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Bill Nygren's Oakmark Select Fund - First Quarter 2014 Letter

April 14, 2014 | About:
Holly LaFon

Holly LaFon

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For the quarter, the Oakmark Select Fund gained 5%, compared to 2% for the S&P 500 Index. We are pleased to report the Fund ended the quarter at a new all-time high NAV, meaning that as of 03/31/14, all current Select shareholders have unrealized gains in their holdings. These strong absolute and relative results were due in large part to Forest Laboratories (Forest) agreeing to be acquired by Actavis Plc in the quarter. Our relatively large exposure to auto-related cyclicals and financials continued to benefit our results. The largest detractors were MasterCard, Kennametal and FedEx. As discussed below, we eliminated our positions in Forest, Texas Instruments (TI) and Newfield Exploration, and we established new positions in Franklin Resources and CBRE Group (CBRE).

After returning 40% last quarter, Forest (FRX) returned another 52% in the first quarter as the company agreed to be acquired by Actavis for both cash and stock. We believe the acquisition price was full and fair. While our investment thesis – that Forest’s new drug launches would be successful and leverage the company’s expenses – did not have the chance to transpire, we are more than pleased that the stock price reached our estimated value in short order. It’s not uncommon for the management of companies in transition to resist being acquired before their strategies to create value are fully realized. We applaud the leaders at Forest for their willingness to pull forward this value, even if it denied them the personal satisfaction of seeing their efforts realized in the coming years. We believe this could serve as a lesson for the leadership of other public companies. If someone wants to pay a fair price on a risk-adjusted basis for ‘what could be’ in your business, you owe it to your shareholders to realize this value so that they can recycle their capital into other attractively valued investments.

At Oakmark, active management means more than just stock selection – it also involves maximizing after-tax returns and managing risk in special situations. As a case in point, we sold our Forest position in a tax-efficient manner throughout the quarter as our shares became long term holdings for tax purposes. To reduce our risk while we sold our shares, we established a short position in Actavis in proportion to the stock component of the transaction. This position was then reduced commensurate with our Forest stake until it was fully eliminated, thereby generating only long-term capital gains. We were comfortable with hedging the stock portion of our Forest position because of our belief that Actavis equity was selling closer to fair value. And unlike that of most acquirers, Actavis’ stock price rose meaningfully upon announcement of the transaction and in the days thereafter. Logic follows that Actavis shares were more likely to fall if the deal was scuttled by another bidder or some other unforeseen reason, thus providing an unusually effective hedge.

We also eliminated the remainder of our investment in TI (TI) as the final tranche of shares went long term. TI offers another example of a management team that we believe puts its shareholders first in a situation where many do not. Since its acquisition of National Semiconductor in 2011, TI has been generously returning excess capital to shareholders while maintaining a prudent, but not lazy, balance sheet. This likely contributed to their shares approaching our estimate of fair value. Many large technology companies today simply grow their already immense cash positions and offer little insight into their plans for distributing that excess capital. We believe TI set a terrific example for other companies in the technology sector. Finally, we also sold Newfield Exploration after we came to believe that its effort to transition the company to liquids was a low-return proposition that would limit its ability to grow per-share value.

We established a position in Franklin Resources (BEN), one of the world’s largest global mutual fund companies, with leading products in both equities and fixed income. For starters, we believe asset management is an attractive business and Franklin has a history of strong fund performance across various asset classes and geographies. The company is selling for less than 14x our estimate of this year’s EPS and just over 11x adjusting for net cash and securities. In our view, this is a cheap price for a well-run company in such an attractive industry. Management has historically returned capital to shareholders through stock buybacks and dividends, and with insiders owning 35% of outstanding shares, we expect Franklin to continue to be good stewards of shareholders’ capital.

As the largest commercial real estate brokerage and property management company in the U.S., CBRE has the geographic reach, scale and breadth of services that very few competitors in this fragmented industry can match. Bundling its services across the globe has led to share gains, which we believe will continue. While certain business lines are more volatile, related commercial real estate activity metrics are improving. At the same time, an increasing proportion of the company’s profits are coming from more stable fee-based revenues. Management has a good track record, and we believe this growing company is selling for a substantial discount to value.

William C. Nygren, CFA
Portfolio Manager
oaklx@oakmark.com

Anthony P. Coniaris, CFA
Portfolio Manager
oaklx@oakmark.com

Win Murray
Portfolio Manager
oaklx@oakmark.com

As of 03/31/14, Forest Laboratories, Inc. represented 0%, Actavis PLC 0%, Mastercard, Inc., Class A 4.9%, Kennametal, Inc. 2.7%, FedEx Corp. 4.0%, Texas Instruments, Inc. 0%, Newfield Exploration Co. 0%, Franklin Resources, Inc. 4.2%, and CBRE Group, Inc. 4.1% of the Oakmark Select 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 Select Fund as of the most recent quarter-end.

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.

EPS refers to Earnings Per Share and is calculated by dividing total earnings by the number of shares outstanding.

Because the Oakmark Select Fund is non-diversified, the performance of each holding will have a greater impact on the Fund's total return, and may make the Fund's returns more volatile than a more diversified fund.

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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