Oakmark Fund: Fourth Quarter 2017
December 31, 2017
The Oakmark Fund increased 6.0% during the fourth quarter of 2017, which compares to a 6.6% gain for the S&P 500. For all of calendar 2017, the Fund increased 21.1%, which was slightly below the 21.8% return for the S&P 500. The strong fourth-quarter performance capped off a very strong calendar year for the Oakmark Fund and the broader market, and we are pleased that the Fund hit another all-time high adjusted NAV. In fact, this represents the sixth quarter in a row that the Fund has hit an all-time high. With this strong absolute performance comes a brief word of caution: over longer periods of time, we expect S&P 500 returns to moderate to historical single-digit levels. We remain very pleased that the strongest contributions for both the fourth quarter and calendar year have come from our highest-weighted sectors, financials and information technology.
Caterpillar and Ally Financial were the best individual contributors for the quarter, both returning in excess of 20%. Our lowest-contributing sectors for the quarter were energy and consumer staples, but our exposure to those sectors was lower than the S&P 500’s weightings. Our worst-contributing securities for the quarter were General Electric and Aon. General Electric has been a very frustrating holding during 2017, as business fundamentals have lagged behind our expectations, but we believe a fresh look reveals an attractive opportunity to own a high-quality, improving business with a strong new management team at just 12.5x our estimate of forward earnings. For the calendar year, our best individual contributors were Caterpillar and Fiat Chrysler, and our biggest detractors were General Electric and Apache. Energy was our only detracting sector for the calendar year.
Despite rising valuation levels throughout the year, we continued to find attractively valued investment opportunities during the fourth quarter, and we added new positions in American Airlines, CVS Health and Priceline Group (see below). Delphi Technologies and Aptiv are also new holdings for the Fund, following Delphi’s separation into two distinct companies. We believe that focusing on their unique businesses will benefit both companies and that the separation will help investors better realize each company’s intrinsic value. We eliminated positions in Microsoft and Qualcomm during the quarter. Microsoft reached our estimate of intrinsic value, climbing 38% during the calendar year, and Qualcomm was sold due to increasing and unquantifiable regulatory and capital allocation risks.
American Airlines Group, Inc. (AAL - $53)
Although the airlines have always provided a useful consumer service, we feel they have historically been unattractive long-term investment candidates. In the past, the major U.S. airlines lacked pricing power and faced problems related to poor corporate cultures. However, after years of consolidation capped by the merger of US Airways and American Airlines in 2013, the industry has become more mature and disciplined. The three major hub-and-spoke carriers each have strengths in their respective hubs, and their management teams are making wiser decisions about capacity additions and capital allocation. American Airlines’ CEO Doug Parker sees substantial opportunity to grow value as the company completes the US Airways merger integration. He is improving the company’s culture and restoring credibility with employees. Parker believes that American Airlines has around $5 billion of pretax earnings power, which is up 50% from our 2017 estimate, and he has bought back 37% of the company’s shares since the merger closed. With the stock selling for a single-digit multiple of normal earnings power, we believe American Airlines is an attractive investment.
CVS Health Corporation (CVS - $73)
CVS is well positioned in a U.S. health care system that rewards scale, as the company owns the nation’s largest pharmacy benefit manager (PBM), the largest retail pharmacy and the largest retail clinic. Both the PBM and retail pharmacy segments are as concentrated as they have ever been, and we believe these lines of business protect existing players and pose serious challenges for new entrants. After underperforming the S&P 500 by nearly 60% over the past two years, CVS is now valued at less than 12x next year’s consensus earnings after adding back amortization of intangible assets. In our view, the market is underestimating the durability of the company’s competitive advantages across multiple end markets. Additionally, the pending acquisition of Aetna, Inc. would bring together two forward-thinking management teams and give them a broad suite of assets through which to address sector-wide trends, like the shift toward value-based care models and the increasing “consumerization” of health care.
Priceline Group, Inc. (PCLN - $1,760)
During the quarter, we established a position in Priceline, a pioneer and global leader in the online travel industry. We believe Priceline’s valuation is attractive when viewed against our long-term growth expectations, as we expect online bookings to continue capturing share from offline sources for years to come. The company is investing heavily in business travel, mobile, alternative accommodations and other ancillary businesses, which we believe will further solidify its competitive position and support attractive long-term growth. Priceline’s strong brands, significant investment expenditure and scale advantages should further enhance the company’s powerful network effect. In addition, its geographic exposure, revenue mix and superior online traffic conversion make it one of the best operating models in the industry. On our one-year forward estimate, Priceline trades in line with the S&P 500 P/E ratio (excluding its net cash and investments), despite having a superior growth outlook, an above-average margin profile and extremely high returns on incremental capital, allowing us to buy an above-average business at just an average price.
William C. Nygren, CFA
Kevin G. Grant, CFA
Oakmark Fund - Investor Class
Average Annual Total Returns (12/31/17)
Since Inception (08/05/91) 13.04%
Gross Expense Ratio as of 09/30/16 was 0.93%
Net Expense Ratio as of 09/30/16 was 0.89%
Gross Expense Ratio as of 09/30/17 was 0.90%
Net Expense Ratio as of 09/30/17 was 0.86%
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. To obtain the most recent month-end performance data, view it here.
The securities mentioned above comprise the following percentages of the Oakmark Fund’s total net assets as of 12/31/17: Caterpillar, Inc. 2.5%, Ally Financial Inc. 2.6%, General Electric Co. 1.8%, Aon Corp. 1.8%, Fiat Chrysler Automobiles N.V. 2.1%, Apache Corp. 1.8%, American Airlines Group, Inc. 0.5%, CVS Health Corp. 1.0%, The Priceline Group, Inc. 1.0%, Delphi Technologies PLC 0.2%, Aptiv PLC 1.0%, Microsoft Corp. 0%, QUALCOMM, Inc. 0% and Aetna, Inc. 0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
Access the full list of holdings for the Oakmark Fund as of the most recent quarter-end.
The net expense ratio reflects a contractual advisory fee waiver agreement through January 28, 2018. Harris Associates has agreed to continue the advisory fee waiver agreement through January 28, 2019.
The S&P 500 Total Return Index is a market capitalization-weighted index of 500 large-capitalization stocks commonly used to represent the U.S. equity market. All returns reflect reinvested dividends and capital gains distributions. This index is unmanaged and investors cannot invest directly in this index.
The Oakmark 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.
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 12/31/17 unless otherwise specified.