Oakmark International Small Cap Fund: Third Quarter 2014
September 30, 2014
The Oakmark International Small Cap Fund declined 9% for the quarter ended September 30, 2014, underperforming the MSCI World ex U.S. Small Cap Index, which declined 8% for the same period. For the fiscal year ended September 30, the Fund declined 2%, and the MSCI World ex U.S. Small Cap Index returned 3%. Since the Fund’s inception in November 1995, it has returned an average of 10% per year.
The Fund’s regional South Korean banks, DGB Financial Group and BS Financial, were two of the top-performing stocks for the recent quarter. We believe that strong economic growth in DGB’s primary business region and a current undervaluation of the stock adds to DGB’s attractiveness. BS Financial’s proposed acquisition of another small regional bank, Kyongnam Bank, would be a strategic use of capital that could further enhance the company’s competitive position, should the deal close. We also think BS’s strong deposit franchise gives it a significant funding advantage over its peers and should generate substantial profitability once interest rates normalize. (DGB, like BS, should also benefit from interest rate normalization.) We continue to believe the valuation of this high quality regional bank with dominant market share remains attractive, offering a compelling reason to own.
Altran Technologies, an engineering and technology consulting company that offers services throughout Europe, was the largest contributor to performance for the fiscal year ended September 30. Altran’s restructuring efforts demonstrate how our emphasis on quality management teams can pay off. First, the management team reduced overhead costs, and second, Altran has more recently shown material improvements in the utilization of its engineers, causing invoicing rates to rise quarter over quarter. Higher invoicing rates are necessary for Altran to narrow the margin gap compared with its best-in-class peers. We are optimistic that these positive trends will continue into the second half of 2014 and that Altran will report another year of margin improvement.
Fugro was the largest detractor from performance for the fiscal year and recent quarter end. This Netherlands-domiciled geological engineering company released a profit warning in July, indicating that first-half margins would be in the low single-digits (lower than both market and our expectations) and that it would be booking EUR 300-350 million of impairments in its subsea joint venture and multi-client library. These disappointments caused the share price to decline over 40% during July. The very weak first-half results were a culmination of both a soft end market (a majority of Fugro’s profits are derived from the offshore oil and gas market) and a number of company-specific operational issues. The slowdown in offshore exploration and production (E&P) spending looks like it will likely continue into 2015 and possibly beyond. We have adjusted our forecasts and estimates of intrinsic value to reflect this lower growth environment. However, longer term, we believe that off-shore capital expenditure trends will eventually improve as oil demand continues to increase moderately, while production from existing fields continues to decline. We continue to remain shareholders of Fugro because of its dominant positions in a number of niche businesses that should benefit from an eventual recovery in offshore E&P spending.
Five new securities were added to the Fund this quarter, two of which – Brunel and Countrywide – are previous Fund holdings. Brunel is a professional staffing company with major operations in the Netherlands, Germany and within the global energy market. Countrywide is the U.K.’s largest real estate agency and also operates a large surveying business as well as letting business. Melco International Development is a Hong Kong-based holding company that derives nearly all of its value from a 33.6% stake in Melco Crown, an operator of casinos globally, predominantly in Macau. Transpacific Industries is Australia’s leading recycling, waste management and industrial services company; and U.K. based Electrocomponents is the world’s leading high service distributor of electronics and maintenance products for engineers. There were no names fully divested from the Fund during this past quarter.
Geographically we ended the quarter with 22% of our holdings in Asia, 62% in Europe and 13% in Australasia. The remaining positions are in North America, Latin America and the Middle East.
While the U.S. dollar has strengthened, our view is that certain global currencies are still overvalued. We maintained hedge positions on three of the Fund’s currency exposures. As of the recent quarter end, we slightly increased the Fund’s Australian dollar hedge to 39% and continue to have 45% of the Norwegian krone and 34% of the Swiss franc exposures hedged.
Thank you for your continued confidence.
David G. Herro, CFA
Michael L. Manelli, CFA
Average Annual Total Returns (09/30/14)
Expense Ratio as of 9/30/13 was 1.35%
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.
As of 09/30/14, DGB Financial Group, Inc. represented 2.4%, BS Financial Group, Inc. 2.4%, Kyongnam Bank Co., Ltd. 0%, Altran Technologies 1.1%, Fugro NV 1.6%, Brunel International NV 0.1%, Countrywide PLC 1.3%, Melco International Development, Ltd. 0.9%, Transpacific Industries Group, Ltd. 1.3% and Electrocomponents PLC 1.5% 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.
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 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.
Oakmark International Small Cap Fund: 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.
Oakmark International Small Cap 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 Small Cap 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.