The Oakmark International Small Cap Fund returned 48.5% for the fiscal year ending September 30, compared to its benchmark, the MSCI World ex U.S. Small Cap Index, which returned 30.1% for the same period. The Fund underperformed the benchmark for the quarter end, returning -1.8%, compared to the MSCI World ex U.S. Small Cap Index return of 0.7% for the period. Since the Fund’s inception in November 1995, it has returned an average of 9.3% per year.
Despite a slightly weaker third quarter, the Fund experienced strong 12-month performance on both an absolute and relative basis driven by its overweight exposure to businesses perceived as “economically sensitive,” namely industrials and financials, and a significant underweight in Japan. Our multi-year overweight in industrials and financials is largely the result of recent macro uncertainties (e.g., global trade conflicts, Brexit, Covid-19) that pushed the valuation spread between “economically sensitive” stocks versus “defensive/growth” stocks to near-record levels. Over the past 12 months, as vaccines have rolled out, economies reopened and global GDP growth accelerated, many of these cyclical stocks have enjoyed strong share price performance. Even though many of our holdings have done well, we believe the portfolio remains attractively valued. We expect robust global GDP growth into 2022, and given how exceptionally low valuation levels were 12 months ago, multiples still look attractive relative to historical levels. Recent concerns about inflation have dampened equity returns, especially for some industrial companies. However, because our investment process focuses on quality, we tend to own businesses with strong market share, which enables them to pass along higher costs to their customer base over time. In addition, many of our holdings, such as financial companies and some staffing businesses, will likely enjoy stronger earnings and increased cash flow in a higher inflationary environment.
A top contributor to performance for the one-year period was Volaris (VLRS, Financial), the leading low-cost airline carrier in Mexico. Rebounding from Covid-19 lows, air traffic accelerated sharply in capacity as well as demand over the past year, and, as Volaris’ management team noted, the rebound was broad-based and likely to continue, given pent-up demand. The company’s low-cost position and strong balance sheet enabled it to quickly fill capacity vacated by its main competitors, Interjet and AeroMexico, both of which declared bankruptcy in 2020. Amid these conditions, Volaris has taken significant market share from its peers during the past year. We believe that the company is still well positioned to be the long-term winner in Mexican air travel. However, since its share price has appreciated over 200% in the past 12 months and approached our estimate of intrinsic value, we exited our position.
Duerr (XTER:DUE, Financial), a German-based global mechanical and plant-engineering firm, was a top contributing stock for the quarter after the company issued second-quarter results that beat market expectations. Much of the earnings improvement was driven by the HOMAG division (woodworking machinery and systems), which generated improved sales and profitability. This led Duerr to increase guidance for sales, earnings and free cash flow for the full year. The company also provided medium-term guidance, suggesting that 8% EBIT margins would be achievable by 2024 at the latest—a significant improvement over the expected margins of 5-6% in 2021. The company also announced the attractive bolt-on acquisition of Hekuma, a German specialist in high-performance automation and a leading supplier of automatic systems for large-scale production of disposable plastic products used in the medical, diagnostics and lab industries. We believe Duerr is successfully delivering on its restructuring goals. The business appears poised for further growth as orders and sales continue to recover from early-pandemic lows.
A large detractor from the Fund’s performance for both the quarter and one-year periods was Wynn Macau (HKSE:01128, Financial), which owns and operates two luxury hotel and casino resorts in the Macau region of China. Wynn Macau’s shares underperformed for two reasons. First, sporadic increases in Covid-19 cases in both China and Macau led the Macau government to impose strict travel requirements in the area, which deterred visitors and depressed revenue. Second, the Macau government began the concession renewal process for gaming licenses, which are set to expire in June 2022. The initial public consultation document indicated that the government may increase regulation on casino operators. Although the new concession terms have not been finalized, investors are worried that new regulations could hinder casino operators. We believe it is too early to draw any meaningful conclusions, and Wynn Macau’s current share price already assumes a significant hit to the company’s long-term value. We continue to monitor the situation carefully and should have greater clarity in the coming quarters.
We initiated four new positions during the quarter:
- JDE Peet’s (XAMS:JDEP, Financial) (Netherlands) is the second-largest producer of coffee products globally. We believe that coffee is among the most attractive product categories within consumer packaged goods. It benefits from both volume growth and positive revenue mix as a result of premiumization. We purchased shares of JDE Peet’s at a discount to our estimate of intrinsic value when concerns about increased green coffee prices pushed down JDE’s share price. Although the company could experience some short-term margin pressure, we believe that over the long term it will successfully grow revenue and expand margins above expectations.
- Strauss Group (XTAE:STRS, Financial) (Israel) is a food and beverage producer with strong market positions in dairy, snacks, coffee and hummus. The company benefits from favorable market trends and significant barriers to entry in its home country of Israel, where it holds the second-largest market share position within its industry. Further, Strauss Group maintains the leading market share position in Brazil, which is one of the largest and fastest growing global coffee markets. The company also owns a portfolio of other international assets, which collectively trade at a discount to our estimate of total intrinsic value.
- Vitesco Technologies Group (XTER:VTSC, Financial) (Germany), formerly Continental’s powertrain division, spun off from Continental in September. Although the Oakmark International Small Cap Fund does not hold a position in Continental, the Oakmark International Fund and the Oakmark Global Fund do. Following the corporate action, we determined that Vitesco met our investment criteria and initiated a position in the Oakmark International Small Cap Fund. Vitesco has benefited from the increasing pace of automotive electrification in Europe, which has boosted sales and improved the margins of the electrification technology segment. We think the company is positioned to grow significantly and that the stock is underpriced compared to our estimate of its intrinsic value.
- Medmix (XSWX:MEDX, Financial) (Switzerland), formerly Sulzer’s applicators business, spun off from Sulzer in September. The company manufactures high-precision delivery devices for the mixing, application and injection of liquids. These products are considered mission critical to Medmix’s customers, leading to stable growth and attractive margins.
During the quarter, we sold Equiniti Group (LSE:EQN, Financial) (U.K.), following an announced acquisition by Siris. In addition, we sold our positions in Morgan Advanced Materials (LSE:MGAM, Financial) (U.K.), TIS Inc. (TSE:3626, Financial) (Japan) and Volaris as their share prices approached our estimates of intrinsic value.
Geographically, we ended the quarter with approximately 70% of our holdings in Europe and the U.K., 13% in Asia, and 9% in Australasia. The remaining positions are 5% in Latin America (Mexico), 3% in North America (Canada) and 1% in Middle East/Africa (Israel)1. We believe the Swiss franc remains overvalued versus the U.S. dollar, and we ended September with hedges on 13% of the Fund’s franc exposure.
Thank you for your continued confidence in our investment process.
1Due to rounding, the subtotal of the weights may not equal 100%.
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.
