The Oakmark International Small Cap Fund returned -2.9% for the fiscal year that ended September 30, compared to its benchmark, the MSCI World ex U.S. Small Cap Index, which returned -5.6% for the same period. The Fund slightly underperformed the benchmark for the recent quarter end, returning -0.8%, compared to the MSCI World ex U.S. Small Cap Index return of -0.3% for the period. Since the Fund’s inception in November 1995, it has returned an average of 8.6% per year.
The top contributing stock for the quarter was Tower Bersama Infrastructure, an Indonesia-based provider of telecommunications infrastructure support and one of the largest independent tower operators in the country. During the quarter, investors responded favorably to Tower Bersama’s first-half earnings report. The company’s full-year expectations call for a business mix shift toward the more lucrative co-locations model (in which telecommunications companies lease tower space on a tower that is already constructed). What we value about the co-location model is that once a tower is built, additional tenants come with high incremental returns on capital employed and the Indonesia telco networks will require more of these co-locations over the medium to long term. Overall, we appreciate that management seems to be returns focused, operationally disciplined, financially sophisticated and is invested alongside its shareholders, adding to our confidence in the investment.
For the fiscal one-year period, the top contributing stock to performance was Element Fleet Management, a Canada-based firm, offering acquisition, servicing and financing for vehicles, spanning from cars and trucks to municipal and industrial fleets. The stock’s strong performance was driven by significant fundamental improvement and de-leveraging, both of which were initiated by the new CEO Jay Forbes who joined Element in June 2018. Forbes put in place a two-year transformation plan with the goal to leverage Element’s leading scale in the North American marketplace, and the initial signs have been quite positive. To date, customer churn has significantly declined, following the completion of a new IT system, and organizational complexity has been significantly reduced. The company’s cash flow generation has also improved, enabling Element to reduce its debt and strengthen its balance sheet. The company’s recent adoption of a new syndication structure will further reduce balance sheet leverage as the company will be able to sell originated assets to third parties rather than keeping those assets on the balance sheet. This syndication structure will also enable Element to grow more rapidly and further widen its unit cost competitive advantage versus peers. This should lead to an additional increase in return on invested capital and earnings per share.
The past two years have been a period of elevated volatility in equity markets. As we’ve discussed in the past, we believe the market often overreacts to near-term news flow, which can present opportunity for investors with longer term time horizons. When looking at our top 10 contributors to fiscal-year 2019 performance, half were among the 10 largest detractors of the fiscal-year 2018 performance. In addition to Element Financial (discussed above), Travis Perkins (U.K.), Azimut Holding (Italy), Sarana Menara Nusantara (Indonesia) and IWG (Switzerland) went from top 10 detractors a year ago to top 10 contributors this year. Volatile markets can be exaggerated, particularly in the small-cap space. We make our investment decisions based on our view of intrinsic value and the discount a company is trading at versus our estimate of fair value, not based on short-term share movements. As the past 12 months have shown, yesterday’s losers can quickly become today’s winners.
The largest detractor to the Fund’s performance for both the quarter and the one-year period was Germany-based Duerr, a global mechanical and plant engineering firm for the automotive industry. Duerr operates in five segments: automotive paint and assembly systems; paint, sealants and adhesives application technology; measuring and process systems; exhaust-air purification and clean technology systems; and woodworking machinery and systems. Late in July, the company pre-released its first-half earnings results and also issued a profit warning for full year 2019, driven by weakness in the HOMAG (maker of wood processing machines) and in the measuring and process systems businesses. In HOMAG, sales in China were cut in half and margins fell short of expectations. In addition, sales weakness plagued the measuring and process systems segment. Slower and lower prepayments for paint shops are also negatively impacting working capital, and Duerr now expects free cash flow to be lower year-over-year. Although the current environment is more challenging than anticipated, we recently met with Duerr’s management, and the company is very focused on taking action to improve its financial results. Duerr has a market-leading position in nearly everything it does, and management has a strong track record of value creation and operational improvement. We believe it remains a very attractive investment.
We initiated one new holding in the Fund this quarter: oOh!media, an Australia-based, out-of-home advertising operator with operations focused in Australia and New Zealand. The company provides physical and digital advertising in places, such as airports, restaurants, shopping centers, office buildings and gyms, as well as along the roadside. We eliminated positions in dormakaba Holding (Switzerland) and Ingenico Group (France). Also during the quarter, Panalpina Welttransport (Switzerland) exited the Fund as the company was acquired by portfolio holding DSV (Denmark). In addition, GrandVision (Netherlands) will soon be acquired by EssilorLuxottica (France), and with its stock trading within 5% of its offer price, we exited our position in GrandVision during the quarter.
Geographically, we ended the quarter with approximately 67% of our holdings in Europe and the U.K., 13% in Asia and 8% in Australasia. The remaining positions are in the Americas with 5% in Latin America (Mexico) and 3% in North America (Canada).
We continue to believe both the Swiss franc and Norwegian krone are overvalued versus the U.S. dollar, so the Fund remains hedged against these currencies. As a result, we ended September with hedges on 12% of the Fund’s franc exposure and 17% of the krone exposure.
During this volatile year, we thank you, our shareholders, for your continued confidence and support. We remain committed to finding attractive, undervalued foreign companies with management teams that are dedicated to building shareholder value.
David G. Herro, CFA
Portfolio Manager
[email protected]
Michael L. Manelli, CFA
Portfolio Manager
[email protected]
Justin D. Hance, CFA
Portfolio Manager
[email protected]
The securities mentioned above comprise the following preliminary percentages of the Oakmark International Small Cap Fund’s total net assets as of 09/30/19: Azimut Holding 2.6%, dormakaba Holding 0%, DSV A/S 0.9%, Duerr 3.5%, Element Fleet Management 2.5%, EssilorLuxottica 0%, GrandVision 0%, Ingenico Group 0%, IWG 1.2%, oOh!media 0.9%, Panalpina Welttransport 0%, Sarana Menara Nusantara 1.3%, Tower Bersama Infrastructure 1.7% and Travis Perkins 2.5%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
The MSCI World ex USA Small Cap Index (Net) is designed to measure performance of small-cap stocks across 22 of 23 Developed Markets (excluding the United States). The index covers approximately 14% 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 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 stocks of smaller companies often involve more risk than the stocks of larger companies. Stocks of small companies tend to be more volatile and have a smaller public market than stocks of larger companies. Small companies may have a shorter history of operations than larger companies, may not have as great an ability to raise additional capital and may have a less diversified product line, making them more susceptible to market pressure.
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.
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 discussion of the Fund’s investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Fund’s investments and the views of the portfolio managers and Harris Associates L.P., the Fund’s investment adviser, at the time of this letter, and are subject to change without notice.
All information provided is as of 09/30/2019 unless otherwise specified.
