The S&P 500 Index staged a comeback during the second quarter after falling by 20 percentage points during the first three months of the year. The rebound was driven by increased optimism regarding the pace and shape of the economic recovery as shelter-in-place restrictions eased throughout many parts of the country and most businesses were allowed to reopen in some capacity. The Oakmark Fund performed well during this period on both an absolute and relative basis. For the quarter, the Fund appreciated by 23%, outperforming the S&P 500’s return of 21%. We remained active during the second quarter as we carefully assessed the potential impacts from the coronavirus—positive and negative, cyclical and structural—on our portfolio holdings. The heightened market volatility has afforded us the opportunity to upgrade the portfolio by rebalancing existing positions and adding new ideas that offer compelling risk-adjusted return potential.
Apache (APA, Financial) and Facebook (FB, Financial) were the top contributors for the quarter. The former benefitted from a rebound in oil prices, while the latter reported resilient advertising trends and strong engagement. The biggest detractors for the quarter were General Electric (GE, Financial) and Wells Fargo (WFC, Financial). Concerns about future parts and services revenue, tied to General Electric’s installed base of aircraft engines, weighed on its share price during the period. Wells Fargo’s continued regulatory issues and temporarily inflated cost base have disproportionately hurt its near-term earnings expectations amid a challenging macro environment. We believe both companies remain attractive investment opportunities and are priced at unsustainably low multiples of their normal earnings. Our strongest contributing sectors were financials and communication services and our lowest contributing sectors were consumer staples and health care. To illustrate the amount of volatility and opportunity we’re seeing in the market, three of the positions we added to the Fund during the first quarter (Pinterest (PINS, Financial), Match Group (MTCH, Financial) and Workday (WDAY, Financial)) appreciated by at least 44% during the period, more than twice the S&P 500’s return.
During the second quarter, we eliminated positions in Apple (APPL), Delphi (DLPH, Financial), FedEx (FDX), Fiat (FCAU), Intel (INTC) and Texas Instruments (TXN) and we added new positions in General Dynamics, Reinsurance Group of America and T-Mobile. Apple, Intel and Texas Instruments all approached our estimate of intrinsic value, so we sold them in favor of more attractive alternatives. Each of these securities handily outperformed the S&P 500 over their decade-plus presence in the Oakmark Fund. Apple increased a remarkable 30x since our first purchase in January of ’09! We sold Delphi and Fiat because both companies are currently engaged in proposed mergers at disappointing prices. After selling nearly half of our FedEx position during the first quarter, we completed the sale during the current period. The stock performed well on a relative basis and was no longer attractive relative to our opportunity set.
We appreciate your continued support and confidence in the Oakmark Fund. Below is a brief description of our new additions during the quarter:
General Dynamics (GD, Financial)
General Dynamics is one of the leading U.S. defense contractors and controls the world’s premier business jet franchise (Gulfstream). Short-term fears that the coronavirus will hurt demand for business jets drove down the share price, so we were able to purchase this high-quality business at a large discount to both its historical and peer valuation levels. Taking a longer term view, we believe the company is poised to benefit from new product introductions within its business jet division, an improvement in free cash flow conversion and a highly visible, decade-long increase in deliveries of next generation nuclear-powered submarines. As these positives come into clearer view, we believe the discount to intrinsic value will close.
Reinsurance Group of America (RGA, Financial)
RGA primarily reinsures life insurance contracts. As the coronavirus spreads throughout the world, the company’s share price collapsed to levels that, in our view, reflected a worst-case scenario. Our discussions with management, as well as our own scenario analysis, further buttressed our assessment, and we established a position at a price well below the company’s tangible book value. RGA also maintains a conservative balance sheet, and we expect it will earn double-digit returns on tangible equity on average over time. We were excited to purchase this stock as it is trading for just a mid-single digit multiple of our estimate of normalized earnings per share.
T-Mobile U.S. (TMUS, Financial)
We initiated a position in T-Mobile after the company announced that regulators would approve its merger with Sprint. AT&T and Verizon have long dominated the market for wireless services due to their incumbent network quality advantage. The recently closed merger of T-Mobile and Sprint creates the first opportunity for a challenger to build the fastest, most reliable and highest capacity wireless network in the United States. We believe the impact of this combination will be non-linear from not only a network perspective but also a financial one. Our long-term investing horizon enables us to look several years ahead to assess the benefits of scale, synergy and low-incremental cost growth, which should generate more subscribers, faster revenue growth and higher margins. We like that the company will be led by veteran T-Mobile managers who have successfully integrated previous acquisitions and have gained impressive market share, despite a previously inferior network. A secondary offering by a large, non-economic seller gave us the opportunity to purchase our stake at a below market price.
The securities mentioned above comprise the following preliminary percentages of the Oakmark Fund’s total net assets as of 06/30/20: Apache 1.6%, Apple 0%, AT&T 0%, Delphi 0%, Facebook Cl A 3.5%, FedEx 0%, Fiat 0%, General Dynamics 1.0%, General Electric 1.5%, Intel 0%, Match Group Cl A 1.4%, Pinterest Cl A 1.1%, Reinsurance Group 1.4%, Sprint 0%, Texas Instruments 0%, T-Mobile US 0.9%, Verizon 0%, Wells Fargo 1.5% and Workday Cl A 1.4%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
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 information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change and may change based on market and other conditions and without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.
Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.
All information provided is as of 06/30/2020 unless otherwise specified.
