Oakmark Global Fund: Third Quarter 2015

Seasonal Affective Disorder
Seasonal Affective Disorder (SAD), according to Wikipedia, “is a mood disorder subset in which people who have normal mental health throughout most of the year experience depressive symptoms in the winter or summer.”  Investors know that the stock market has historically demonstrated seasonality in its return pattern.  September, the month when the Northern Hemisphere generally experiences its most pleasant weather, is also the month with the stock market’s worst return record.  Academics have attempted to explain this phenomenon, but the explanation remains elusive.  Regardless of the reason, stock markets around the globe fully demonstrated this SAD tendency in late summer 2015.

Many factors contributed to the difficult environment for investors, including U.S. monetary policy uncertainty, the international refugee crisis, seemingly endless Middle East conflicts, commodity price declines, currency volatility and decelerating Chinese economic growth.  But we must assert again what we have said many times before: In our view little has changed to affect our holdings’ abilities to produce positive economic outcomes for shareholders.  We expect the Fund’s holdings to continue to generate free cash flow, invest in their businesses, pay dividends and repurchase stock, and, in general, grow their intrinsic value per share.  As always, market prices are far more volatile than intrinsic value, and it is our job to prey upon this volatility. 

Perhaps nothing better demonstrates the quarter’s difficult market than the outcomes in the automotive industry.  The Fund owns three original equipment manufacturers (OEMs) spread across the globe:  Toyota, Daimler and General Motors.  In September, Volkswagen admitted that its diesel engines were outfitted with software enabling them to cheat on emissions tests.  As might be expected, Volkswagen’s shares plummeted as the story unfolded.  Less predictably, its competitors’ share prices also fell, as at least in the short term, the market took a more pessimistic view toward the entire automotive industry.  We anticipate that our three OEMs will gain market share at Volkswagen’s expense, and this should help to increase their per share intrinsic value. 

Quarter Review
For the quarter, the Oakmark Global Fund lost 11%, which compares to the MSCI World Index’s 8% loss in the period and the Lipper Global Fund Index’s loss of 9%.  For the first nine months of 2015, the Fund lost 10%, which contrasts to losses of 6% for both the MSCI World Index and the Lipper Global Fund Index.  For the Fund’s fiscal year ended September 30, the Fund lost 7%, and both the MSCI World Index and the Lipper Global Fund Index lost 5%.  Since inception in 1999, the Fund has achieved a compound annual rate of return of 10%, which compares to 3% for the MSCI World Index and 4% for the Lipper Global Fund Index.
 
For the quarter, every country represented in the Fund detracted from return.  The U.S., Switzerland and the U.K. detracted most.  Google (U.S.), Nestle (Switzerland), Intel (U.S.), Danone (France, position now eliminated) and Allianz (Germany) were the only positive contributors to Fund return.  The Fund holdings that detracted most were CNH Industrial (Netherlands), Tenet Healthcare (U.S.), Credit Suisse Group (Switzerland), Julius Baer Group (Switzerland) and Daimler (Germany).     

For the calendar nine months, Australia and France contributed to investment return, while the U.S., U.K. and Japan detracted most.  Leading contributors to return were Google, Health Net (U.S.), Adecco (Switzerland), Incitec Pivot (Australia) and Julius Baer Group.  Chesapeake Energy (U.S.), Tenet Healthcare, CNH Industrial, Union Pacific (U.S.) and Franklin Resources (U.S.) were the leading detractors. 

Finally, for the Fund’s fiscal year that ended September 30, 2015, the countries that contributed most to return were Australia and Switzerland, and detractors were the U.S., the Netherlands and the U.K.  The largest return contributors were Health Net, MasterCard (U.S.), Incitec Pivot, TE Connectivity (Switzerland) and Google. Tenet Healthcare led the detractors, followed by National Oilwell Varco (U.S.), Chesapeake Energy, CNH Industrial and Credit Suisse Group.

Portfolio Activity
Given the poor portfolio return described above, it cannot be surprising to learn that alongside the aforementioned automobile manufacturers many holdings suffered significant price declines in the quarter.  Companies with interest rate sensitivity or exposure to energy and/or China had especially weak performance.  Perhaps most surprising, however, is the price decline that Fund holding Health Net experienced in the period.  On July 2, Centene (CNC) announced that it had agreed to purchase Health Net for a mixture of cash and CNC stock.  At the time of the announcement, the deal offered a significant premium to Health Net shareholders.  After an initial leap higher, however, the stock prices of both Health Net and Centene declined as investor enthusiasm for health care providers cooled.  We also believe that some Centene investors sold their shares because they had anticipated that CNC itself would be a target rather than an acquirer.  We reduced the Health Net holding after the deal announcement but would have been better served by eliminating the holding completely.  Nevertheless, we find the combination of the two companies to be intriguing and look forward to learning more about their combined potential.

