The Oakmark Global Fund earned 0.1% in the quarter, trailing the 5.0% that the MSCI World Index generated and the 3.4% that the Lipper Global Fund Index returned. For the calendar nine months, the Fund lost 2.8%, compared to a return of 5.4% for the MSCI World Index and 2.7% for the Lipper Global Fund Index. Finally, for the Fund’s fiscal year ended September 30, the Fund earned 1.0%, which compares to 11.2% for the MSCI World Index and 7.6% for the Lipper Global Fund Index.
The countries that contributed most to return in the quarter were the U.S., Australia and India, while South Africa, Switzerland and the U.K. detracted from return. Mastercard (U.S.), Arconic (U.S.), CNH Industrial (U.K.), Oracle (U.S.) and Alphabet (U.S.) were the largest contributors to return, while Travis Perkins (U.K.), General Motors (U.S.), Naspers (South Africa), Bayer (Germany) and Julius Baer Group (Switzerland) detracted most.
Over the calendar nine months, the U.S., China and the Netherlands were the countries that contributed most to return—and, in fact, were the only ones to generate a positive return—while the U.K., Germany and Switzerland detracted. The companies whose stocks contributed most were all from the U.S.: Mastercard, Tenet Healthcare, Alphabet, Interpublic Group and National Oilwell Varco. The largest detractors from return were Daimler (Germany), Travis Perkins, General Motors, Credit Suisse (Switzerland) and Lloyds Banking Group (U.K.).
For the Fund’s fiscal year ended September 30, the U.S., Australia and India contributed most to return while the U.K., Switzerland and Mexico detracted. Again, the contributors for the period were all U.S.-domiciled: Mastercard, Alphabet, Tenet Healthcare, Bank of America and USG. The largest detractors for the 12 months were Daimler, Travis Perkins, General Electric (U.S.-sold), Grupo Televisa (Mexico) and Naspers.
After an exceptional 32% return in the previous fiscal 12 months, fiscal 2018 proved disappointing. The worldwide investing environment itself has been unusual: according to the Financial Times, “the relative performance of the S&P 500 versus the rest of the world is now at its most extreme level since 1970.” We are fundamental value investors who seek to identify individual equities selling at a material discount to their intrinsic business value. As such, we do not make macro predictions such as “U.S. stocks will dominate non-U.S.” We go wherever value takes us, and that led us to weight the Global Fund more heavily in non-U.S. issues. This proved unrewarding in fiscal 2018. (FYI, the MSCI World Index now has a 60% weight in U.S. equities, a larger than typical proportion resulting from the substantial performance differential favoring the U.S.) The portfolio has also suffered from our heavy allocation to consumer discretionary industry companies. This sector includes sub-industries, such as automotive, entertainment/media and luxury goods. Outside of Japan, automotive has been quite weak as the stock market attempts to discount trade and tariff issues. The cable television/broadband/broadcasting sub-industry also performed badly in the period for a variety of company-specific reasons.
As you may well imagine, we think that the Global Fund portfolio is unusually attractive today and we have been adding to our personal Fund holdings. We have continued to shift assets from the U.S. allocation to international to take advantage of the exceptional opportunities available abroad. The current 45% U.S. allocation, down from nearly 47% at the end of June, underrepresents the degree of this shift because of the disproportionate returns the U.S. generated versus international in the period. Value investors are often cursed with making their investment decisions too early. As we reallocate, we believe that we are identifying significant value opportunities that will be the foundation of future returns. We thank our shareholders for their patience.
As noted above, 2018 has been a year of unusual divergences in the securities markets. Most non-U.S. markets have languished, with emerging markets particularly hard hit. In contrast, the U.S. has experienced material, if uneven, outperformance, led primarily by growth equities. In managing the Oakmark Global Fund, we seek to invest in the most undervalued equities while considering corporate governance issues, portfolio tax implications and prospectus guidelines. During the quarter, we increased the international allocation as valuation parameters continued to shift. The new purchases were Continental (Germany) and Ryanair (Ireland), while the one sale was MTU Aero Engines (Germany).
