The Oakmark Small Cap Fund
Report from Steven J. Reid, Portfolio Manager
The Oakmark Small Cap FundReport from Steven J. Reid, Portfolio Manager |
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THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK SMALL CAP FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (12/31/98) AS COMPARED TO THE RUSSELL 2000 INDEX |
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12/31/98 NAV $14.77
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Total Return |
Average Annual |
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The Oakmark Small Cap Fund |
17.7% |
19.6% |
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Lipper Small Cap Fund Index** |
18.4% |
10.3% |
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Russell 2000 w/inc** |
16.3% |
13.3% |
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S&P Small Cap 600 w/inc** |
17.6% |
15.7% |
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*Total return includes change in share prices and in each case includes reinvestment of any dividends and capital gain distributions. **Each of the three indexes or averages is an unmanaged group of stocks or funds whose composition is different from the Fund. The Lipper Small Cap Fund Index is comprised of 30 Small Cap Funds. The Russell 2000 Index measures the performance of smaller companies, and represents approximately 10% of the total value of publicly traded companies in the U.S. The S&P 600 Index measures the performance of selected U.S. stocks with small market capitalization. Past performance is no guarantee of future results. |
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WHAT'S OLD
1998 is over, and I will not miss it. While the mega-cap and super-high-growth stocks continued to soar, the marketplace largely ignored small cap stocks. However, as we enter 1999 on the eve of the millennium, there are several reasons to be optimistic. It takes a strong imagination to conjure up a list of headlines that would top the events of 1998. Last year was rife with real and imagined financial and political crises. Although the share price of the companies we own do not reflect it, in general, our holdings continued to grow their underlying value. Our Fund trades at a large discount to its underlying value. The Oakmark Small Cap Fund's first fiscal quarter ended on December 31, 1998. Results for the quarter were encouraging; your Fund appreciated 17.65%, which was in line with the relevant indices.
CONSISTENCY AND CONFIRMATION OF VALUE: THE IMPORTANCE OF BEING THERE
We manage your Fund with a very consistent investment philosophy, regardless of the overall market environment. We do not try to guess the price direction of our holdings, but simply buy those holdings with good managements that sell at the largest discount to their underlying value. Sometimes it takes a long time to close the gap between price and value and sometimes—as with the case of First Brands (FBR)—it can happen overnight.
In early July, First Brands announced a slowdown in their business which led to lower net income in the June quarter. The market reacted negatively to the announcement and the shares declined in price as many holders headed for the exits. The problems FBR faced were very short-term in nature and the near-term fundamentals were actually very favorable. Investments should be made with a forward-looking vision, not with one's eyes focused on the rear view mirror. I took advantage of this price drop and purchased additional shares for The Oakmark Small Cap Fund and FBR became one of our larger holdings.
As it happens, we were not the only ones sensing this opportunity. On October 19, Clorox (CLX) announced it would acquire FBR for $39 per share, a significant premium over the price FBR was trading in the market (as well as our cost). This confirmed two things: one, that we had correctly assessed that FBR was undervalued and, two, that management's interest was aligned with shareholders. In other words, our investment rationale was utterly validated.
This is also a great example of the importance of a forward-looking perspective to investing. Had we sold FBR on the news that the past quarter's earnings would not meet expectations, we would merely be a part of the legion of shortsighted lemmings. Obviously, an event such as CLX's acquisition of FBR is an instantaneous confirmation of value. It was our long-term investment horizon and discipline in the face of a difficult market environment that allowed us to be there for such an event.
WHAT'S NEW
Declining share prices represent a two-way street. On the one hand, a price decline does impact the short-term value of your portfolio. On the other hand, if the investment rationale and intrinsic value are still intact, a price decline represents an opportunity. (Of course, when lettuce is selling at 2-for-1 in the supermarket, it can lead one to search for brown spots). The broad-based decline in small cap companies, particularly those that fit a value-oriented investment philosophy, has created a number of new investment opportunities for the Fund. I believe that our Fund sells at the biggest discount to underlying value in its short history.
