Quarter Review
For most of the summer quarter, growth stocks continued to dominate value equities as they did for much of 2020. Near the quarter’s end, value improved somewhat as U.S. interest rates increased. Although controversial, low interest rates have arguably boosted growth stocks’ outperformance since future earnings are worth more when discounted back to the present at low rates. We believe that a material increase in interest rates could favor value equities, but could also cause market turbulence.
The Chinese market was particularly volatile this quarter because of multiple government regulatory changes and difficulties at the country’s second-largest real estate developer, China Evergrande Group (HKSE:03333, Financial). Most exposure to Evergrande is limited to Chinese investors, but international markets remain wary of the collateral damage that could be caused if such a large enterprise defaults. During the quarter, Chairman Xi Jinping articulated his vision of a more equitable Chinese economy, and large Chinese internet platform companies responded by pledging billions of dollars to various charitable endeavors.
Oakmark Global lost 3.3% in the quarter, which compares to a small loss for the MSCI World Index and -1.1% for the Lipper Global Fund Index. For the calendar nine months, the Fund gained 14.3%, compared to a 13.0% gain for the MSCI World Index and 10.7% for the Lipper Global Fund Index. Finally, for the Fund’s fiscal year ended September 30, the Fund gained 48.0% and the MSCI World Index gained 28.8%, while the Lipper Global Fund Index returned 28.6%. Since inception, the Fund’s compound annualized return rate is 10.2%
For the quarter, the countries that contributed most to return were Australia, the U.K. and France, and Germany, China and Switzerland detracted from return. Alphabet (GOOG, Financial) (U.S.), Incitec Pivot (ASX:IPL, Financial) (Australia), Liberty Global (LBTYA, Financial) (U.K.), Oracle (ORCL, Financial) (U.S.) and Interpublic Group (IPG, Financial) (U.S.) were the largest contributors to return, while Alibaba Group (BABA, Financial) (China), General Motors (GM, Financial)(U.S.), Continental (XTER:CON, Financial)(Germany), Bayer (XTER:BAYN, Financial)(Germany) and Naspers (JSE:NPN, Financial)(South Africa) detracted most. General Motors and Continental have suffered largely due to pandemic-related issues that extend across the automobile industry. At the beginning of the pandemic, auto manufacturers cut back semiconductor chip orders, which resulted in production shifts at the chip manufacturers. When auto demand snapped back, the auto industry was unable to source sufficient parts, causing lost sales and poor market performance throughout the segment.
Over the calendar nine months, the U.S., U.K. and Australia were the countries that contributed most to return while China, Switzerland and South Africa detracted most. The companies whose stocks contributed most were Alphabet, Tenet Healthcare (THC, Financial)(U.S.), Lloyds Banking Group (LSE:LLOY, Financial) (U.K.), Bank of America (BAC, Financial) (U.S.) and General Motors. The largest detractors from return were Credit Suisse (DGLD, Financial) (Switzerland), Alibaba Group, Continental, Naspers and Prosus (XAMS:PRX, Financial) (Netherlands). We discuss Naspers and Prosus later in this letter as they are closely linked.
For the Fund’s fiscal year, the U.S., U.K. and Germany contributed most to return while China and the Netherlands were the only detractors. Lloyds Banking Group, a large detractor one year ago, was the largest contributor, followed by Alphabet, CNH Industrial (CNHI, Financial) (U.K.), General Motors and Tenet Healthcare. Alibaba Group, Prosus, Credit Suisse, Bayer and Humana (HUM, Financial) (U.S.) detracted most from return for the 12 months. We review some of the 12-month winners and losers in the next section.
Over the past few years, we have often discussed the disparity in returns between value and growth equities, but we have infrequently touched on the differences between U.S. and international returns. Yet, over the past 20 years, the S&P 500 has generated an annualized total rate of return of 9.5%, compared to 6.6% for the EAFE Index of developed country stock markets (non-U.S.). On a more granular basis, the Japanese Nikkei 225 Index has never exceeded its 1989 peak, and the London FTSE 100 Index currently trades near its 1999 levels on a price-only basis (i.e., not including income). Since 2000, U.S. markets have benefited from the performance of dynamic technology companies, few of which are located in Europe. The FAANG companies alone account for a substantial portion of the return differential.
Regardless of the investing landscape, our job as managers of the Global Fund is to invest in the most attractive opportunities wherever we find them. The location of a company might affect its short-term return potential, but in the long term, price and value usually find a way to come together. This year’s stock market returns have favored the U.S., but that tells us little about the future. At quarter end, the Fund was 47% allocated to U.S. equities, but that is not a reflection of any attempts to forecast which markets will excel. Instead, it indicates where we have found the most compelling investment opportunities.
