The Oakmark Select Fund declined 21.7% in the fourth quarter, while the S&P 500 Index declined 13.5%. As fellow shareholders in the Fund and stewards of your capital, we are disappointed in these results. As we wrote last quarter, the market has broadly rejected investments in pro-cyclical companies, regardless of their underlying fundamentals or their relative cheapness. We remain committed to the same investment process that has generated our strong long-term returns. Furthermore, the drop in stock prices during the fourth quarter enabled us to add four companies to the portfolio (Anadarko, Hilton, Lear, and Netflix) – all of which are well regarded in their respective industries for the quality of their management teams and assets.
Our energy sector holdings accounted for more than half of the Fund’s underperformance during the quarter, as oil prices fell roughly 37% from $75 to $47. Increased concern about the outlook for the economy, as opposed to actual fundamental weakness, negatively impacted the prices of our financial, consumer discretionary, and industrial sector holdings. The largest detractors in the quarter were Weatherford (-79%), Adient (-56%), and Apache (-44%). The largest contributors (smallest detractors) were Hilton Worldwide (+1%), Netflix (-2%), and Lear (-2%).
We want to provide a few words on portfolio positioning as detailed in Bill Nygren (Trades, Portfolio)’s commentary for the Oakmark Fund. In general, the Select Fund’s positioning is similar to that of the Oakmark Fund, with larger weights in our highest conviction areas - this is not surprising given the concentrated nature of the Select Fund. For example, about one-seventh of the Oakmark Fund’s portfolio is invested in companies that are more undervalued than their GAAP earnings would indicate. In contrast, the Select Fund has roughly one-fifth of its portfolio invested in companies that fit this criterion (such as Alphabet, Netflix, and Regeneron). Both funds have about one-quarter of their portfolios invested in the financial sector, but Select’s weighting is concentrated in fewer names. Just over 30% of Select’s portfolio is invested in cyclical stocks (industrial, consumer discretionary, and energy) versus about 25% of the Oakmark Fund’s. Like the Oakmark Fund, the Select Fund is also underweight less cyclical and currently more popular sectors like health care. The Select Fund doesn’t own any consumer staples (vs. a small weighting in Oakmark), utilities (none in Oakmark), or telecom companies (none in Oakmark).
As stock prices fell in the fourth quarter, companies with less debt became cheaper on an enterprise value basis. We used the extreme volatility in both the energy and auto industries to add new positions in Anadarko Petroleum and Lear, and we eliminated our ownership of Chesapeake Energy and Adient. In both cases, we retained exposure to very undervalued industries and have done so through new investments in companies with stronger balance sheets, while capturing tax losses. Anadarko has a stronger balance sheet than Chesapeake Energy, was selling at a similar discount to enterprise value, and has a history of returning capital to shareholders. Lear, Adient’s chief competitor, has a much stronger balance sheet and better mix of businesses than Adient. In addition, Lear has the financial wherewithal to purchase significant amounts of its stock at current prices. We believe Lear is cheaper on an enterprise value basis and that Adient’s significant equity upside is a function of its large debt load.
We purchased Netflix (NFLX, Financial) in the quarter because its share price fell roughly 40% from its July high. We’ve owned Netflix in the Oakmark Fund for nearly 18 months and written extensively about our thesis. Nothing at Netflix has fundamentally changed in our opinion. The price merely fell to a level that justified owning it in a concentrated portfolio like Oakmark Select.
We also started a position in Hilton Worldwide (HLT, Financial). Our reasons to own the company are the same as when we first purchased Hilton in the Oakmark Fund in the second quarter of this year. Additionally, the company’s valuation improved as its share price fell due to broad skepticism about cyclical businesses. Our analysis of the company is based on through-cycle economics, which accounts for the cyclical gyrations of the business.
We also eliminated our position in Oracle to pursue these other attractive opportunities.
Thank you, our fellow shareholders, for your continued investment in the Oakmark Select Fund.
William C. Nygren, CFA
Portfolio Manager
[email protected]
Anthony P. Coniaris, CFA
Portfolio Manager
[email protected]
Win Murray
Portfolio Manager
[email protected]
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.