In fact, more new names were added to the portfolio through this past year's market decline than at any other time during the Fund's short history. During the past quarter, a number of new companies were added to the portfolio. One of those, Paymentech Inc. (PTI), was a former holding of the Fund. PTI is a processor of credit card transactions. It is also the closest thing we have to an Internet company. One of the attractive attributes of Paymentech is that it is a large processor of Internet credit card transactions. However, unlike most Internet companies, PTI has revenues, earnings, and an operating history that goes back years instead of months.
Another addition to the portfolio is the Mony Group (MNY). Mony is probably better recognized as the old Mutual of New York. During November, MNY converted from a mutual insurance company (owned by its policyholders) to a publicly traded insurance company (owned by its shareholders). While the company is attractively priced, we believe that, over the long term, management will be able to improve the operating returns significantly. A much more recognizable addition to the portfolio is Reebok International Ltd. (RBK). Reebok is a bit of a turnaround situation, having stepped on its own shoelaces during the past two years. After a recent visit with management at their headquarters, we believe management has what it takes to revitalize the company's lackluster product line and financial performance. We believe that Reebok's current share price poses little risk versus upside potential if they can execute their plan to improve results.
REDEMPTIONS, DISTRIBUTIONS, AND RE-OPENING... PART II
In the annual report last quarter, I discussed a brief explanation of some of the events of this year. In the January issue of "Smart Money" magazine, Tom Lauricella wrote a lengthy article entitled "Caught in the Crossfire," which portrays an accurate, but slightly dramatized picture of how The Oakmark Small Cap Fund and I operate. Since the article was published, I have received numerous comments, phone calls, and e-mails regarding Tom's article. If you have the opportunity, take a look at the article and let me know your thoughts. Those who have read it overwhelmingly appreciated it.
Once again, I would like to thank everyone involved, especially our shareholders, for your support of The Oakmark Small Cap Fund.
STEVEN J. REID
Portfolio Manager
sreid@oakmark.com
January 13, 1999
THE OAKMARK SMALL CAP FUND |
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Shares Held |
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Common Stocks—94.9% |
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Food & Beverage—10.2% |
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Ralcorp Holdings, Inc. (a) |
1,213,500 |
$22,146,375 |
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Triarc Companies, Inc. (a) |
1,250,000 |
20,000,000 |
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Vlasic Foods International Inc. (a) |
500,000 |
11,906,250 |
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International Multifoods Corporation |
400,000 |
10,325,000 |
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M & F Worldwide Corp. (a) |
750,000 |
7,546,875 |
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71,924,500 |
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Apparel—2.1% |
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Reebok International Ltd. |
1,000,000 |
$14,875,000 |
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Retail—5.3% |
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Department 56, Inc. (a) |
750,000 |
$28,171,875 |
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Ugly Duckling Corporation (a) |
1,750,000 |
8,093,750 |
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The Great Atlantic & Pacific Tea Company, Inc. |
28,400 |
841,350 |
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37,106,975 |
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Other Consumer Goods & Services—7.8% |
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Libbey, Inc. |
750,000 |
$21,703,125 |
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Scotsman Industries, Inc. |
835,200 |
17,173,800 |
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Barry (R.G.) Corporation (a) |
900,000 |
9,900,000 |
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P.H. Glatfelter Company |
500,000 |
6,187,500 |
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54,964,425 |
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Banks & Thrifts—8.9% |
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People's Bank of Bridgeport, Connecticut |
1,450,000 |
$40,056,250 |
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BankAtlantic Bancorp, Inc., Class A |
1,000,001 |
6,437,506 |
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Northwest Bancorp Inc. |
600,000 |
5,850,000 |
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Niagara Bancorp Inc. (a) |
417,500 |
4,383,750 |
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PennFed Financial Services, Inc. |
260,000 |
3,380,000 |
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Finger Lakes Financial Corp. |
188,000 |
2,162,000 |
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62,269,506 |
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Insurance—2.4% |
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The MONY Group Inc. (a) |
543,600 |
$17,021,475 |
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Other Financial—5.9% |
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ARM Financial Group, Inc., Class A |
