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 |
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| 9/30/99 NAV $13.88 |
Total Return Last 3 mos. |
Average Annual Total Return* Through 9/30/99 From Fund Inception 11/1/95 |
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| The Oakmark Small Cap Fund | -9.0% | 13.7% |
| Lipper Small Cap Fund Index** | -2.1% | 10.1% |
| Russell 2000 w/inc** | -6.3% | 11.3% |
| S&P Small Cap 600 w/inc** | -4.8% | 12.5% |
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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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The Oakmark Small Cap Fund's fiscal year ended on September 30, 1999. Results for the fourth quarter and the fiscal year were a disappointment. The Fund lost 9.0% in the quarter and gained only 10.6% for the year. These results lagged the relevant small cap indices. It is worth noting that since inception The Oakmark Small Cap Fund has outperformed the relevant indices. While we do not believe that our investment philosophy is flawed, it is definitely out of favor. Still, we are taking steps to improve the investment performance of the Fund.
WHAT ARE WE DOING?
We are firmly committed to our style of value investing. Over time, it has produced results that best accomplish our long-term investment objectives. In the last year we have been much more active in the portfolio. Although we try to keep turnover as low as possible to limit taxable events, buy and sell decisions are not driven by tax considerations. However, if I have scared any shareholders away by the thought of a year-end distribution, rest assured that our expectation is that there will not be a distribution this year.
During the past year we have had substantial changes in the holdings of The Oakmark Small Cap Fund. This activity increased the net number of holdings to 45. What drove this activity? Succinctly, investment opportunities. Our investment process requires that we continually scan and monitor the small cap stock universe for new ideas. In a difficult small cap stock environment it is only natural that we should come across new ideas that are more attractive than some of our existing holdings. My primary responsibilities are to see that the portfolio is composed of the most attractive investment ideas available and adhere to our disciplined style of value investing. I am very encouraged by the attractive valuation level of the portfolio, the mix and quality of the businesses we own, and the strength of the people who guide these companies.
The past year had its disappointments, but also had its bright spots. The Fund's three largest holdings Symantec Corp., SPX Corp., and Duff & Phelps Credit Rating Co. gained 173%, 120%, and 74%, respectively. I credit much of the appreciation of these companies share prices to the due diligence of our research staff. Sourcing of ideas is not a simple task and this group is a valuable asset in helping to produce investment results.
Another encouraging sign is that we were not the only ones to recognize the value of our holdings. In the course of the fiscal year five of our holdings were acquired by other companies that saw the values we had also discovered. First Brands Corporation, Paymentech, Inc., Scotsman Industries, Inc., Sequent Computer Systems, Inc., and American Heritage Life Investment Corporation were all acquired in the past fiscal year.
This begs the question: what went wrong? There are two parts to this answer. First, small cap stocks and, in particular, value stocks remain out of favor. The valuation gap between large cap stocks and small cap stocks, and growth stocks and value stocks, has continued to widen. Since I have made this point ad nauseam in previous shareholder letters, there is no point in belaboring it. Second, our investment in ARM Financial turned into nothing short of an investment disaster. We eliminated the holding from the portfolio in the fourth quarter, but not before significant losses were realized. The full story on all that went wrong at ARM is still not known from public information available to investors. Suffice it to say that by the number of lawsuits filed against the company it appears likely that we won't know all the facts until these issues circulate through the courts.
WHAT ELSE ARE WE DOING?
I have received numerous comments that as shareholders you would like to hear more about the holdings of the Fund. We added a number of new holdings to the portfolio in the quarter. A brief description of four of them follows:
Hudson City Bancorp, Inc. (HCBK) is a very well run thrift based in New Jersey. It recently converted to public ownership through the Mutual Holding Company structure. HCBK has a significant share of loans and deposits in their market. We believe their shares are trading at a significant discount to their underlying value.
The Great Atlantic & Pacific Tea Company, Inc. (GAP) is an old-line grocery store chain based in the Northeast. GAP is controlled by the Haub family that has stepped in to operate the business. Their goal is to improve the margins and achieve industry-like returns from the company.
ITT Educational Services, Inc. (ESI) is a leading provider of technology-oriented post-secondary degree programs. We see demographics benefiting their business and are highly intrigued by the high free cash flow characteristics of their operations.
National Data Corporation (NDC) is a merchant processor of credit card transactions and a health care information service provider. NDC should have tremendous internal and external growth opportunities. The shares are close to their 52-week low and very attractively valued.
