inception 17 months ago! Although our entire research department is very proud of this record, we are certainly aware that these results have been possible only with the aid of an unbelievably powerful tailwind. In the last 25 years, the market's quarterly return exceeded 10% about once every ten quarters. Over the life of The Oakmark Select Fund, the market return has reached double-digit levels in three out of six quarters, five times the historical frequency. The strength of this market has been truly amazing!
Stocks rallied further last month after Warren Buffett stated his opinion that stocks were not generally overvalued as long as interest rates remained low and businesses continued to earn exceptionally high returns on equity. Investors saw the positive "stocks not overvalued" rather than focusing on the risk of a change in our near-perfect economic environment. As stock prices and, therefore, risk levels keep rising, you need to remember that we are not market timers. We doubt that anyone is very good at predicting market moves, but we know we are not. Since we will always find stocks that look inexpensive relative to prices paid for similar businesses, the Select Fund will remain fully invested. That means that the Fund's cash levels will almost always be low, a single-digit percentage. It also means that when the market goes down, if the Fund goes down less, we will view that outcome as consistent with our goal of achieving excellent long-term returns.
Since we stay fully invested, it is our shareholders' responsibility to make sure their personal exposure to the stock market is appropriate for their individual situations. Although we do not advocate market timing, it is important to remember that when stock prices go up more than other asset prices do, the percentage of one's net-worth exposed to stocks increases. Something I ask myself after a stock has risen is, "would I buy more if it declined in price by 20%?" If the answer is not a strong yes, I'll usually reduce the position size. I encourage all of our shareholders to review their various investments and make sure the amount invested in the stock market is still appropriate for their circumstances—only then can you take advantage of a market decline by buying more.
KNOW YOUR MANAGER!!
We see ads almost daily for services promising to make us better investors: "Now you can trade like a pro!" "Make money no matter which way the Dow goes!" "Discover tomorrow's winners today!" But the one that really caught my eye this quarter was the following offer for an astrological review of your portfolio. The astrologer claims: "I have the expertise to give you an astrological evaluation of [your] stocks, and of the market as a whole. When your expertise and mine are brought together, we form a filter that eliminates losers and allows only winning stocks to enter your portfolio."
These services prey on investors who aren't committed to a sound investment philosophy. When the inevitable periods of poor performance arrive, the services promise a quick-fix. What should concern you about this is that the astrological stock selection service claimed that its subscribers include "well-known fund managers." It is imperative that investors know the investment philosophy of their fund managers. Hot performers come and go, but understanding how managers make decisions creates the confidence to follow a successful, long-term investment approach. Since you will not find us relying on the stars to construct our portfolios, let me share with you our approach.
Like all the funds in The Oakmark Family, The Oakmark Select Fund is a long-term value investor. We have an outstanding team of analysts who search for companies that sell at large discounts to intrinsic value. To us, a company's intrinsic value is the price a knowledgeable buyer would pay to acquire the entire business. Stocks are not just pieces of paper, they are fractional interests in businesses. Next, we look for companies that have values that grow with time. That means not only looking for growing sales and operating income, but identifying free cash flow that can be invested in the business, used to pay dividends, repurchase shares, pay down debt and so on. Lastly, we want managements that are owner-oriented. That means that through their economic incentives (share ownership, options, bonuses) we are assured that management's interests align with outside shareholders. When we find these companies, we buy them and patiently wait for their value to be recognized by others. When companies with growing values and owner-oriented managements are available at discounts to their true value, we do not have to predict when the market will recognize that value, because the longer it takes, the greater will be our ultimate reward. Over time, we'll make our share of mistakes, but it will not be because of how Jupiter aligned with Mars!
A BENEFICIAL PURCHASE
During the quarter, your Fund added one new position, Beneficial Corporation. Because it was an unusual buy for us, I want to explain it. Beneficial is a consumer-finance company whose stock performance lagged behind its peers. We had been evaluating Beneficial for some time: quite confident of its undervaluation, less certain of management's owner-orientation. In February, Beneficial announced the sale of its Canadian operation at a price that was well above our estimate. The price they received showed us that Beneficial was more undervalued than we realized, but equally important, the willingness to sell off non-core assets to strategic buyers showed management's owner-orientation. Their focus was not on maximizing size, it was on maximizing their value.
Unfortunately for us, almost simultaneously, Beneficial announced they were considering sale of the entire company. Beneficial stock immediately rose in price from $82 to $110. Normally, you will not find us buying stocks after a possible sale is announced because the stock price is usually quite close to estimated business value. In this case, however, we felt our valuation of Beneficial had been more thorough than other analysts and felt strongly that Beneficial was worth an absolute minimum of $120 and was quite possibly worth in excess of $150. Despite its price increase, Beneficial met all our criteria. We look forward to watching the bids come in and congratulate Beneficial management for realizing that their share price could be maximized only by finding a strategic partner.