1,000,000 |
$22,187,500 |
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Duff & Phelps Credit Rating Co. |
350,000 |
19,184,375 |
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41,371,875 |
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Broadcasting & Cable TV—1.6% |
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Ascent Entertainment Group, Inc. (a) |
1,500,000 |
$11,062,500 |
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Computer Services—6.8% |
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Symantec Corporation (a) |
1,500,000 |
$32,625,000 |
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Paymentech, Inc. (a) |
800,000 |
14,800,000 |
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47,425,000 |
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Computer Systems—2.2% |
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Micron Electronics, Inc. (a) |
600,000 |
$10,387,500 |
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Sequent Computer Systems, Inc. (a) |
400,000 |
4,825,000 |
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15,212,500 |
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Managed Care Services—1.4% |
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First Health Group Corp. (a) |
600,000 |
$9,937,500 |
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Automotive—8.8% |
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SPX Corporation (a) |
400,000 |
$26,800,000 |
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Stoneridge, Inc. (a) |
1,000,000 |
22,875,000 |
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Standard Motor Products, Inc. |
500,000 |
12,125,000 |
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61,800,000 |
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Transportation Services—3.2% |
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Teekay Shipping Corporation (b) |
1,000,000 |
$18,812,500 |
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Air Express International Corporation |
180,000 |
3,915,000 |
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22,727,500 |
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Machinery & Industrial Processing—2.6% |
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Graco, Inc. |
250,000 |
$7,375,000 |
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Northwest Pipe Company (a) |
400,000 |
6,450,000 |
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DT Industries, Inc. |
300,000 |
4,725,000 |
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18,550,000 |
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Forestry Products—1.0% |
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Schweitzer-Mauduit International, Inc. |
450,000 |
$6,946,875 |
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Other Industrial Goods & Services—12.9% |
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Ferro Corporation |
860,700 |
$22,378,200 |
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H.B. Fuller Company |
400,000 |
19,250,000 |
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Columbus McKinnon Corporation |
967,500 |
17,415,000 |
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MagneTek, Inc. (a) |
1,500,000 |
17,343,750 |
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Watts Industries, Inc. |
600,000 |
9,975,000 |
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Binks Sames Corporation |
275,000 |
4,537,500 |
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90,899,450 |
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Real Estate—6.4% |
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Catellus Development Corporation (a) |
2,250,000 |
$32,203,125 |
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Prime Hospitality Corp. (a) |
1,200,000 |
12,675,000 |
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44,878,125 |
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Diversified Conglomerates—5.4% |
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U.S. Industries, Inc. |
2,050,000 |
$38,181,250 |
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Total Common Stocks (Cost: $653,829,697) |
667,154,456 |
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Principal Value |
Market Value |
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Short Term Investments—3.8% |
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Commercial Paper—2.1% |
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General Electric Capital Corporation, 4.70% due 1/4/1999 |
$15,000,000 |
$15,000,000 |
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Total Commercial Paper (Cost: $15,000,000) |
15,000,000 |
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Repurchase Agreements—1.7% |
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State Street Repurchase Agreement, 4.50% due 1/4/1999 |
$11,854,000 |
$11,854,000 |
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Total Repurchase Agreements (Cost: $11,854,000) |
11,854,000 |
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Total Short Term Investments (Cost: $26,854,000) |
26,854,000 |
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Total Investments (Cost $680,683,697)—98.7% |
$694,008,456 |
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Other Assets In Excess Of Other Liabilities—1.3% |
9,219,383 |
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Total Net Assets—100% |
$703,227,839 |
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(a) Non-income producing security.
(b) Represents a foreign domiciled corporation.
