The Oakmark Fund
Report from Robert J. Sanborn, Portfolio Manager
The Oakmark FundReport from Robert J. Sanborn, Portfolio Manager |
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THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK FUND FROM ITS INCEPTION (8/5/91) TO PRESENT (9/30/98) AS COMPARED TO THE STANDARD & POOR'S 500 INDEX |
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9/30/98 NAV $33.54 |
Total Return |
Average Annual Total Return* |
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The Oakmark Fund |
-13.8% |
25.2% |
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Standard & Poor's 500 Stock Index w/inc** |
-10.0% |
17.3% |
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Dow Jones Industrial Average w/inc** |
-12.0% |
17.1% |
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Value Line Composite Index** |
-19.6% |
6.7% |
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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 stocks whose composition is different from the Fund. The S&P 500 is a broad market-weighted average dominated by blue-chip stocks. The Dow Jones Average includes only 30 big companies. The Value Line Index is an unweighted average of more than 1,000 stocks. Past performance is no guarantee of future results. |
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WHAT A SUMMER AND WHAT A YEAR...!
...and am I glad it's over!
Summer was beautiful in Chicago—great weather, another Bulls championship, Sammy Sosa and the Cubs. It was also the summer we learned the definitions of a lot of neat words—"salacious," "parse," and "is," among others.
Yet, it was (and remains!) a very rocky period for the global economy and financial markets. The emerging market contagion, Monicagate, and the hedge fund debacle all combined to make equity markets very volatile. In the past month-and-a-half, the Standard & Poor's 500 had 17 trading sessions where it was up or down more than 1 percent! The height of what Shakespeare termed in Twelfth Night "this very midsummer madness" occurred on the morning of Friday, September 11. The Dow opened down big, but in the course of about ten minutes reversed, appreciating more than 3 percent. The proximate cause of this stunning reversal? President Clinton's tearful confession that he had "sinned." The market took this confession as sincere—as opposed to his prior confessions—and, I guess, interpreted these ostensibly real tears as increasing the chance that he will remain in office for the rest of his term.
What are value investors like ourselves to do in this sort of wacky environment in which stock prices are decoupled from intrinsic value?
Well, in light of the new forces driving the stock market, we have decided to abandon our one-stock-at-a-time, value-based philosophy. Instead, we have hired a linguist to interpret the nuances of the pronouncements of President Clinton and Alan Greenspan, we have installed cable tuned to CNBC in every investment professional's office, and have implemented a new investment philosophy we term "Buy what's going up." We are very optimistic that these moves will get us back in synch with the current market.
Just kidding. Repeat: just kidding. REPEAT: JUST KIDDING.
This has been a frustrating year and quarter for us (and for virtually all value investors, be they large cap, small cap, international—whatever). For the year, we lagged behind the S&P 500 by thirteen percent and, for the quarter, four percent. Last quarter, I discussed what I consider to be the reasons for this, and things have not changed. Frankly, many professional investors tend to be either paralyzed by the market weakness or, even worse, abandon their stated philosophies in pursuit of "performance." Many mutual fund managers encounter pressure from their shareholders and bosses to "do something"; generally, this means buying the hot stocks and selling the cold ones.
What are we doing? Well, both in our business affairs and our investment execution, we always do the same thing no matter what the environment. We continue to adhere to our philosophy and tune out all the noise. In fact, I am more confident about our Fund's prospects than I have been in a long time. Apparently, the managements of most of our holdings agree, as share repurchase activity among our holdings is at a very high level. As I have said before, we do not regard share buybacks as a panacea, but when stocks are trading significantly below value, they are a very efficient way to increase long-term value per share. In the market declines of 1987 and 1990, these were early indicators of under-valuation in many stocks. I believe it will also be the case this time.
As I write this, we are seeing very attractive buying opportunities and, in fact, putting our cash reserves to work. As many of our competitors adopt shorter and shorter investment time-frames, we find less competition from others with our long-term time-frame. While the volatility and uncertainty we are witnessing is not pleasant, it does present us with opportunities that should pay off over time. In future quarters, I hope to discuss individual investments at length.
