Oakmark International Small Cap Fund: Second Quarter 2011
June 30, 2011
The Oakmark International Small Cap Fund lost 2% for the quarter ended June 30, 2011, compared to the MSCI World ex U.S. Small Cap Index, which had a fractional loss. For the past 10 years, the Fund has earned an annualized rate of return of 13%, compared to the MSCI World ex U.S. Small Cap Index, which has returned 11% for the same period.
The top-contributing stock to Fund performance this quarter was LSL Property Services, a leading U.K. residential property-services company. Its appraisal-services segment is the largest in the country and represents approximately two-thirds of the company’s operating profit; its real-estate brokerage segment provides the remainder. LSL has been taking market share in the brokerage business from smaller, struggling U.K. competitors. In addition, the company posted good operating performance despite a very challenging U.K. housing environment. Company management has set forth growth initiatives that we believe should allow the company to gain additional market share in the medium to long term. Finally, the company has diversified its business into countercyclical areas, such as renting and repossessions. Though LSL’s core markets remain under pressure, we believe that the company’s talented management team will position LSL to emerge from the downturn in a better competitive position.
Another top contributor for the quarter was Duerr, the world’s largest paint-shop designer and installer. Duerr reported strong results early in the quarter with orders increasing significantly, up 54%. In June, the company raised its revenue guidance from more than 15% growth for 2011 to more than 30%, while maintaining margin guidance. We believe this growth is primarily being driven by the rebound in the automobile industry, which is expanding and modernizing its production capacity. Duerr has also recently announced multiple small, sensible acquisitions that we believe should enhance value. Despite the strong performance during the quarter, we continue to view Duerr as a good investment opportunity.
The largest detractor from Fund performance this quarter was Myer Holdings, Australia’s largest department-store group, which operates 67 stores throughout the country. Its stores sell diversified products such as apparel (for women, men and children), beauty, fragrance and cosmetics, housewares, electrical goods, toys, fashion accessories and general merchandise. Myer released its third-quarter sales update during the month of May, showing a decline for both the quarter and for the past nine months. Same-store sales were down 3.1% for the quarter, with electronics sales causing the vast majority of the deterioration. In an attempt to reverse this negative trend, management has reduced the amount of overall floor space dedicated to electronics and is focusing on smaller niches in that product area. We believe that Myer can succeed despite Australia’s difficult retail environment because of its restructuring of the electronics business, its higher private-label penetration, its increased direct sourcing and its markdown reductions. In our view, Myer has a great deal of upside potential and, due to some short-term investor pessimism, its stock trades at a significant discount to intrinsic value.
We sold GEA Group, Brunel International, Travis Perkins and Aegis Group from the Fund during the quarter. We used the proceeds to add two new Japanese securities to the Fund this quarter: Konica Minolta Holdings, an office-equipment manufacturer; and convenience-store operator LAWSON.
Konica Minolta is one of the world’s largest makers of photocopiers, specializing in color multi-function printers. The stock has underperformed because decreased IT spending has dampened equipment sales throughout the industry. In addition, Konica Minolta has suffered due to the strong yen. Even though these circumstances have caused unimpressive recent results, the move toward higher-margin color copiers continues, and the company has maintained its strong global market position. We used the stock’s recent underperformance as an opportunity to build a position within the Fund.
LAWSON is the second-largest convenience-store chain in Japan. Despite a difficult Japanese retail market, convenience stores are one of the most attractive retail channels in the country. LAWSON’s management team is focused on operations and on generating returns. We believe the company’s new store formats should spur growth, its self-procurement of food ingredients should help expand gross margins, and its refranchising efforts should also boost company returns.
Geographically, we ended the quarter with our European holdings decreasing to 49% of the portfolio, and the Pacific Rim holdings increasing from 45% to 48%, a result of adding the two new Japanese names to the Fund.
Because we believe the U.S. dollar remains weak relative to a number of currencies held in the Fund, we continue to hedge a percentage of the Fund’s currency exposure. At the recent quarter-end, approximately 71% of the Fund’s Swiss franc, 69% of the Australian dollar, 49% of the Japanese yen, 42% of the Norwegian krone, 35% of the Swedish krona and 21% of the euro exposures were hedged.
We thank you for your continued confidence and support.
David G. Herro, CFA
Michael L. Manelli, CFA
As of 6/30/11, LSL Property Services PLC represented 2.7%, Duerr AG 1.6%, Myer Holdings, Ltd. 2.8%, GEA Group AG 0%, Brunel International NV 0%, Travis Perkins PLC 0%, Aegis Group PLC 0%, Konica Minolta Holdings, Inc. 1.7%, and LAWSON, INC. 0.3% of the Oakmark International Small Cap 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 ex U.S. Small Cap Index (Net) is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance, excluding the U.S. The MSCI Small Cap Indices target 40% of the eligible Small Cap universe within each industry group, within each country. MSCI defines the Small Cap universe as all listed securities that have a market capitalization in the range of USD200-1,500 million. 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 stocks of smaller companies often involve more risk than the stocks of larger companies. Stocks of small companies tend to be more volatile and have a smaller public market than stocks of larger companies. Small companies may have a shorter history of operations than larger companies, may not have as great an ability to raise additional capital and may have a less diversified product line, making them more susceptible to market pressure.
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 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.