We initiated two new holdings in the quarter, one U.S. and one international.  We also eliminated one U.S. and two international holdings.  Although the net reduction in international holdings suggests that we reduced the international portfolio weight, in fact, we increased the international weight in the quarter based on our analysis of relative attraction.  Once again, we did not intentionally choose these geographical allocations; they are the result of our bottom-up search for value across the globe and of divergent price movements.

Our international new purchase was Baidu (BIDU), China’s largest Internet search engine that commands over 70% market share.  The company is also a leading provider of various Internet properties, such as maps, an app store, videos, and travel services.  More recently, management has been investing heavily in new businesses such as online-to-offline services (e.g., food delivery, ride sharing, etc.).  These investments appear to be causing a drag on both profitability and stock price.  Macro fears in China have also contributed to Baidu’s weak stock performance.  Despite these headwinds, we remain optimistic about Baidu’s long-term prospects.  Investments in new businesses are masking the strength of the core search business, which continues to grow at a healthy rate and generates high levels of profitability.  We believe today’s valuation neither reflects the fair value of the company’s search business nor gives any credit for its many non-search businesses; therefore, the stock price significantly underestimates its true value. 

The Baidu purchase doubled the Fund’s emerging market holdings (from one to two!), although many Fund investors may have assumed that China and Korea had already graduated from the emerging market category.  Our equity research department devotes considerable time to analyzing companies based in emerging markets.  Yet corporate governance and business quality continue to be the limiting factors when looking at companies in these regions.

Our one new U.S. purchase, Oceaneering International (OII), ironically, has the word “International” in its name.  Oceaneering offers various niche products and services used in deepwater oil and gas exploration and production, many of which relate to its industry-leading fleet of remotely operated vehicles (ROVs).  In our opinion, management has capably grown market share and profitability through strong execution and wise capital allocation.  This combination of management and franchise has always interested us, but only recently has the decline in energy prices caused OII’s share price to fall to levels that meet our requirements for purchase.  Although the large decline in oil prices affects near-term demand for deepwater services, we believe that deepwater production remains necessary to meet future energy needs. 

We eliminated holdings of Applied Materials (U.S.), Danone and Fugro (Netherlands) during the quarter.  These sales reflected three factors: our perception that their intrinsic value growth was not meeting our expectations, our effort to enhance the Fund’s tax efficiency and our recognition that better opportunities were available elsewhere.

Currency Hedges
Global currencies were relatively stable during the quarter.  However, both the Swiss franc and Australian dollar weakened versus the U.S. dollar.  Although we continue to believe these currencies are overvalued, we reduced our hedging levels during the quarter.  Approximately 26% of the Swiss franc and 10% of the Australian dollar were hedged at quarter end.  

Thank you for being our partners in the Oakmark Global Fund.  Please feel free to contact us with your questions or comments.

As of 09/30/15, Toyota Motor Corp. represented 3.6%, Daimler AG 3.6%, General Motors Co. 3.6%, Volkswagen AG 0%, Google, Inc. 3.8%, Nestle SA 0.7%, Intel Corp. 1.9%, Danone 0%, Allianz AG 4.3%, CNH Industrial N.V. 3.4%, Tenet Healthcare Corp. 1.9%, Credit Suisse Group 5.8%, Julius Baer Group, Ltd. 3.8%, Health Net, Inc. 2.7%, Adecco SA 0%, Incitec Pivot, Ltd. 3.1%, Chesapeake Energy Corp. 0.4%, Union Pacific Corp. 2.4%, Franklin Resources, Inc. 0.7%, MasterCard, Inc. Class A 3.5%, TE Connectivity, Ltd. 3.9%, National Oilwell Varco, Inc. 0.8%, Centene Corp. 0%, Baidu, Inc. 2.6%, Oceaneering International, Inc. 1.1%, Applied Materials, Inc. 0%, and Fugro N.V. 0% of the Oakmark Global Fund’s total net assets.  Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

Click here to access the full list of holdings for The Oakmark Global Fund as of the most recent quarter-end.

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. This benchmark calculates reinvested dividends net of withholding taxes using Luxembourg tax rates. This index is unmanaged and investors cannot invest directly in this index.

The Lipper Global Funds Index measures the performance of the 30 largest mutual funds that invest in securities throughout the world. 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 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 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.