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David Herro's Oakmark International Small Cap Fund: First Quarter 2014 Commentary

April 08, 2014 | About:
Holly LaFon

Holly LaFon

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The Oakmark International Small Cap Fund returned 2.3% for the quarter ended March 31, 2014, underperforming the MSCI World ex U.S. Small Cap Index, which returned 3.5% for the same period. Holdings in Japan contributed most to the Fund’s quarterly return, while Swiss and Australian names were the largest detractors.

The top contributing stock for the quarter was French company Altran Technologies (XPAR:ALT). Altran provides a range of outsourced consulting services, categorized into four main areas: information systems, mechanical engineering, systems engineering and managing product lifecycles. Altran’s fiscal 2013 revenues increased a modest 2% year-over-year, which was in line with our expectations; however, revenue trends accelerated during the second half of 2013, positioning the company for better growth in 2014. More importantly, Altran continues to improve how it uses its employees. Its invoicing rates improved in the 4th quarter up from the prior year’s 4th quarter period, and they surpassed 86% in November for the first time. Higher invoicing rates are necessary for Altran to narrow the gap between its margins and the margins of its best-in-class peers. Assuming these positive trends continue in 2014, we expect Altran will report another year of margin improvement.

A large detractor from the Fund’s performance for the past quarter was Hengdeli Holdings (HKSE:03389), the large luxury watch retailer in the greater China region. The company recently reported weaker than expected results due to lower demand for luxury watches in China and Hong Kong in 2013. After reporting a number of years of double-digit growth, the luxury watch market was flat year-over-year in 2013. This slowdown is a result of a government crack-down on gifting as well as weakening macro trends in China. While the high end of the market remains under pressure, demand seems to be improving in the mid-end segment, where Hengdeli is more heavily exposed. We believe that Hengdeli’s results will begin to improve when demand in China recovers more broadly, which we expect to occur within the next few years as a result of the significant wealth creation still occurring in China today.

Portfolio Activity
We added a new Japanese security to the Fund this quarter, Hakuhodo DY Holdings (TSE:2433), Japan’s second-largest advertising agency. Hakuhodo has offices in more than 15 countries, including approximately 14% of the market share of Japan. It consists of three advertising businesses that offer a wide range of services to client advertisers and media companies. During the quarter, we sold Square Enix Holdings, Takata, and NORMA Group.

Geographically, we ended the quarter with 21% of our holdings in Asia, 55% in Europe and 11% in Australasia. The remaining positions are in North America, Latin America and the Middle East.

Because we continue to believe that some global currencies are overvalued, we maintained hedge positions on four currency exposures. At the recent quarter end, we had hedged 26% of the Fund’s Australian dollar, 42% of the Norwegian krone, 36% of the Swiss franc and 16% of the Swedish krona exposures.

Our team continues to focus on finding attractive, undervalued international companies with management teams dedicated to building shareholder value. We thank you for your support.

David G. Herro, CFA
Portfolio Manager
oakex@oakmark.com

Michael L. Manelli, CFA
Portfolio Manager
oakex@oakmark.com

As of 03/31/14, Altran Technologies represented 1.5%, Hengdeli Holdings, Ltd. 1.6%, Hakuhodo DY Holdings, Inc. 0.4%, Square Enix Holdings Co., Ltd. 0%, Takata Corp. 0%, and NORMA Group AG 0% 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.

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.


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