Quarter Review
The summer quarter mostly continued the process of recovery that the stock market experienced since its March panic bottom. September, however, lived up to its reputation for being the month most likely to see stocks decline. Economies worldwide continued to generate erratic recovery from the Covid-19-induced recession, and periodic resurgences of the virus depressed many service industries.
Oakmark Global gained 6.9% in the quarter, which compares to a gain of 7.9% for the MSCI World Index and 8.1% for the Lipper Global Fund Index. For the calendar nine months, the Fund lost 15.8%, compared to a 1.7% gain for the MSCI World Index and 2.4% for the Lipper Global Fund Index. Finally, for the Fund's fiscal year ended September 30, the Fund lost 6.7% and the MSCI World Index gained 10.4%, while the Lipper Global Fund Index gained 11.2%. Since inception, the Fund's compound annualized return rate is 8.7%
For the quarter, the countries that contributed most to return were the U.S., Germany and Ireland, while the U.K., Belgium and South Africa detracted from return. Daimler (XTER:DAI, Financial) (Germany), Pinterest (PINS, Financial) (U.S.), TE Connectivity (TEL, Financial)(U.S.), Mastercard (MA, Financial) (U.S.) and Tenet Healthcare (THC, Financial) (U.S.) were the largest contributors to returns, while Rolls-Royce Holdings (LSE:RR., Financial) (U.K.), Lloyds Banking Group (LSE:LLOY, Financial) (U.K.), Bayer (XTER:BAYN) (Germany), National Oilwell Varco (NOV)(U.S.) and Citigroup (C) (U.S.) detracted most.
Over the calendar nine months, South Africa, China and Taiwan were the countries that contributed most to return, while the U.K., U.S. and Switzerland detracted most. The companies whose stocks contributed most were Pinterest, Mastercard, CoreLogic (CLGX) (U.S.—sold), Alphabet (GOOG) (U.S.) and Liberty Broadband (LBRDA) (U.S.). The largest detractors from return were Lloyds Banking Group, Rolls-Royce, Citigroup, CNH Industrial (CNHI) (U.K.) and Bank of America (BAC) (U.S.). The fact that the five largest contributors were all U.S.-domiciled yet the U.S. was one of the countries that detracted most from return speaks to the extreme outcomes in this turbulent time period.
For the Fund's fiscal year, the U.S., Ireland and South Africa contributed most to return, while the U.K., Australia and Mexico were the largest detractors. For the second fiscal year in a row, Mastercard was the largest contributor, followed by Pinterest, Alphabet, Daimler and Liberty Broadband. Lloyds Banking Group, Rolls-Royce, CNH Industrial, Citigroup and Howmet Aerospace (HWM) (U.S.) detracted most from return for the 12 months.
The lists of detractors above collectively include almost all of the Fund's banking industry holdings and the Fund's entire financials sector has been the largest detractor throughout the fiscal year. This reflects many factors. Central banks have suppressed interest rates across the developed world, which depresses the profit margins on banks' loan books. As well, banks have vigorously increased their reserves for bad debts in response to the Covid-19 crisis, even though actual losses incurred to date are not consistent with a major downturn. Indeed, after selling off during the early days of the pandemic, corporate bond prices now reflect an expectation of rapid recovery. Nevertheless, banks have put their share repurchase plans on hiatus and some have cut or eliminated dividends. Banks' substantial capital positions have virtually eliminated the chance that they will need to raise capital and, therefore, dilute their balance sheets. Yet share prices that declined when the Covid-19 crisis hit have not yet bounced back. In perhaps a more dramatic demonstration of the industry's poor relative market performance, 10 years ago European banks accounted for six times technology's share of the Eurozone market index while today their respective shares are roughly equal.
Value investors must decide whether the drop in bank share prices properly reflects evolving circumstance or is an overstated case. We have concluded the latter and believe that the passing of the Covid-19 crisis will allow the undervaluation to become clear. European banks are generally priced at half of book value (and in some cases even less), so modest improvements in their operating environment can have leveraged positive effects on valuations. U.S. banks are more highly valued today, reflecting stronger home market economic conditions, but they still offer considerable value if conditions ever normalize. At that time, we expect share repurchases to accelerate intrinsic value per share growth. Although holdings in this industry have proven painful in 2020, we expect future outcomes to be rewarding.