Thank you for your continuing support.
BILL NYGREN
Portfolio Manager
bnygren@oakmark.com
April 2, 1998
P.S. On April 7, Household International announced an agreement to purchase Beneficial for stock valued at $150. (After the announcement, a decline in Household stock decreased the offer to $144.) Congratulations to our Jim Benson for his outstanding analysis of this company.
THE OAKMARK SELECT FUND |
| Shares Held | Market Value | |
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| Common Stocks—91.6% | ||
| Other Consumer Goods & Services—9.0% | ||
| Ralston Purina Group | 581,000 | $61,586,000 |
| Brunswick Corporation | 1,034,900 | 36,092,137 |
| Polaroid Corporation | 815,900 | 35,899,600 |
| 133,577,737 | ||
| Banks—3.8% | ||
| People's Bank of Bridgeport, Connecticut | 1,496,000 | $56,801,250 |
| Insurance—7.8% | ||
| PartnerRe Ltd. | 2,356,100 | $115,743,413 |
| Other Financial—3.5% | ||
| Beneficial Corporation | 420,000 | $52,211,250 |
| Broadcasting & Cable TV—9.8% | ||
| Cablevision Systems Corporation (a) | 2,210,200 | $145,320,650 |
| TV Programming—8.8% | ||
| Tele-Communications, Liberty Media, Class A (a) | 3,803,550 | $130,747,031 |
| Publishing—6.1% | ||
| Dun & Bradstreet Corporation | 1,570,500 | $53,691,469 |
| ACNielsen Corporation (a) | 1,425,100 | 37,676,081 |
| 91,367,550 | ||
| Medical Products—4.5% | ||
| Amgen, Inc. (a) | 1,110,000 | $67,571,250 |
| Aerospace & Defense—3.8% | ||
| Lockheed Martin Corporation | 505,900 | $56,913,750 |
| Building Materials & Construction—11.6% | ||
| USG Corporation (a)(c) | 2,540,200 | $137,647,087 |
| Armstrong World Industries, Inc. | 404,700 | 35,031,844 |
| 172,678,931 | ||
| Oil & Natural Gas—2.5% | ||
| Union Teas Petroleum Holdings, Inc. | 1,670,100 | $36,950,963 |
| Other Industrial Goods & Services—6.1% | ||
| Premark International, Inc. | 1,538,600 | $50,966,125 |
| General Signal Corporation | 836,200 | 39,092,350 |
| 90,058,475 | ||
| Diversified Conglomerates—12.6% | ||
| U.S. Industries, Inc. (c) | 6,220,000 | $186,988,750 |
| Foreign Securities—4.4% | ||
| Gucci Group (b) | 1,380,700 | $65,583,250 |
| Total Common Stocks (Cost: $1,088,223,426) | 1,402,514,250 | |
| Short Term Investments—6.4% | ||
| U.S. Government Bills—2.0% | ||
| United States Treasury Bills, 5.01%-5.21% due 4/2/1998-7/16/1998 | $30,000,000 | $29,815,644 |
| Total U.S. Government Bills (Cost: $29,814,319) | 29,815,644 | |
| Commercial Paper—3.1% | ||
| American Express Credit Corp., 5.53%-5.55% due 4/3/1998-4/7/1998 | $10,000,000 | $10,000,000 |
| Ford Motor Credit Corp., 5.54%-5.57% due 4/2/1998- 4/6/1998 | 10,000,000 | 10,000,000 |
| General Electric Capital Corporation, 6.02% due 4/1/1998 | 25,000,000 | 25,000,000 |
| Total Commercial Paper (Cost: $45,000,000) | 45,000,000 | |
| Repurchase Agreements—1.3% | ||
| State Street Repurchase Agreement, 5.75% due 4/1/1998 | $19,467,000 | $19,467,000 |
| Total Repurchase Agreements (Cost: $19,467,000) | 19,467,000 | |
| Total Short Term Investments (Cost: $94,281,319) | 94,282,644 | |
| Total Investments (Cost $1,182,504,745)—100.7% (d) | $1,496,796,894 | |
| Other Liabilities In Excess Of Other Assets—(0.7)% | (9,932,893) | |
| Total Net Assets—100% | $1,486,864,001 | |
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(a) Non-income producing security.
(b) Represents an American Depository Receipt.
(c) See footnote number five in the Notes to Financial Statements regarding transactions in affiliated issuers.
(d) At March 31, 1998, net unrealized appreciation of $314,292,149, for federal income tax purposes consisted of gross unrealized appreciation of $315,843,337 and gross depreciation of $1,551,188.