Oakmark Global Fund: Third Quarter 2012
September 30, 2012
The September quarter witnessed a strong rebound in European equity markets while Japan and the U.S. lagged. It remains to be seen whether this rebound is well-founded, as European economic and political circumstances remain challenging. The Oakmark Global Fund gained 2% in the quarter, while the MSCI World Index returned 7%, and the Lipper Global Fund Index returned 6%. The Fund’s return for the calendar nine months is 9%, which contrasts to the 13% return for the MSCI World Index and 11% for the Lipper Global Fund Index. For the fiscal year, ended September 30, the returns are 15% for the Fund, 22% for the MSCI World Index, and 19% for the Lipper Global Fund Index. As always, we are most pleased to report the Fund’s 10% compound annualized rate of return since inception, which compares to 2% for the MSCI World Index and 3% for the Lipper Global Fund Index for the same period.
The countries that contributed most to the Fund’s quarterly return were the U.S., Switzerland, and Spain, although it should be noted that the U.S. return was weak in relative terms. Japan was the only country to detract from the Fund’s return in the quarter. The five largest contributors to the Fund’s return in the quarter were Snap-on (U.S.), Credit Suisse (Switzerland), Hirose Electric (Japan), Banco Santander (Spain), and Discovery Communications, Series C (U.S.). The Fund holdings that detracted most were Canon (Japan), Intel (U.S.), FedEx (U.S.), ROHM (Japan) and Omron (Japan).
For the calendar nine months, the highest contributing countries were the U.S., Germany and Switzerland, although it must be noted that none of these three stand out relative to their local markets. Australia and Japan detracted from the nine-month return. Snap-on, Discovery Communications, Oracle (all U.S.-domiciled), Daiwa Securities Group and Hirose Electric (both Japan) were the leading contributors. Square Enix (Japan), Canon, ROHM, Health Net (U.S.), and Julius Baer (Switzerland) detracted most from the nine-month return. For the Fund’s fiscal year, the U.S., Switzerland and Germany were the leading contributors to return, while Japan was the only detractor. Although the U.S. return was not exceptional on a relative basis in the period, all five companies that led the contributors list were American: Snap-on, Equifax, Discovery Communications, MasterCard and Union Pacific. Detractors were ROHM, Canon, Square Enix, Health Net and Credit Suisse.
Last quarter, we wrote about Credit Suisse, which had performed poorly in that period. We noted that the Swiss National Bank was pressuring the company to increase its balance sheet strength even though Credit Suisse was likely to satisfy regulatory capital requirements well into the future. Credit Suisse chose to issue new equity in the September quarter, and somewhat surprisingly the stock responded with a strong gain. We always find equity issuances at low valuations to be troubling because they dilute the intrinsic value per share of pre-issuance shareholders. Nevertheless, this issuance, timed with a strong rebound in the Swiss stock market, seems to have had a salutary effect.
Another Swiss holding of interest in the quarter was Julius Baer Group. Julius Baer formally announced the acquisition of Bank of America’s International Wealth Management (IWM) business for CHF 1.5 billion, the amount investors expected. The valuation is very attractive at only 9.5x earnings, assuming Baer retains approximately 90% of IWM’s assets under management and achieves its synergy targets. However, there are some risks to the deal. First, IWM is currently operating at a loss and needs to improve profitability. We believe this risk to be limited given Baer’s track record of successfully integrating past acquisitions. Second, the transaction could take 12 to 18 months to complete, which is longer than investors had expected. While many of the assets are in legal entities that can transition quickly, approximately half are tied to individual bankers. Baer’s management will need to attract each of these bankers individually to integrate these assets. Although this method produces some uncertainty, a positive aspect is that the pricing of the entire deal is variable and predicated on retaining assets.
Investor anxiety over the unclear elements surrounding this acquisition weighed on Baer’s stock price. Although we also believe that it will take time to determine the total cost and scale of the deal, we find IWM’s geographic footprint very attractive. In our view, the acquisition price is reasonable, and considering that Baer’s management team has a history of success when it comes to acquisitions, we believe that IWM will be even more valuable under the Julius Baer brand.
