The Oakmark International Small Cap Fund
Report from David G. Herro and Michael J. Welsh, Portfolio Managers
The Oakmark International Small Cap FundReport from David G. Herro and Michael J. Welsh, Portfolio Managers |
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The value of a $10,000
investment in The Oakmark |
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9/30/98 NAV $6.89 |
Total Return Last 3 mos. |
Average Annual Total Return* Through 9/30/98 |
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The Oakmark International Small Cap Fund |
-17.0% |
-6.5% |
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Morgan Stanley World ex U.S. w/inc.** |
-14.7% |
5.0% |
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Lipper Analytical International Small Cap Fund Average** |
-17.0% |
5.8% |
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Micropal International Small Co. Fund Index** |
-16.8% |
5.6% |
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*Total return includes change in share prices and in each case includes reinvestment of any dividends and capital gain distributions. |
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**Each of the three indexes or averages is an unmanaged group of indexes or funds whose composition is different from the Fund. The Morgan Stanley World ex U.S. Index includes 19 country sub-indexes. The Lipper International Small Cap Fund Average includes 59 mutual funds that invest in securities whose primary markets are outside the United States. The Micropal Int'l Small Co. Fund Index sector average is an unweighted index comprised of all funds within the international small company fund sector. Past performance is no guarantee of future results. |
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FELLOW SHAREHOLDERS,
The Oakmark International Small Cap Fund declined by 17% in the past quarter. This compares with a drop of 17% of the Lipper International Small Cap Fund Index and a 14% drop of EAFE. Market conditions for global equities and especially international equities with exposure in emerging markets continue to be volatile. Besides the obvious places like the emerging markets, there have been certain pockets of severe price contraction in apparently economically healthy countries.
AS AN EXAMPLE...
Your fund currently has over 20% of its assets invested in the United Kingdom. Though conditions there are stable (See Traveler's Log below), that country's small cap index has dropped by close to 25% in the last three months. Furthermore, over the last year that index is down by over 15%. What gives? Last year, in order to head off the possibility of rising inflation, The Bank of England began raising interest rates. This caused sterling to strengthen which ultimately hit small and medium cap stocks and especially weakened stocks in the export sector. Our fund was not exempted from the mark-down...some of our larger positions were hit hard, hurting the performance of your Fund.
One example of this was in the price of retailer Carpetright. When we began purchasing the stock, it had plummeted off its highs because of a slowing in the torrid pace of home remodeling in the UK; market punishment of a leading competitor for significant accounting problems also hurt sentiment for the industry. The company has little debt, has a shareholder-oriented management that owns a lot of stock, and is one of the most efficient retailers in the UK. Unfortunately, the price continues to drop, and has fallen roughly 40% from our first purchases. Today Carpetright is yielding 14% on a stable dividend, and trades at 7.5 times core earnings. All through the price fall, those who know the company the best, management and the board of directors, have been buying stock. Furthermore, the company itself has also bought back shares. While the recent price drop has been another painful example of sell first, ask questions later, we feel extremely comfortable being investors in this business at this price. We have also taken advantage of price weakness to increase our holding.
TRAVELER'S LOG...THE UNITED KINGDOM
Recently, we spent a week visiting companies in the United Kingdom. Though it is an area of Europe with some of the strongest economic fundamentals, the most market-oriented government, and some of the best managements, the equity market has greatly underperformed those of the continent. Many of the companies we met with have experienced falls in their share prices of over 50% in the last year and are currently trading at five-year lows. Most of these managements were baffled by the share price declines, saying that while business conditions have slowed, they have experienced no collapse nor do they expect one. Clearly, there is a pervasive fright in the UK and in foreign markets that is taking prices down to unrealistic levels. Besides Carpetright, consider Royal Doulton. This company makes tableware and gifts and is one of the global leaders in those two sectors. Formerly, the company was a poorly managed, neglected stepchild of a diversified conglomerate that didn't seem to bother focusing on the business's fundamentals. Recently, the newly independent company which was spun out of its parent, has installed new, more aggressive management that is much more focused on enhancing the profitability of the brand. Since the spin-off, the stock has dropped by over 50%, giving us the opportunity to buy it at a very attractive price. In Royal Doulton we are getting a good global brand and new, incentivized management focused on enhancing profitability. Equally important, Royal Doulton is trading at a price of about four times our estimate of "normal" earnings. The new chairman also thinks the stock is cheap, as he recently purchased a big block of stock for himself on the open market.
