Oakmark Global Fund: First Quarter 2012
March 31, 2012
World stock markets rallied strongly during the March quarter. In fact, the only country to experience a loss was Spain. The Oakmark Global Fund participated in the advance, gaining 16% in the quarter. The MSCI World Index return was 12%, and the Lipper Global Fund Index gained 12%. For the Fund’s fiscal six months, the return was 22%. This compares to 20% for the MSCI World Index and 20% for the Lipper Global Fund Index. As always, we are most pleased to report the Fund’s 11% compound annualized rate of return since inception, outperforming the MSCI World Index, which has averaged 2%, and the Lipper Global Fund Index, which has averaged 4% over the same time period.
The countries that generated the highest total returns for the Fund this quarter were Germany, Italy and Sweden, of which the latter two have small representations in the Fund. The highest contribution to the Fund’s results came from the U.S., both because of return and its very large portfolio weight. The other two heavily weighted countries, Japan and Switzerland, also made significant contributions to return, and they were matched in contribution by lesser-weighted Germany, which experienced an exceptional outcome in the quarter. No countries produced losses in the Fund. Fiscal six-month country outcomes are similar to the quarter except for the Fund’s Spanish representation, which produced a loss over that period.
The holdings that contributed most significantly to the Fund’s quarterly return were Toyota Motor (Japan), Daiwa (Japan), Snap-on (U.S.), Daimler (Germany) and Rheinmetall (Germany). No holdings detracted from Fund performance this quarter. For the first six months of the Fund’s fiscal year, the leading contributors were all from the U.S.: Snap-on, Equifax, MasterCard Class A, Intel and Discovery Communications Series C. The only two stocks to detract from return in the six months were Rohm (Japan) and Banco Santander (Spain).
We initiated four new positions in the quarter and eliminated three. As it happens, all seven holdings were comparatively small weights in the portfolio. Beginning with the sales, Sara Lee neared our price target for the stock after the company announced its plan to divide into two parts. We thank the Sara Lee management team for working hard to benefit its shareholders. We sold Covidien (Ireland) to fund another health-care industry purchase. We eliminated the small Meitec (Japan) holding because our assessment of value came down and made it relatively less attractive versus other names.
Our four new purchases were Cimarex Energy (U.S.), Health Net (U.S.), Kansai Paint (Japan) and Smiths Group (U.K.). Cimarex is an independent oil and gas exploration and production company with operations in three regions – the Midcontinent, Gulf Coast and Permian Basin. We perceived an investment opportunity in Cimarex’s shares when the company reported quarterly production that disappointed investors. In our opinion, the production decline is occurring according to plan in short-lived Gulf Coast properties at the same time that production and reserves are growing in longer-lived Texas and Oklahoma fields. In our view, Cimarex is a very well-run company and, at our purchase price, the shares sold at a large discount to our asset value estimates and compared to its industry peers. The company has large undeveloped acreage holdings in attractive liquids-rich areas that should provide the foundation for substantial future production and reserve growth. In addition, cash flow is strong. Although oil and gas price volatility may have a short-term impact on Cimarex’s stock price, we are confident that Cimarex’s prospects for increasing shareholder value over the long term are excellent.
Health Net is a California managed-care company that we perceive to have an unusually strong market position. After a decade of spotty operational results, Health Net hired new actuarial talent from a competitor and has since been gaining market share with innovative tailored products. Management has shed non-core assets and has bought back the company’s stock with the proceeds. The California market, which is primarily capitated, is often very difficult for large competitors to break into organically (i.e., without making an in-market acquisition), and this factor adds to Health Net’s inherent appeal.
Kansai controls 30% of the decorative paint market in Japan and 50% of the auto paint industry. However, we believe the reason to get excited about Kansai paint is its strong deco and auto market positions in India and other southeastern Asian markets. In addition, the company recently acquired Freeworld, a dominant paint company in South Africa and other smaller African countries, for a very cheap price. Yuzo Kawamori, Kansai’s president, is one of the more impressive Japanese managers we have met. He understands operational, as well as capital, returns and may be one of the only Japanese managers to refuse a company car. We are excited to be invested with this new partner.
Smiths Group is a U.K.-based conglomerate with five independent divisions. Of note is John Crane, which accounts for about one-third of its sales and profits. It is the world’s leading provider of mechanical seals and sealing support systems used in pumps, compressors and other rotating equipment, holding roughly 30% of market share. With over 60% of its sales coming from the after-market, the business is very stable and earns very high returns. At the time we initiated the position, our assessment of this division alone accounted for almost 90% of Smiths Group’s market cap. Also of note is the medical division, which generates over 35% of the company’s profits. The management team has already received an offer for this division that equaled roughly two-thirds of Smiths Group’s market cap at the time we initiated our position. CEO Philip Bowman rejected this offer as too low. Although it is too early to know what price he could get for the medical division, Bowman does have a strong track record of selling businesses for solid prices in the past, first Allied Domecq to Pernod Ricard and later Scottish Power to Iberdrola.
