Oakmark International Fund: Third Quarter 2015
September 30, 2015
The Oakmark International Fund declined 9% for the fiscal year ended September 30, 2015, outperforming the MSCI World ex U.S. Index, which declined 10%. For the most recent quarter, the Fund underperformed the MSCI World ex U.S. Index, declining 13% versus a decline of 11%. However, the Fund has performed well versus the MSCI World ex U.S. Index since its September 1992 inception, returning an average of 10% versus 6% over the same period.
Intesa Sanpaolo, an Italian retail and commercial bank, was the top contributor to performance over the past 12 months. Intesa’s share price has rebounded as fears over Italy’s banking system and government have subsided. During the period of concern a few years ago, the share price of Intesa plummeted and it was a major detractor from performance. However, we were patient and added to our position, and our shareholders have benefited from the turnaround. This example illustrates why we often increase our holdings in quality companies whose stock prices suffer as a result of short-term fears. During the past 12 months, investors reacted positively to Intesa’s impressive revenue growth numbers in spite of challenging headwinds: Italian GDP has been static and banking penetration remains low, while the household savings rate remains high. Management has announced additional returns of capital to shareholders in 2015 via an increased dividend, resulting in a payout ratio in excess of 70%. Even with this return of capital to shareholders, Intesa should be over-capitalized compared with Basel III requirements, leaving the door open for additional capital returns and merger and acquisition opportunities. Additionally, management plans to increase investments in fee-based businesses, including asset management and insurance, and to exit non-core businesses and investments.
The top contributor for the quarter was Safran, a French aerospace and defense company. Earnings in the propulsion unit (which accounts for about 78% of overall earnings) grew 28% in the first half of 2015, significantly above expectations. Safran is benefiting from airline companies, which are relatively healthy in today’s environment, catching up on deferred engine maintenance. As a result of robust growth, management raised the 2015 earnings growth guidance for the commercial spare parts division from 10% to the higher teens. We believe Safran has a strong position and will continue to provide value for our shareholders.
Glencore (Switzerland), one of the world’s largest mining and commodity trading companies, was the largest detractor from performance during the quarter and the past twelve months. Weaker than expected demand for copper in China has driven the price of the commodity lower and negatively impacted Glencore’s share price. Although both supply and demand determine an item’s price, we believe that copper’s steep cost curve means that if prices dip lower, supply will be rapidly cut back. This quick reduction in supply should protect us against continued price weakness. China’s copper consumption is still growing, and copper will likely be in deficit in the coming years. Shares have also been weak due to concerns about Glencore’s ability to service its debt. Management wanted to take decisive action to quell investors’ fears and decided to pay down debt via an equity offering of $2.5 billion, asset sales and a suspension of the dividend. We were comforted that Glencore management bought 22% of the new equity during the equity raise, a clear indication that management’s interests remain aligned with shareholders. This purchase allowed them to maintain their significant personal investment in the company. The management team and other employees own about one-third of Glencore’s stock, and CEO Ivan Glasenberg pledged not to sell shares while employed by the company. In our view, Glencore is uniquely positioned in its industry due to the management team’s entrepreneurial and value-focused approach to running the business. We believe Glencore’s business value balance of 70% mining operations and 30% commodities trading affords the company an unmatched knowledge of industry pricing and supply/demand dynamics.
Another large detractor from performance for the quarter was CNH Industrial (Netherlands), a manufacturer of agricultural and construction equipment. CNH Industrial’s fiscal first-half revenue decline of 22% (-11% in constant currency) was larger than we estimated, as revenues dropped across segments. Earnings and margins also dropped more substantially than we expected. The core agriculture segment was the driving force behind these poor results, as demand for tractors and combines fell across all geographies. In response, management reduced agriculture equipment production by 33% in the second quarter year-over-year. Conversely, the Iveco segment performed better than we anticipated, as revenue declined less than our forecasts (and gained 9% in constant currency) while margins expanded. Management updated full-year guidance, with a reduced operating profit margin (to a range of 5.6%-6% owing to production cuts) and unchanged sales projections. Management continues to cut costs across the board, and in light of very challenging market conditions, we believe CNH Industrial’s leadership team is executing relatively well. Therefore, our investment thesis for this company remains intact.
There was abundant portfolio activity during the past quarter. We sold our positions in Adecco, Christian Dior, Heineken Holding, Publicis and Wolseley. We added five new names to the Fund: Ashtead Group, a U.K.-based equipment rental company; Baidu, a China-based Internet search engine; Bank Mandiri, an Indonesian commercial bank; Burberry Group, a U.K.-based luxury goods brand; and Valeo, a French auto supplier. Geographically, we ended the quarter with 68% of our holdings in Europe, 18% in Japan, 4% in South Korea and 3% in Australia. The remaining positions are in North America (U.S.), Hong Kong, Indonesia, China and the Middle East (Israel).
Global currencies were relatively stable during the quarter. However, both the Swiss franc and Australian dollar weakened versus the U.S. dollar. Although we continue to believe these currencies are overvalued, we reduced our hedging levels during the quarter. Approximately 22% of the Swiss franc and 11% of the Australian dollar were hedged at quarter-end.
We continue to adhere to a long-term value philosophy that has enabled us to build a portfolio of what we believe are high quality names trading at discounts to our estimate of intrinsic value. We thank you, our shareholders, for your continued support.
David G. Herro, CFA
Robert A. Taylor, CFA
Average Annual Total Returns (09/30/15)
Expense Ratio as of 9/30/14 was 0.95%
Past performance is no guarantee of future results. The performance data quoted represents past performance. Current performance may be lower or higher than the performance data quoted. The investment return and principal value vary so that an investor’s shares when redeemed may be worth more or less than the original cost. The To obtain the most recent month-end performance data, view it here.
As of 09/30/15, Intesa Sanpaolo SpA represented 1.4%, Safran S.A. 0.3%, Glencore PLC 2.2%, CNH Industrial N.V. 2.3%, Adecco SA 0%, Christian Dior SA 0%, Heineken Holdings NV 0%, Publicis Groupe 0%, Wolseley PLC 0%, Ashtead Group PLC 0.4%, Baidu, Inc. 2.4%, PT Bank Mandiri (Persero) Tbk 1.0%, Burberry Group 0.4%, and Valeo S.A. 1.0% of the Oakmark International Fund’s total net assets. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
Click here to access the full list of holdings for The Oakmark International Fund as of the most recent quarter-end.
The MSCI World ex U.S. Index (Net) is a free float-adjusted market capitalization index that is designed to measure international developed market equity performance, excluding the U.S. 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 Oakmark International Fund’s portfolio tends to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.
Oakmark International Fund: The percentages of hedge exposure for each foreign currency are calculated by dividing the market value of all same-currency forward contracts by the market value of the underlying equity exposure to that currency.
Oakmark International Fund: Investing in foreign securities presents risks that in some ways may be greater than 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.