Continental’s stock price has fallen due to industry-wide concerns about auto production volumes and tariffs, but we believe the company has superior end-market exposures and a lower risk profile than many of its peers. Continental’s tire business accounts for about 45% of the company’s earnings, and we find that it generates solid margins and returns relative to industry peers. Replacement tires account for a large portion of segment earnings and provide a meaningful source of stable growth, which gives the company an advantage over auto supplier peers, especially in an economic downturn scenario. The company recently optimized its footprint of large, modern factories in low-cost countries. This strategy benefits Continental, compared to other global tire manufacturers that are burdened with onerous legacy cost structures in smaller, less-automated plants, which are difficult and costly to shutter. The company also has leading market share in concentrated segments of the automotive components business, where it derives a good amount of revenue from high value-added components. We expect increasing trends for vehicle electrification and autonomous driving will provide significant, ongoing growth in this part of Continental’s business. In addition, we think management has done a good job improving the company by taking action to deleverage the business, enhance profitability and drive organic growth.
Ryanair is the leading low-cost airline in Europe, and its structurally advantaged cost structure should enable it to continue to take market share from its less efficient competitors. Ryanair’s share price has suffered recently as a result of flight cancellations and pilot disruptions, as the company negotiates new contracts with its employees. We believe this disruption will be temporary as Ryanair’s enhanced offer is now in excess of what pilots can earn at competing airlines, and we are seeing encouraging signs of acceptance. Importantly, the company will still have a far more efficient cost structure than competitors and its new labor agreement should enable the airline to replicate its low-cost offerings in new locations. We like that Ryanair is the leading ultra-low-cost carrier in Europe and that it has a strong management team that is focused on maximizing operational efficiencies to provide the lowest cost service in the region. Ryanair ranks among the best performers with regard to punctuality, canceled flights, mishandled bags and technical capability. From January 2010 to July 2017, the company had the best on-time performance in Europe each month, with the exception of one month in 2012. In addition to its low-cost structure, Ryanair has gained market share by flying into secondary airports with lower landing fees, undercutting flag carriers. The company is now the largest competitor among the low-cost carriers and possesses a 15% market share of the total intra-Europe market, and it has plans for a 22% market share by 2024. Moreover, Ryanair has a strong direct distribution platform and maintains an all Boeing 737 fleet, allowing it to make large single aircraft orders and realize procurement benefits, as well as to standardize pilot training, maintenance and utilization of spare parts. We also appreciate Ryanair’s strong balance sheet, which helps it navigate turbulent markets, as well as its strong free cash flow.
MTU’s strong returns reduced our margin of safety on the investment, and we exited our position as the market price approached our estimate of intrinsic value. We recycled the MTU profits into investments with better risk/return profiles.
On September 26, USG Corporation shareholders voted to approve the company’s acquisition by a private German business, and although this transaction is not complete yet, a review of this holding seems appropriate. We began purchasing USG shares for the Fund in May 2015, believing that the company’s position in wallboard and structural ceiling tile was undervalued. We spent five months gradually building the position in the portfolio to an appropriate size. The stock was volatile over the next three years as the company’s earnings stream proved to be rather inconsistent. We stuck with the holding, however, with occasional sales to fund more pressing demands on the portfolio’s cash. In early 2018, the share price rose to the $40 level, which approached our sell target. We began cutting back the holding to fund more attractive opportunities. In June, the company agreed to be acquired for $43.50 in cash, and we sold more shares both to reduce the Fund’s exposure to the risk of the deal breaking and because the spread between the deal price and the market price was less rewarding than for other securities we were considering. Assuming completion of this transaction early next year, USG overall will have generated a compound annualized return in the mid-teens for the Fund—not heroic, but a solid example of our identifying an issue selling for materially less than an investor would pay to own it in its entirety. We thank the USG management team for their excellent work for the Fund’s shareholders.
We defensively hedge a portion of the Fund’s exposure to currencies that we believe to be overvalued versus the U.S. dollar. As of quarter end, we found only the Swiss franc to be overvalued and have hedged approximately 19% of the Fund’s franc exposure.
As always, we thank you for being our partners in the Oakmark Global Fund. We invite you to send us your comments or questions.