In closing, and mining the same vein that characterized this summer's most famous speech, I take complete responsibility for the performance of the Fund, this has gone on too long and hurt too many innocent people. If I have ever misled anyone—even my wife—that returns would be straight up to the moon, I offer my regret. God bless you and God bless The Oakmark Fund!
HEDGE FUND 101
What do you get in an investment firm where partners are ex-Vice Chairman of the Fed, two Nobel Prize winners in economics, and one of the all-time legendary traders? Answer: a decline in your portfolio of over 90 percent this year. Long-Term Capital Management was once a successful hedge fund that has been—alas!—in the news a lot recently.
A hedge fund is an investment vehicle whose investors are institutions and very wealthy individuals. Due to this clientele, hedge funds are exempt from most of the onerous regulations that other financial institutions—such as banks and mutual funds—must follow. While hedge funds follow a large variety of strategies, most use borrowed money to enhance returns.
The ironically named Long-Term Capital Management was formed by an ex-Solomon Brothers trader who figured prominently in the book Liar's Poker. Its specialty was in the fixed-income area. Generally, using computer models, its strategy was to buy and short a wide variety of debt securities that its computers identified as mispriced. During this past summer, Long-Term's portfolio consisted of about $100 billion of securities, and the fund itself had partner equity of around $3.5 billion. This leverage ratio of almost 30:1 made the fund a high-octane one but also made it very vulnerable if its model failed. Thus, after financing costs, if Long-Term was able to eke out a one percent gain from its portfolio, the leverage would allow the partners to realize a return of 30%.
Long-Term Capital attracted some very savvy investors, including the heads of many of Wall Street's most prominent firms. The terms were pretty tough: investors paid a management fee plus a percentage of profits, were given only a sketchy annual peek at the portfolio, and had to commit capital for three years. With the outsized gains that were generated, why worry?
Well, just like the seemingly infallible HAL in 2001: A Space Odyssey, Long-Term's computers made a boo-boo. Its models undoubtedly were sophisticated, but depended upon order in the markets in which it invested. (This was the same assumption that blew up portfolio insurance, which was partly responsible for the Crash of 1987). Well, this summer saw volatile, disorderly markets. Long-Term's bets were off, and the leverage magnified them. Long-Term has surrendered virtual control to a passel of financial institutions who had lent it all that money.
Personally, I think the long-term effects of Long-Term's demise are negligible. Its clients can afford the loss and should have known about the risk. Perhaps lenders to hedge funds will now exercise more discretion. However, the long-term effect on the economy and the stock market is nil.
Individual investors can learn two important lessons from Long-Term. The first is a skepticism towards focusing soley on the historical returns of an investment vehicle. Just looking at the returns Long-Term was generating in its first few years of existence enticed a lot of people who should have known better. A responsible investor should know how one's money is being invested, the philosophy behind it, the leverage and any derivatives used, etc. The second is the ironclad relation between risk and return. Prior to this year, Long-Term had racked up great returns with an apparently low-risk system. We now know the risk was far greater than had been assumed by its investors.
ROBERT J. SANBORN
Portfolio Manager
rsanborn@oakmark.com
October 5, 1998
THE OAKMARK FUND |
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Shares Held/ |
Market Value |
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Common Stocks—88.5% |
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Food & Beverage—15.2% |
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Philip Morris Companies Inc. |
13,810,700 |
$636,155,369 |
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H.J. Heinz Company |
4,007,250 |
204,870,656 |
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Gallaher Group Plc (b) |
3,835,500 |
112,667,812 |
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Nabisco Holdings Corporation, Class A |
2,572,100 |
92,434,844 |
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The Quaker Oats Company |
118,000 |
6,962,000 |
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1,053,090,681 |
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Apparel—6.1% |
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Nike, Inc., Class B |
11,457,100 |
$421,764,494 |
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Retail—0.3% |
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American Stores Company |
648,400 |
$20,870,375 |
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Other Consumer Goods & Services—20.1% |
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Mattel, Inc. |
13,439,400 |
$376,303,200 |
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The Black & Decker Corporation (c) |
8,267,000 |
344,113,875 |
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H&R Block, Inc. (c) |
7,665,800 |
317,172,475 |
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Polaroid Corporation (c) |
4,552,400 |
111,818,325 |
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Brunswick Corporation (c) |
7,280,800 |
94,195,350 |
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Fortune Brands, Inc. |
2,746,800 |
81,373,950 |
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Juno Lighting, Inc. (c) |
1,085,000 |
24,276,875 |
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First Brands Corporation |
1,070,400 |
23,348,100 |
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GC Companies, Inc. (a)(c) |
