Oakmark International Small Cap Fund: Second Quarter 2017
June 30, 2017
The Oakmark International Small Cap Fund returned 9.1% for the quarter ended June 30, 2017, outperforming the MSCI World ex U.S. Small Cap Index, which returned 7.3% for the same period. Since the Fund’s inception in November 1995, it has returned an average of 9.9% per year.
The top-performing stock for the quarter was Melco International Development, a Hong Kong-based holding company that controls Melco Resorts & Entertainment in addition to other casino gaming and tourism assets. During the quarter, the company’s stock price rose after Melco Resorts & Entertainment announced that its first quarter revenues surpassed market estimates by roughly 8% and that its earnings far outpaced market forecasts by about 19%. These strong results reflected the recovery in Macau’s gross gaming revenue, which has increased for several consecutive months. Melco Resorts has impressive plans to continue to grow its business in Macau, which chairman and CEO Lawrence Ho discussed with us in a May meeting. We came away confident that Melco Resorts’ leadership team is steering the company in the right direction and that these efforts will benefit the subsidiary’s shareholders as well as the shareholders of Melco International Development.
The largest detractor to Fund performance for the quarter was Canada-based Element Fleet Management. Element is the largest provider of fleet management services in North America—more than twice the size of the second-largest player. A number of factors hurt the stock’s performance during the quarter. The most significant issue was a joint venture between Element and financially troubled truckload operator Celadon. We share the market’s concern that the joint venture could result in asset write-downs, but we remain comfortable that Element has the balance sheet strength to meet any capital requirement associated with its involvement. Despite some near-term challenges, we continue to find Element an attractive medium- to long-term investment. Element’s scale, coupled with the platform nature of the fleet management business, should enable the company to generate strong over-the-cycle returns, which we expect to become increasingly evident in the coming quarters.
Hengdeli Holdings, based in Hong Kong, was the second-largest detractor to Fund performance for the quarter as minority shareholders approved the sale of the company’s mainland China retail operations to Hengdeli’s founder, Mr. Zhang Yuping, at book value—a staggering 50% discount on our estimate of intrinsic value. Hong Kong’s listing rules provide protection to minority shareholders as Mr. Zhang was prohibited from voting on the transaction. Despite this, more than 70% of shareholders voted in favor of it. In addition, the independent members of the board of directors failed to look out for the best interests of shareholders by recommending approval of the transaction and publishing a delayed and, what we consider, highly misleading circular. The board’s apparent lack of independence is frustrating, but the ultimate responsibility for the vote rests with the minority shareholders, who clearly did not complete the necessary due diligence to properly assess the transaction. The market reacted quickly to this destructive deal, and Hengdeli’s share price dropped approximately 40% during the quarter. We are highly disappointed with the outcome of the vote and believe Hengdeli’s remaining operations in Hong Kong offer little value. We are not confident that the management team can add value via mergers and acquisitions, given what we believe is its very poor historical track record. As a result, you will notice we have trimmed our position.
We initiated positions in two new holdings this quarter, Sabanci Holding and Sarana Menara Nusantara. Based in Turkey, Sabanci Holding is a conglomerate with a focus in the industrial and financial sectors. Approximately one-half of the asset value of Sabanci comes from its stake in Akbank, the third-largest bank in Turkey. The company is also active in a number of other sectors, including cement, retail and electricity. Sarana Menara Nusantara is an Indonesian investment company that owns and operates telecommunication towers for wireless operators through its subsidiary Profesional Telekomunikasi Indonesia (“Protelindo”). With more than 14,500 towers, Protelindo is the largest independent owner and operator of towers in Indonesia. Finally, we eliminated our position in Melrose Industries (U.K.) during the quarter.
Geographically, we ended the quarter with 20% of our holdings in Asia, 62% in Europe and the U.K., and 10% in Australasia. The remaining positions are 4% in North America (Canada and the U.S.) and 3% in Latin America (Brazil and Mexico).
As of the quarter end, the Swiss franc hedge was 10% and we closed the Australian dollar hedge as we believe the currency approached fair value.
Thank you for your continued confidence and support.
David G. Herro, CFA
Michael L. Manelli, CFA
Justin D. Hance, CFA
Oakmark International Small Cap Fund – Investor Class
Average Annual Total Returns (06/30/17)
Since Inception (11/01/95) 9.87%
Expense Ratio as of 09/30/16 was 1.38%
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 performance of the Fund does not reflect the 2% redemption fee imposed on shares redeemed within 90 days of purchase. To obtain the most recent month-end performance data, view it here.
The securities mentioned above comprise the following percentages of the Oakmark International Small Cap Fund’s total net assets as of 06/30/17: Melco International Development, Ltd. 1.5%, Element Fleet Management Corp. 2.2%, Celadon Group, Inc. 0%, Hengdeli Holdings, Ltd. 0.3%, Haci Omer Sabanci Holding A.S. 1.0%, Sarana Menara Nu Rg 0.9%, Akbank T.A.S. 0% and Melrose Industries PLC 0%. 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 Small Cap Fund as of the most recent quarter-end.
The MSCI World ex U.S. Small Cap Index (Net) is a free float-adjusted, market capitalization-weighted index that is designed to measure the equity market performance of developed markets 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.
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.
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.
All information provided is as of 06/30/17 unless otherwise specified.