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David Herro's Oakmark International Fund 2nd-Quarter Commentary

Discussion of markets and holdings

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Sydnee Gatewood
Jul 09, 2020
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The Oakmark International Fund had a strong quarter of absolute and relative performance, returning 24.4%. The benchmark MSCI World ex U.S. Index returned 15.3% for the same period. The Fund has returned an average of 8.2% per year since its inception in September 1992, outperforming the MSCI World ex U.S. Index, which has averaged 5.5% per year over the same period.

Glencore (

LSE:GLEN, Financial), headquartered in Switzerland and one of the world’s largest mining firms and commodities traders, was the largest contributor for the quarter, returning 38%. The company’s first-quarter production was lower than a year earlier, specifically for copper, cobalt, coal and ferrochrome, though its zinc, nickel and oil output increased. Management reduced full-year production guidance across commodities due to operational disruption from the coronavirus and also postponed some investment work. However, in our assessment, the disruptive effects should not have a material impact on the company’s value. Furthermore, we were pleasantly surprised that overall cost guidance for 2020 fell while we had expected an increase. The combination of the company’s cost-cutting efforts, lower input prices (particularly diesel fuel) and beneficial currency exchange rates helped reduce the cost position across a number of Glencore’s operations. In addition, management decreased full-year capital expenditure guidance by $1-1.5 billion, which will support free cash flow generation in the current year. Finally, the company noted that its marketing segment has performed in line with the annual earnings guidance of $2.2-3.2 billion, despite significant volatility in commodities markets, particularly oil. Despite the share price increase during the quarter, we believe that Glencore remains an attractive investment.

Rolls-Royce Holdings (

LSE:RR., Financial), based in the U.K. and a leading producer of engines for the aerospace sector, was the largest detractor for this quarter, returning -16% and down approximately 60% year to date. As we discussed during our last quarterly write-up, we believe that the coronavirus has only modestly affected the intrinsic value of most of our holdings. Unfortunately, this is not the case with Rolls-Royce. We think that the coronavirus will cause a material and long-lasting disruption to the company’s civil business. This segment accounted for approximately 55% of the company’s 2019 revenue and generated most of its cash flow primarily due to its dominance in the wide-body jet engine market. However, the vast majority of wide-body aircraft are flown on international routes, and with nearly all international traffic grounded, wide-body flight hours decreased 90% year-over-year during the second quarter. Although we expect international air travel to recover in the coming months, we believe it will not return to 2019 levels for many years. As a result, we’ve significantly decreased our earnings forecasts for the company’s civil business, which is now likely to be a smaller and less profitable part of the business than we had assumed at time of initial investment. Fortunately, Rolls-Royce has other businesses, namely power systems and defense, which combined are nearly the same size as the civil business and have been much less disrupted by the coronavirus. The recent share price correction, though, implies that all of the company’s businesses have declined as much in value as the civil business has, which we believe is not the case. We estimate that the value of the power systems and defense business exceeds the current quote, implying the market believes the civil business has negative value. Although the civil business could report a couple years of losses and negative cash flow, we believe the business still has positive long-term value. Rolls-Royce has been a poor investment to date, but we think its current risk-return profile is favorable. Thus, we remain shareholders, despite a significant reduction in our estimate of the company’s intrinsic value.

During the quarter, we initiated a position in Amadeus IT Group (

XMAD:AMS, Financial) (Spain), a leading global software and payments company serving the airline, hospitality and rail sector, and Compass Group (LSE:CPG, Financial) (U.K.), a global food service and support service provider.

We continue to believe the Swiss franc is overvalued versus the U.S. dollar. As a result, we defensively hedged a portion of the Fund’s exposure. Approximately 13% of the Swiss franc exposure was hedged at quarter end.

Geographically, we ended the quarter with almost 81% of our holdings in Europe and the U.K., 10% in Asia, and 3% in Australasia. The remaining positions are 2% in South Africa, 3% in North America and 1% in Latin America (Mexico).

We thank you for your continued support.

The securities mentioned above comprise the following preliminary percentages of the Oakmark International Fund’s total net assets as of 06/30/20: Amadeus IT Group 1.3%, Compass Group 0.7%, Glencore 4.3% and Rolls-Royce Holdings 1.4%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

The 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.

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 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.

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.

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