Our trading activity in the quarter was comparatively modest, so country allocations did not change substantively. The Fund’s largest overweight countries, when compared to the MSCI World Index, continue to be Japan, Switzerland, Germany, Spain and Italy. Because the Fund holds a relatively limited number of companies and is value-oriented, it does not hold positions in many countries represented in the MSCI World Index. The largest underweights include the U.K., Canada and the U.S. While it may not be obvious to U.S. residents, the U.S. stock market has meaningfully outperformed most peers over the past few years, resulting in the U.S. weight in the MSCI World Index growing to 54%. In the Fund, the U.S. is by far the largest allocation at 49%, but this is still well below the Index weight. As we’ve often said, we do not invest the Fund against the benchmark but attempt to select the most attractive securities based on our understanding of their intrinsic value per share. The Fund’s prospectus guidelines give us considerable flexibility to go wherever our understanding of value takes us.
During the past quarter we initiated one new position, Devon Energy (U.S.) and exited our investment in Assa Abloy (Sweden). Assa Abloy performed well for the Fund, and its sale primarily reflects our recognition that other opportunities were more attractive.
Devon Energy is an independent energy company with exploration and production operations in the U.S. and Canada. The company reported proved reserves of 3 billion barrels of oil equivalent and drilled almost 2,500 gross wells in 2011. It holds roughly 13 million net acres, of which roughly two-thirds are undeveloped. Devon Energy also produces more than 3% of all the natural gas consumed in North America each day. Although the market perceives Devon Energy as mainly a natural gas company, approximately 40% of its reserve base and 80% of its revenues come from sales of oil and natural gas liquids (such as propane, butane and ethane). We think this will provide Devon the advantage of maintaining cash flows and growing per-share value even when natural gas prices are depressed. During the past few years, management intensified its focus on increasing shareholder value. John Richels, elected president and chief executive officer in June 2010, has improved Devon Energy’s capital allocation strategy and strengthened its balance sheet. As evidence, Devon divested some of its international and Gulf of Mexico operations and used about half of the proceeds to repurchase shares and the other half to reduce net debt. In our opinion, both uses enhanced shareholder value. In addition, despite the reduction of assets, the company’s proved reserves have grown subsequent to these sales. Devon and Sumitomo Corporation recently entered into a joint venture in which Sumitomo will invest $1.4 billion and receive 30% interest in approximately 650,000 of Devon’s net acres. This partnership will result in the drilling of approximately 40 additional gross wells in the Permian Basin, and Sumitomo will pay 79% of the overall drilling and completion costs during the carry period. We think this joint venture may also be a value-enhancing activity. In our view, Devon Energy is a high-quality company with strong fundamentals and a management team that is working effectively for the benefit of investors.
We continue to believe that the U.S. dollar is undervalued relative to other global currencies. As of quarter end, approximately 60% of the Fund’s Australian dollar, 60% of the Japanese yen and 35% of the Swiss franc exposures were hedged. After the sale of Assa Abloy during the quarter, we no longer had exposure to the Swedish krona, so we closed the hedge.
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 9/30/12, Snap-on, Inc. represented 4.5%, Credit Suisse Group 4.1%, Hirose Electric Co., Ltd. 3.0%, Banco Santander SA 2.5%, Discovery Communications, Inc., Class C 3.3%, Canon, Inc. 2.9%, Intel Corp. 2.8%, FedEx Corp. 3.2%, ROHM Co., Ltd. 1.4%, OMRON Corp. 1.7%, Oracle Corp. 4.5%, Daiwa Securities Group, Inc. 4.0%, Square Enix Holdings Co., Ltd. 3.3%, Health Net, Inc. 1.8%, Julius Baer Group, Ltd. 3.4%, Equifax, Inc. 3.3%, MasterCard, Inc., Class A 3.9%, Union Pacific Corp. 2.0%, Bank of America Corp. 0%, Devon Energy Corp. 1.4%, Assa Abloy AB, Class B 0% and Sumitomo Corporation of America 0% 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.
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 Fund’s investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Fund’s investments and the views of the portfolio managers and Harris Associates L.P., the Fund’s investment adviser, at the time of this letter, and are subject to change without notice.