THINGS WILL GET BETTER!
Though share prices have been weak, and this fund has been slumping since the Asia crisis started last year, we continue to be confident about the future. It is true that as shareholders we have all suffered over the last year. However, we strongly assert that current prices of this Fund's underlying investments do not come close to reflecting their true fundamental value. Over time, value and price have always converged and we have no reason to believe it will not happen again this time. We feel so certain of this that, as co-portfolio managers of this fund, we represent the largest ownership block and we continue to invest in the Fund. Fundamentals will assert themselves and while we wait, we thank you for your patience.
DAVID HERRO
Portfolio Manager
72242.772@compuserve.com
MICHAEL WELSH
Portfolio Manager
102521.2142@compuserve.com
October 5, 1998
THE OAKMARK INTERNATIONAL SMALL CAP FUND |
THE OAKMARK INTERNATIONAL SMALL CAP FUND |
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Description |
Shares |
Market |
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Common Stocks—95.7% |
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Consumer Non-Durables—3.9% |
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Royal Doulton plc (Great Britain) |
Tableware and Giftware |
990,000 |
$1,540,035 |
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Designer Textiles (NZ) Limited (New Zealand) (c) |
Knit Fabrics |
2,960,000 |
459,213 |
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Dickson Concepts International Limited (Hong Kong) |
Jewlery Wholesaler and Retailer |
20,000 |
15,615 |
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2,014,863 |
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Food & Beverage—9.6% |
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Matthew Clark plc (Great Britain) |
Spirits & Drinks |
1,054,000 |
$2,150,285 |
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Alaska Milk Corporation (Philippines), (a) |
Milk Producer |
39,327,000 |
1,707,915 |
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Hite Brewery Company (Korea) |
Brewer |
165,010 |
761,722 |
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Souza Cruz S/A (Brazil) |
Tobacco Products |
55,000 |
347,969 |
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4,967,891 |
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Retail—11.3% |
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Carpetright plc (Great Britain) |
Carpet Retailer |
650,000 |
$2,375,889 |
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Daimon (Japan) (c) |
Liquor Retailer & Distributor |
657,700 |
1,516,602 |
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Paris Miki Inc. (Japan) |
Optical Supplies Retailer |
85,100 |
1,140,024 |
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Giordano International Limited (Hong Kong) |
East Asian Clothing Retailer & Manufacturer |
3,112,000 |
421,691 |
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Jusco Stores Co., Limited (Hong Kong) |
Department Stores |
4,244,000 |
410,773 |
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5,864,979 |
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Other Consumer Goods & Services—6.5% |
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Sanford Limited (New Zealand) |
Fisheries |
1,275,240 |
$1,595,485 |
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CeWe Color Holding AG (Germany) |
Photo Equipment & Supplies |
9,400 |
1,519,806 |
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CDL Hotels International Limited (Hong Kong) |
Hotel Operator |
1,072,000 |
246,252 |
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3,361,543 |
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Banks—0.3% |
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Shinhan Bank (Korea) |
Commercial Bank |
47,764 |
$110,931 |
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Kookmin Bank (Korea) |
Commercial Bank |
11,351 |
27,587 |
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138,518 |
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Other Financial—11.0% |
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Lambert Fenchurch Group plc (Great Britain) |
Insurance Broker |
1,411,000 |
$2,470,805 |
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JCG Holdings Ltd. (Hong Kong) |
Investment Holding Company |
9,461,000 |
1,709,348 |
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Ichiyoshi Securities (Japan) |
Stock Broker |
1,575,000 |
1,498,847 |
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5,679,000 |
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Computer Software—7.5% |
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Enix Corporation (Japan) |
Entertainment Software |
129,100 |
$2,778,478 |
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Koei (Japan) |
Computer Software |
196,000 |
1,120,574 |
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3,899,052 |
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Computer Systems—3.9% |
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Solution 6 Holdings Limited (Australia), (a)(c) |
Systems Design & Consulting |