Transaction Activity
We were rather active in the quarter, culling several small holdings and initiating one new name. These actions, combined with the solid performance of U.S. stocks, resulted in a 1% increase in the Fund's U.S. allocation. The U.S. retains the largest weighting in our portfolio, but it still falls well below the ever-increasing U.S. weight in the MSCI World Index. We do not think the indexes' overweight in the U.S. reflects economic reality. Nevertheless, given continual U.S. outperformance, our relative underweighting has not helped the portfolio.
During the quarter, we eliminated four holdings—two U.S. and two international. On the U.S. side, we sold EOG Resources (EOG) to harvest a tax loss. We continue to believe that EOG is one of the best positioned energy producers, but current economic activity has not rewarded that position. In our June letter, we wrote about the takeover offer that another holding, CoreLogic, had received. Because of this offer, the stock attained a price close to our estimate of intrinsic value and we sold our shares to purchase more attractive names.
On the international side, we disposed of Taiwan Semiconductor Manufacturing Co (TSM) and LafargeHolcim (XSWX:LHN). TSMC was sold as its share price approached our estimate of intrinsic value. We used this capital to allocate to securities with more attractive risk-reward profiles. We sold LafargeHolcim to opportunistically fund a position in Anheuser-Busch Inbev (BUD) (ABI). ABI is the world's largest brewer and its global 27% market share is more than twice the volume of the #2 player. Importantly, its dominant market share positions, strong brands and vertical integration allow it to generate industry-leading margins, returns and cash flows. ABI's significant scale advantage enables it to earn more than 4x the profitability of the #2 player. The majority of the company's profitability is derived from developing markets where duopoly market structures, growing per capita income and premiumization drive attractive growth and profitability. ABI is a good example of finding opportunities during times of volatility. We have long covered the company and admired the franchise from afar, but our strict valuation criteria kept us on the sidelines. However, when the share price fell by nearly 50% due to shorter term Covid-19 concerns, we quickly ramped up our research and initiated a position. Covid-19-related closures of bars and restaurants have depressed recent operating performance, which has hurt sales in the on-trade channel and pressured the stock price. Nevertheless, we expect these headwinds will prove short term. We think that ABI's scale should enable it to outperform smaller peers during this pandemic. Notably, the company's debt structure has been smartly termed out, so it has plenty of liquidity to invest while navigating the pandemic. ABI's management has done an excellent job of creating long-term value and its interests are aligned with shareholders.
Currency Hedges
We defensively hedge a portion of the Fund's exposure to currencies that we believe to be overvalued versus the U.S. dollar. As of quarter end, we found the Swiss franc to be overvalued and have hedged approximately 17% of the Fund's franc exposure.
As always, we thank you for being our partners in the Oakmark Global Fund. We invite you to send us your comments or questions.
The securities mentioned above comprise the following preliminary percentages of the Oakmark Global Fund's total net assets as of 09/30/20: Alphabet Cl C 5.6%, Anheuser-Busch InBev 0.8%, Bank of America 3.6%, Bayer 2.5%, Citigroup 1.8%, CNH Industrial 4.1%, CoreLogic 0%, Daimler 3.6%, EOG Resources 0%, Howmet Aerospace 1.7%, LafargeHolcim 0%, Liberty Broadband Cl C 3.1%, Lloyds Banking Group 5.1%, Mastercard Cl A 6.3%, National Oilwell Varco 0.9%, Pinterest Cl A 2.1%. Rolls-Royce Holdings 0.5%, Taiwan Semiconductor Manufacturing Co 0%. TE Connectivity 5.0% and Tenet Healthcare 2.0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
Access the full list of holdings for the Oakmark Global Fund as of the most recent quarter-end.
The net expense ratio reflects a contractual advisory fee waiver agreement through January 27, 2021.
The MSCI World Index (Net) is a free float-adjusted, market capitalization-weighted index that is designed to measure the global equity market performance of developed markets. The index covers approximately 85% of the free float-adjusted market capitalization in each country. This benchmark calculates reinvested dividends net of withholding taxes. This index is unmanaged and investors cannot invest directly in this index.
The Lipper Global Fund Index measures the equal-weighted performance of the 30 largest global equity funds as defined by Lipper. This index is unmanaged and investors cannot invest directly in this index.
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 in 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 compound return is the rate of return, usually expressed as a percentage that represents the cumulative effect that a series of gains or losses has on an original amount of capital over a period of time. Compound returns are usually expressed in annual terms, meaning that the percentage number that is reported represents the annualized rate at which capital has compounded over time.
The percentages of hedge exposure of 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 09/30/2020 unless otherwise specified.
