THE OAKMARK INTERNATIONAL AND
OAKMARK INTERNATIONAL SMALL CAP FUNDS

David G. Herro photo
  

Fellow Shareholders,

Your Funds have achieved a satisfactory performance for the quarter ending March 31st with The Oakmark International Fund achieving a return of 2% and The Oakmark International Small Cap Fund returning 5%. This compares favorably with the MSCI World ex U.S. Index15. More importantly, since the Funds’ inception, they have strongly outperformed the MSCI World ex U.S. Index.

With little imbalance in the global macroeconomic system and subsiding political fears, foreign equity markets, in local market terms, started the year positively. Additionally, a strong global economy and good profitability also helped create an attractive equity environment. We continue to believe that the international equity markets represent good value, as signified by acceptable—and rising—profitability levels and attractive valuations.

Look out below!

One potential problem may be a deflation of the commodity bubble. Whether it is metals or energy, prices have risen to record levels. Due to the forces of supply and demand, producers are willing to take advantage of this by looking to increase output. Meanwhile, panicked Chinese industrial companies from steel to shipping are also aggressively adding “supply” by ramping up capacity. Though I am optimistic about the Chinese economy, in the short to medium term some companies in these industries likely will be clobbered by falling prices just as their new capacity comes on stream. Though this would be damaging for steel and other commodity producers, in all likelihood, it would be good for the consumers of these products.

Corporate Governance, cont’d

Lately a couple of our holdings have attracted attention in the media because of corporate governance issues. First, Deutsche Boerse (DB), the German based owner of the German stock exchange, and Euronext, its counterpart in other major European exchanges, have expressed interest in acquiring The London Stock Exchange (LSE). Both deals would represent major transactions for either purchaser. This quarter, DB made a bid for the LSE. However, DB management announced that they would not seek shareholder approval for the purchase, as no formal rule required them to do so. This upset a number of major shareholders, including ourselves, forcing DB to table its bid. I believe, in most cases, that the owners of corporations should have to approve major business-changing deals, and we will continue to watch closely the LSE situation. In the case of Euronext, the other potential bidder, they must, by law, receive approval from their owners.

Another company, Nestle, has attracted global attention, as their Board of Directors desires to combine the CEO role with that of Chairman. Though we are extremely pleased with the improving operational management at Nestle, this governance move flies against commonly accepted international corporate governance principles that call for a separation of these two positions. Geneva-based Ethos Foundation and ISS have come out forcefully against this move and I have publicly supported that position. I feel strongly that in order to protect owners’ interests, strong, independent corporate boards need to be led by strong, independent chairmen. Though we do not feel it is our role to meddle in the details of how companies are managed, it is our role to help ensure that the board members (who are elected by shareholders) act in the best interests of the shareholders. We are pleased that Nestle’s management has recognized the importance of “separation” and has agreed to make this departure from principle temporary.

A very important part of our investment philosophy is to invest with management teams that “think, and (more importantly) act, like owners”. We will continue to monitor the corporate governance practices of our holdings as well as those of potential investments.

David G. Herro signature
David G. Herro, CFA
Portfolio Manager
dherro@oakmark.com