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
October 11, 1999
THE OAKMARK SMALL CAP FUND |
| Shares Held | Market Value | |
| Common Stocks—98.5% | ||
| Food & Beverage—7.6% | ||
| Del Monte Foods Company (a) | 1,000,000 | $14,125,000 |
| Ralcorp Holdings, Inc. (a) | 500,000 | 8,843,750 |
| International Multifoods Corporation | 275,000 | 6,325,000 |
| M & F Worldwide Corp. (a) | 500,000 | 4,000,000 |
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| 33,293,750 | ||
| Apparel—1.8% | ||
| Reebok International Ltd. (a) | 750,000 | $8,015,625 |
| Retail—8.7% | ||
| The Great Atlantic & Pacific Tea Company, Inc. | 500,000 | $15,156,250 |
| Ugly Duckling Corporation (a)(c) | 1,750,000 | 12,468,750 |
| Michaels Stores, Inc. (a) | 350,000 | 10,325,000 |
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| 37,950,000 | ||
| Hardware—1.0% | ||
| Jore Corporation (a) | 353,000 | $4,213,938 |
| Other Consumer Goods & Services—7.0% | ||
| Department 56, Inc. (a) | 500,000 | $11,968,750 |
| Libbey, Inc. | 300,000 | 8,868,750 |
| Barry (R.G.) Corporation (a)(c) | 900,000 | 5,512,500 |
| Harman International Industries, Incorporated | 100,000 | 4,206,250 |
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| 30,556,250 | ||
| Banks & Thrifts—10.2% | ||
| People's Bank of Bridgeport, Connecticut | 500,000 | $11,812,500 |
| Golden State Bancorp Inc. (a) | 600,000 | 10,762,500 |
| BankAtlantic Bancorp, Inc., Class A | 1,150,001 | 6,396,881 |
| Hudson City Bancorp, Inc. (a) | 400,000 | 5,500,000 |
| Northwest Bancorp, Inc. | 500,000 | 4,312,500 |
| PennFed Financial Services, Inc. | 260,000 | 3,900,000 |
| Finger Lakes Financial Corp. (c) | 185,500 | 1,808,625 |
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| 44,493,006 | ||
| Insurance—6.6% | ||
| The MONY Group Inc. (a) | 500,000 | $14,437,500 |
| The PMI Group, Inc. | 350,000 | 14,306,250 |
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| 28,743,750 | ||
| Other Financial—5.5% | ||
| Duff & Phelps Credit Rating Co. (c) | 300,000 | $23,981,250 |
| Educational Services—2.7% | ||
| ITT Educational Services, Inc. (a) | 600,000 | $11,700,000 |
| Information Services—1.8% | ||
| National Data Corporation | 300,000 | $7,800,000 |
| Computer Services—6.6% | ||
| Symantec Corporation (a) | 800,000 | $28,775,000 |
| Computer Systems—1.8% | ||
| Micron Electronics, Inc. (a) | 750,000 | $7,875,000 |
| Managed Care Services—2.0% | ||
| First Health Group Corp. (a) | 400,000 | $8,975,000 |
| Automotive—7.4% | ||
| SPX Corporation (a) | 200,000 | $18,150,000 |
| Standard Motor Products, Inc. | 500,000 | 9,718,750 |
| Stoneridge, Inc. (a) | 250,000 | 4,343,750 |
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| 32,212,500 | ||
| Transportation Services—2.5% | ||
| Teekay Shipping Corporation (b) | 700,000 | $10,937,500 |
| Instruments—0.5% | ||
| Varian Inc. (a) | 135,000 | $2,396,250 |
| Machinery & Industrial Processing—9.5% | ||
| Columbus McKinnon Corporation | 600,000 | $10,350,000 |
| Graco Inc. | 250,000 | 8,203,125 |
| MagneTek, Inc. (a) | 900,000 | 8,043,750 |
| Tokheim Corporation (a)(c) | 860,000 | 7,686,250 |
| Sames Corporation (c) | 250,000 | 4,468,750 |
| Northwest Pipe Company (a) | 185,000 | 2,890,625 |
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| 41,642,500 | ||
| Chemicals—4.8% | ||
| H.B. Fuller Company | 200,000 | $12,175,000 |
| Ferro Corporation | 404,200 | 8,614,512 |
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| 20,789,512 | ||
| Real Estate—6.9% | ||
| Catellus Development Corporation (a) | 1,400,000 | $16,450,000 |
| Prime Hospitality Corp. (a) | 900,000 | 7,200,000 |
| Trammell Crow Company (a) | 500,000 | 6,625,000 |
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| 30,275,000 | ||
| Diversified Conglomerates—3.6% | ||
| U.S. Industries, Inc. | 1,000,000 | $15,750,000 |
| Total Common Stocks (Cost: $414,120,043) | 430,375,831 | |
| Par Value | Market Value | |
| Short Term Investments—3.0% | ||
| Commercial Paper—2.3% | ||
| General Electric Capital Corporation, 5.53% due 10/1/1999 | $10,000,000 | $10,000,000 |
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| Total Commercial Paper (Cost: $10,000,000) | 10,000,000 | |
| Repurchase Agreements—0.7% | ||
| State Street Repurchase Agreement, 5.20% due 10/1/1999 | $3,325,000 | $3,325,000 |
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| Total Repurchase Agreements (Cost: $3,325,000) | 3,325,000 | |
| Total Short Term Investments (Cost: $13,325,000) | 13,325,000 | |
| Total Investments (Cost $427,445,043)—101.5% (d) | $443,700,831 | |
| Other Liabilities In Excess Of Other Assets—(1.5)% | (6,561,552) | |
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| Total Net Assets—100% | $437,139,279 | |
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(a) Non-income producing security.
(b) Represents foreign domiciled corporation.
(c) See footnote number five in the Notes to Financial Statements regarding transactions in affiliated issuers.
(d) At September 30, 1999, net unrealized appreciation of $16,255,788, for federal income tax purposes, consisted of gross unrealized appreciation of $71,981,161 and gross unrealized depreciation of $55,725,373.