In the past few quarters, investors and investment industry consultants have indicated renewed interest in global investing. The Oakmark Global Fund portfolio managers certainly share this interest as we regularly add to our personal Fund holdings. But what is it that makes this kind of investing so alluring? To reduce the answer to one word: flexibility. In Oakmark Global, your managers may invest in any market that we believe offers the appropriate balance of return potential and risk control. The Fund is also “all-cap,” which means that it can own shares of small companies like Live Nation or large companies, such as Nestle or Oracle. The Fund will invest in emerging markets when we find fairly priced stocks there. But aside from retaining minimum investments of 25% in both the U.S. and non-U.S. markets, the Fund is unconstrained. Today the Fund has 48% invested in U.S. equities, which is somewhat below the 53% weight in the MSCI World Index, the Fund’s benchmark. Your managers pay little attention to this statistic. Rather, with every potential investment, we ask, “Would we be willing to own 100% of this company at this purchase price if we could never sell it again?” When we can answer this question with a definitive “yes,” we believe that we have found a worthy opportunity for the Fund shareholders’ hard-earned savings. Investing offers many routes to success, but we believe that Oakmark Global’s flexibility is an important advantage.
Japan – A Year of Natural Disasters
March 11 marked the one-year anniversary of the earthquake and tsunami that devastated the Tohoku region of Japan. In addition to this natural disaster, heavy flooding in Thailand later in the year hurt many Japanese corporations with local Thai operations. Our thoughts go out to those touched by these tragic events.
When you couple these natural disasters with the fact that the Japanese yen hit post-WWII highs versus the dollar during the first quarter of 2012, it seems unsurprising that share prices (as measured by TOPIX) remain below pre-earthquake levels. What is surprising to us is that all of our Japanese holdings with direct and indirect exposure to these disasters have returned to 100% production capacity and are starting to see their profits improve.
As we have stated in the past, the value of any business is not based on one month, one quarter or one year. Instead, we believe the value of any business is based on its normal earnings power. Given all that has happened in 2011, it is hard to argue that corporate earnings in Japan are anywhere close to normal. 2012 is another story. This year’s consensus earnings estimates for the TOPIX, per Bloomberg, are 33% higher than 2010 (a year largely unaffected by disasters). We too expect our Japanese holdings to have higher per-share earnings power in 2012 due to cost-cutting measures, sales growth in faster economies, repurchase of undervalued shares, and the movement of high-cost production in Japan to lower-cost countries. As such, we continue to find what we think is tremendous value in our Japanese holdings.
We continue to believe that the U.S. dollar is undervalued relative to many global currencies. As of quarter-end, approximately 73% of the Fund’s Australian dollar, 55% of the Japanese yen, 42% of the Swiss franc and 36% of the Swedish krona exposures were hedged. Our Japanese yen hedges decreased as the yen weakened versus the U.S. dollar. We no longer hedge the euro, as it has approached fair value relative to the U.S. dollar.
Thank you for being our partners in the Oakmark Global Fund. Please feel free to contact us with your questions or comments.
Clyde S. McGregor, CFA
Robert A. Taylor, CFA
As of 3/31/12, Toyota Motor Corp. represented 3.6%, Daiwa Securities Group, Inc. 3.7%, Snap-on, Inc. 4.2%, Daimler AG 3.0%, Rheinmetall AG 2.9%, Equifax, Inc. 3.6%, MasterCard, Inc., Class A 3.8%, Intel Corp. 3.1%, Discovery Communications, Inc., Class C 3.2%, ROHM Co., Ltd. 2.5%, Banco Santander SA 2.0%, Sara Lee Corp. 0%, Covidien PLC 0%, Meitec Corp. 0%, Cimarex Energy Co. 1.1%, Health Net, Inc. 1.5%, Kansai Paint Co. Ltd. 0.6 %, Freeworld Coatings Ltd. 0%, Smiths Group PLC 0.5%, John Crane Inc. 0%, Allied Domecq Ltd. 0%, Pernod Ricard SA 0%, Scottish Power Ltd. 0%, Iberdrola SA 0%, Live Nation Entertainment, Inc. 1.8%, Nestle SA 1.4%, Oracle Corp. 4.5% of the Oakmark Global Fund’s total net assets. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
The MSCI World Index (Net) is a free float-adjusted market capitalization weighted index that is designed to measure the global equity market performance of developed markets. This benchmark calculates reinvested dividends net of withholding taxes using Luxembourg tax rates. This index is unmanaged and investors cannot invest directly in this index.
The Lipper Global Fund Index measures the performance of the 30 largest mutual funds that invest in securities throughout the world. This index is unmanaged and investors cannot invest directly in this index.
The Japanese TOPIX Index is an index that measures stock prices on the Tokyo Stock Exchange (TSE). This capitalization-weighted index lists all firms that are considered to be under the 'first section' on the TSE, which groups all of the large firms on the exchange into one pool. This index is unmanaged and investors cannot actually make investments in this index.
Investing in foreign securities presents risks that in some ways may be greater than in U.S. investments. Those risks include: currency fluctuation; different regulation, accounting standards, trading practices and levels of available information; generally higher transaction costs; and political risks.
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.