4,150,893 |
$1,992,286 |
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Marketing Services—5.0% |
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Cordiant Communications Group plc (Great Britain) |
Advertising Services |
1,428,500 |
$2,598,593 |
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Broadcasting & Publishing—5.2% |
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Matichon Public Company Limited, Foreign Shares (Thailand) (c) |
Newspaper Publisher |
2,038,900 |
$1,801,468 |
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Woongjin Publishing Company (Korea) |
Publisher |
107,076 |
908,501 |
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Matichon Public Company Limited (Thailand) |
Newspaper Publisher |
600 |
505 |
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2,710,474 |
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Telecommunications—0.5% |
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SK Telecom Co. Ltd. (Korea) |
Telecommunications |
803 |
$243,080 |
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Chemicals—2.0% |
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European Vinyls Corporation International N.V. (Netherlands) |
PVC Manufacturer |
83,100 |
$1,036,902 |
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Machinery & Metal Processing—1.5% |
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Denyo Co., Ltd. (Japan) |
Welding Machines & Power Generators |
184,000 |
$793,353 |
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Mining and Building Materials—3.1% |
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Parbury Limited (Australia) (c) |
Building Products |
11,119,712 |
$1,581,357 |
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Other Industrial Goods & Services—11.6% |
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Elevadores Atlas, SA (Brazil) |
Elevators |
229,200 |
$2,378,135 |
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Dongah Tire Industry Company (Korea), (a) |
Tire Manufacturer |
43,900 |
1,215,280 |
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Nishio Rent All Company (Japan) |
Construction Equipment Rental |
163,900 |
995,842 |
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Yip's Hang Cheung Ltd. (Hong Kong) (c) |
Paint & Solvents |
24,724,000 |
845,532 |
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Groupe Legris Industries SA (France) |
European Crane Manufacturer |
12,800 |
571,220 |
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6,006,009 |
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Production Equipment—3.9% |
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NSC Groupe (France) |
Manufacturer of Textile Equipment |
11,532 |
$1,637,191 |
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Skyjack Inc. (Canada), (a) |
Producer of Elevating Platforms & Lifts |
32,200 |
406,339 |
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2,043,530 |
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Steel—4.3% |
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Steel & Tube Holdings Ltd. (New Zealand) |
Produces and Distributes Steel |
2,995,400 |
$2,023,714 |
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Pohang Iron & Steel Company Ltd. (Korea) |
Manufactures Steel Products |
6,580 |
208,649 |
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2,232,363 |
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Diversified Conglomerates—4.6% |
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Haw Par Corporation Ltd. (Singapore) |
Healthcare and Leisure Products |
3,113,000 |
$2,397,452 |
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Total Common Stocks (Cost: $78,457,722) |
49,561,245 |
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Description |
Principal |
Market |
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Short Term Investments—1.9% |
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Repurchase Agreements—1.9% |
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State Street Repurchase Agreement, |
$967,000 |
$967,000 |
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Total Repurchase Agreements (Cost: $967,000) |
967,000 |
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Total Short Term Investments (Cost: $967,000) |
967,000 |
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Total Investments (Cost $79,424,722)—97.6% (d) |
$50,528,245 |
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Foreign Currencies (Proceeds $31,439)—0.1% |
31,436 |
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Other Assets In Excess Of Other Liabilities—2.3% (b) |
1,210,894 |
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Total Net Assets—100% |
$51,770,575 |
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(a) Non-income producing security.
(b) Includes portfolio and transaction hedges.
(c) See footnote number five in the Notes to Financial Statements regarding transactions in affiliated issuers.
(d) At September 30, 1998, net unrealized depreciation of $28,896,477, for federal income tax purposes consisted of gross unrealized appreciation of $437,043 and gross unrealized depreciation of $29,333,520.