397,000 |
15,334,125 |
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1,387,936,275 |
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Banks & Thrifts—14.0% |
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Banc One Corporation |
8,800,548 |
$375,123,359 |
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Washington Mutual, Inc. |
10,100,000 |
340,875,000 |
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Mellon Bank Corporation |
4,540,500 |
250,011,281 |
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966,009,640 |
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Insurance—1.3% |
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Old Republic International Corporation |
4,122,930 |
$92,765,925 |
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Publishing—4.8% |
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Knight-Ridder, Inc. (c) |
6,929,400 |
$308,358,300 |
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R. H. Donnelley Corporation (c) |
2,098,260 |
25,965,967 |
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334,324,267 |
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Information Services—5.6% |
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The Dun & Bradstreet Corporation (c) |
10,491,300 |
$283,265,100 |
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ACNielsen Corporation (c) |
4,764,000 |
105,999,000 |
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389,264,100 |
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Computer Services—2.2% |
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Electronic Data Systems Corporation |
4,588,000 |
$152,264,250 |
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Medical Centers—3.9% |
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Columbia/HCA Healthcare Corporation |
13,601,000 |
$272,870,063 |
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Medical Products—0.9% |
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Sybron International Corporation (a) |
3,135,600 |
$59,968,350 |
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Automotive—0.5% |
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SPX Corporation (a)(c) |
875,200 |
$36,156,700 |
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Aerospace & Defense—9.1% |
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Lockheed Martin Corporation |
3,625,000 |
$365,445,312 |
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The Boeing Company |
7,599,400 |
260,754,413 |
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626,199,725 |
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Machinery & Industrial Processing—2.5% |
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Eaton Corporation |
2,721,100 |
$170,578,956 |
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Forestry Products—0.1% |
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Fort James Corporation |
237,200 |
$7,783,125 |
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Mining—1.2% |
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DeBeers Centenary AG (b) |
6,546,000 |
$82,234,125 |
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Other Industrial Goods & Services—0.7% |
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Bandag Incorporated, Class A |
1,104,100 |
$34,227,100 |
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The Geon Company |
971,600 |
17,245,900 |
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51,473,000 |
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Total Common Stocks (Cost: $5,810,888,085) |
6,125,554,051 |
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Principal Value |
Market Value |
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Short Term Investments—11.0% |
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Government and Agency Securities—1.4% |
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U.S. Government Bills—1.4% |
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United States Treasury Bills, 4.29%–5.15% due 10/15/1998–1/14/1999 |
100,000,000 |
$99,199,666 |
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Total Government and Agency Securities (Cost: $99,146,486) |
99,199,666 |
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Commercial Paper—7.4% |
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American Express Credit Corp., 5.27%–5.55% due 10/1/1998–10/14/1998 |
$180,000,000 |
$180,000,000 |
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Ford Motor Credit Corp., 5.40%–5.55% due 10/1/1998–10/9/1998 |
160,000,000 |
160,000,000 |
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General Electric Capital Corporation, 5.45%–5.70% due 10/1/1998–10/5/1998 |
170,000,000 |
170,000,000 |
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Total Commercial Paper (Cost: $510,000,000) |
510,000,000 |
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Repurchase Agreements—2.2% |
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State Street Repurchase Agreement, 5.30% due 10/1/1998 |
$153,865,000 |
$153,865,000 |
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Total Repurchase Agreements (Cost: $153,865,000) |
153,865,000 |
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Total Short Term Investments (Cost: $763,011,486) |
763,064,666 |
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Total Investments (Cost $6,573,899,571)—99.5% (d) |
$6,888,618,717 |
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Other Assets In Excess Of Other Liabilities—0.5% |
35,339,165 |
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Total Net Assets—100% |
$6,923,957,882 |
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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 September 30, 1998, net unrealized appreciation of $314,719,146, for federal income tax purposes consisted of gross unrealized appreciation of $1,142,918,937 and gross unrealized depreciation of $828,199,791.
