Oakmark Fund: Second Quarter 2018
June 30, 2018
The Oakmark Fund increased 2.1% for the second quarter, which lagged behind the 3.4% gain for the S&P 500, the Fund’s benchmark. Rapid corporate earnings growth, combined with stagnant share prices since the beginning of the calendar year, has brought broad market valuation multiples back down to historical levels. We believe equities remain the most attractive asset class, and due to the increased number of undervalued companies with misunderstood intangible assets (see Bill Nygren’s market commentary), our research team has produced an impressive number of new investment ideas. The Oakmark Fund has added 10 new names to the portfolio over the past four quarters.
The Oakmark Fund’s best contributing sectors during the second quarter were information technology (with double-digit gains from ADP, MasterCard, Apple, Visa, Facebook and Gartner) and energy (helped by rising commodity prices and improving asset productivity). Our lowest contributing sectors were industrials and financials. The Fund’s best contributing individual securities were Netflix and Anadarko, both up over 20%, and the worst contributing securities were American Airlines and MGM Resorts International, down 27% and 17%, respectively. American Airlines was weak due to near-term profitability concerns, following a period of rapidly rising fuel costs. During the quarter, we added new positions in Bristol-Myers Squibb Company, Gartner and Hilton Worldwide Holdings. We eliminated our position in Aflac as the share price approached our estimate of intrinsic value, and we eliminated our position in Harley-Davidson due to deteriorating demand and profitability trends.
Bristol-Myers Squibb Company (BMY - $55)
Bristol-Myers Squibb is a global biopharmaceutical company with leading franchises in oncology, immunoscience and cardiovascular drugs. Long-time shareholders may recall a successful Bristol-Myers Squibb investment that we sold in 2013. We got another opportunity to own this company during the past quarter when investors became fearful that a competing drug would take share in the cancer market. We believe these fears are overstated because cancer remains a dangerous disease that is difficult to treat. The company’s two most valuable drugs Opdivo and Yervoy should continue to grow revenue as they maintain effectiveness with new tumor types. Bristol Myers Squibb also has the most new molecular agents and the highest number of combinations of agents in trials. Moreover, the company’s R&D and marketing prowess also make it a desired partner for promising academic and small biotech innovators. Collectively, these assets should assure Bristol-Myers Squibb’s oncology leadership for many years. We believe intrinsic value is closer to the $70 level it traded for earlier this year than its more recent price in the low $50s.
Gartner, Inc. (IT - $133)
Gartner is the world’s leading provider of information technology research and advice for information technology executives. The company’s research reports and benchmarking data are used by information technology executives across industries to make mission-critical decisions with potential multi-million dollar ramifications, and the subscription price represents just a fraction of the typical information technology budget. In other words, Gartner is the Consumer Reports of the information technology industry. However, while the Gartner brand has been among the most recognizable in information technology research for more than 35 years, most sizeable enterprises are still not Gartner subscribers. The company is investing heavily in sales and marketing to grow its customer base and based on the excellent long-term track record of Gartner management, we believe these investments are likely to drive years of double-digit growth. While the company trades at a high multiple of GAAP earnings, that multiple falls significantly after adjusting sales and marketing expenses to account for the multi-year life of new customers. (See Bill Nygren’s market commentary). On our adjusted earnings estimates, Gartner’s price-to-earnings ratio is in line with the S&P 500. We believe this is a bargain price for a high-return, high-growth business with an excellent management team.
Hilton Worldwide Holdings Inc. (HLT - $79)
Hilton Worldwide is a high-quality, well-managed company that was the target of a successful leveraged buyout by Blackstone in 2007. We believe the company’s transformation into an asset-light, fee-driven business with a more resilient earnings profile is underappreciated. After spinning off most of the company’s owned hotels and timeshare businesses early last year, Hilton now generates over 90% of its profits from fees (requiring minimal capital investment) and produces substantial free cash flow (greater than 100% of net income). The company should generate high single-digit operating income growth for several years. We became interested in Hilton after we determined that its competitive moat is widening. The company’s unit growth leads the industry and its global pipeline share is almost 22%—over four times larger than its current share of existing rooms (approximately 5%). We initiated our position at a particularly attractive price due to the temporary pressure created by HNA’s sale of its 26% stake in the company for non-fundamental reasons.
William C. Nygren, CFA
Kevin G. Grant, CFA
Oakmark Fund - Investor Class
Average Annual Total Returns (06/30/18)
Since Inception (08/05/91) 12.84%
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 06/30/18: Automatic Data Processing, Inc. 2.2%, MasterCard, Inc., Class A 2.2%, Apple, Inc. 2.5%, Visa, Inc., Class A 2.2%, Facebook, Inc., Class A 1.1%, Gartner, Inc. 1.0%, Netflix, Inc. 2.5%, Anadarko Petroleum Corp. 2.0%, American Airlines Group, Inc. 1.4%, MGM Resorts International 1.3%, Bristol-Myers Squibb Company 1.8%, Hilton Worldwide Holdings Inc. 0.5%, Aflac, Inc. 0% and Harley-Davidson, 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, 2019.
The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. 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 06/30/2018 unless otherwise specified.