Twelve-Month Winners and Losers
Stock prices soared over the past 12 months, a fact that the calendar helps to obscure. The majority of the return was earned in the fourth calendar quarter of 2020, which gave a positive outcome to what had been a bad year. Some smaller markets (Austria, the Netherlands) have enjoyed better than 60% increases over the past 12 months while China was the only significant market to decline in the period, a self-inflicted wound at that. The net result for the Fund in the period was a return of nearly 50%, one of the best 12-month returns the Fund has ever experienced.
Four of the strongest performers in the period were Lloyds Banking Group, Tenet Healthcare, Interpublic Group and CNH Industrial. Lloyds’ great return is partly the result of its exceptionally low starting price. Nevertheless, company fundamentals have also improved in part because of management’s conservative approach to reserving for loan losses as well as its decision at the beginning of the pandemic to suspend its program of returning excess capital to shareholders—a program it has since reinstated. Tenet may be best known as the second-largest public hospital chain in the U.S., but its largest business is outpatient acute care centers. In early 2020, investors fled the health care industry because of the great uncertainty that the pandemic presented. The early days of the pandemic were very hard on the hospital industry especially, but as the Covid-19 surge peaked and diminished, hospitals were able to schedule elective procedures and engage in profitable activities. Interpublic is the fifth largest U.S. advertising agency. Management spent the past few years reorienting the company for a digital marketing future, and these efforts are now paying off through market share gains and improving profit margins. Finally, CNH Industrial, like Lloyds, languished for most of 2020. The company’s most important division, agricultural equipment, began to recover strongly late in the year, and the share price responded accordingly.
The Fund had few losers in such a strong period, and only Alibaba’s loss was meaningful. Chinese regulators have made life difficult for Alibaba in 2021, forcing the cancellation of an initial public offering for a partially owned subsidiary (Ant Financial) and then “encouraging” the company (and its peers) to make enormous charitable contributions to make society more equitable. Chinese regulators also came down hard on the video game industry, and this depressed the Fund’s holding of Prosus, which holds a large ownership stake in Tencent. Credit Suisse has suffered two risk management outcomes in 2021. Given the size of these potential losses, the stock’s small decline in the period illustrates the value in the company. Finally, Bayer’s acquisition of Monsanto continues to haunt the company with expensive lawsuits.
Transaction Activity
All new purchases and final sales of holdings took place on the international side of the portfolio. Although not in alphabetical order, we will begin with Naspers, the highest market value company on the South African stock market. Naspers was an early investor in Tencent, a leading gaming and social media franchise in China, and it currently owns 29% of the company. Naspers has subsequently added additional high-quality businesses to its portfolio, but Tencent remains approximately 85% of our estimate of the company’s fair value. In 2019, Naspers created Prosus to hold its Tencent stake along with other non-South-African assets. As Naspers shareholders, we received shares in the newly established Prosus. During the recent quarter, Naspers and Prosus announced a tender program in which we could receive Prosus shares in return for our Naspers shares. We elected to make this exchange as we believe Prosus offers a better domicile (the Netherlands), more liquidity, a better tax position and a management team that is strongly advocating for moving the weight of ownership to Prosus. Following the tender, we decided to sell the remainder of our Naspers shares to purchase more Prosus shares.
Glencore (LSE:GLEN, Financial) was our second new purchase in the quarter. One of the world’s largest mining firms and commodity traders, Glencore has leading positions in metals, oil, coal, and agricultural commodities marketing, and it distributes these products around the world to a wide array of customer industries. This business offers attractive returns and free cash flow generation and has significant barriers to entry. Glencore is also one of the world’s largest miners of copper, cobalt, zinc and nickel, which leaves it well positioned as economies transition toward a lower carbon footprint. Its coal mining business also provides attractive cash flows, which are reinvested into other areas of the business or returned to shareholders. Glencore is run by a smart, hyper-competitive and value-oriented management team that focuses on improving asset and shareholder returns. We find the company’s current valuation attractive.
During the quarter, Fund holding Continental distributed shares of Vitesco (XTER:VTSC) as a spinoff. Vitesco is a leading supplier of components for electromobility in the auto industry. The current management team has stabilized the business after years of heavy investment. We believe the company’s electrification technology business will boost results over the next few years. Moreover, the shares trade at a significant discount to our estimate of fair value.
We exited two other spinoff distributions during the quarter. In September, Fund holding Prudential (LSE:PRU, Financial) distributed shares of Jackson National, a U.S.-based variable annuity provider, and we sold the shares. The spinoff was well telegraphed by management, and we supported the divesture given the poor strategic fit. Finally, in the second quarter, the Fund received shares in Wickes Group (LSE:WIX) as a spinoff distribution from Travis Perkins (LSE:TPK). We eliminated this holding in the third quarter to move capital into more attractive positions.
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 15% 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 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 09/30/2021 unless otherwise specified.
