Oakmark Equity and Income Fund – Investor Class
Average Annual Total Returns 12/31/16
Since Inception 11/01/95 10.20%
Gross Expense Ratio as of 09/30/16 was 0.79%
Past performance is no guarantee of future results. The performance data quoted represents past performance. Current performance may be lower or higher than the performance data quoted. The investment return and principal value vary so that an investor’s shares when redeemed may be worth more or less than the original cost. To obtain the most recent month-end performance data, view it here.
Why do you invest at all? What financial goals do you have? What do you want your money to enable in your life? If you are a regular reader of the financial press, you might conclude that most investors in funds or investing products do so to satisfy a competitive desire to “beat the market.” Although interesting, we do not believe that this description is accurate. At Oakmark, we have many years of experience working with individual investors, and beating the market rarely shows up on their list of desires. Instead, investors express goals in terms of sustaining a specific lifestyle, affording certain purchases or gifts, or simply providing considerable economic security for themselves and their significant others.
But, you may ask, does “beating the market” play a part in satisfying the kind of financial goals described above? The answer is, “Not really.” The market itself is an abstraction generally expressed in the form of an index (e.g., the S&P 500). Whatever the particular merits of any index, it is only relevant as a measure of value at a particular moment in time for a particular group of businesses. That group of businesses may itself be relevant to you as an investor, but its current price simply identifies what investors in the aggregate are willing to pay for this group. Even in the case of the total market index, which attempts to measure the price of all extant public securities, you still do not have something that is undeniably relevant to the individual investor if the index itself contains many mispriced securities. And, of course, sometimes “beating the market” simply means losing less than the market index—an outcome that few investors find truly satisfying.
We believe that investors should focus first and foremost on their own financial goals and then choose an investment approach that best marries the possibility of meeting those objectives with the investor’s personality traits. Most important of these is the investor’s ability to tolerate price volatility. Investors with little volatility tolerance should choose an asset allocation and investment managers that have a track record of relatively low volatility. Conversely, investors with great tolerance for volatility can choose an aggressive asset allocation and more volatile funds or instruments. But, in our view, the most important decision for the investor is the appropriate asset allocation. Once that is achieved, the investor must periodically monitor allocations and rebalance when necessary.
The Equity and Income Fund helps manage the asset allocation decision for its clients. We rebalance the Fund based on our understanding of market valuations—within the limits stated in our prospectus, of course. When bond prices are high, as they have been for several years, we own less of them. As interest rates rise and bond prices fall, we increase our fixed income allocation. We do not claim to be able to customize the allocation to the needs of each individual, but history demonstrates that a portfolio allocated to approximately 60% equities and 40% fixed income instruments should satisfy most investors’ desire for solid returns and relatively low volatility.
Even if an investor finds a sensible investment approach and the proper asset allocation, he/she still needs to guard against making emotional investment decisions. “Investor share” is a metric that measures the proportion of a mutual fund’s return that investors actually capture, and although this proportion varies from fund to fund, it is oftentimes far below 100%. This typically happens when investors arrive at a fund after it has enjoyed a strong period and then leave when volatility strikes. To avoid this outcome, each quarter we try to communicate clearly what occurred with the portfolio and add to investors’ understanding of our thinking. We also provide many other resources on our website that explain the Fund’s and the firm’s investment philosophy.
In closing this section, we should note that the Equity and Income Fund has done well versus the market since its inception 20+ years ago, but this has been accomplished through its focus on price and value. Outperformance has been an outcome but not a prime objective. We believe that our investors should also focus on developing a portfolio that is right for them and their financial needs. If those needs are being satisfied, one can let the market take care of itself.
A Very Different Year
Last year we began this letter by noting how 2015 had been a “very narrow year.” 2016 was anything but! In 2015, a small group of stocks provided the bulk of the market’s return, whereas 2016’s participation was quite broad. In 2016, the path was far from straight, however. The year began with the worst start ever for U.S. equities, and by mid-February investors wondered whether a new bear market had begun. The markets quickly stabilized and reversed course at that point, however, with the S&P 500 producing positive returns in all but one month, beginning in March. Last year we wrote that “the defining event of the quarter (in financial terms) was the Federal Reserve’s decision to increase short term interest rates.” Most economists forecasted that the Fed would raise rates several times in 2016, but this was not to be. In fact, we could be writing once again that the defining event of the current quarter was the Fed’s decision to increase interest rates for the first time this year, but for the fact of another event—the election. Few pundits projected the election outcome correctly, and fewer still predicted the market’s reaction. Since the election, stocks (as represented by the S&P 500) have returned 5% while bonds (as measured by the 10-year U.S. Treasury) have lost 5%. Within the stock market, previously shunned sectors (e.g., financials) have enjoyed new popularity while high-yielding issues have experienced diminished investor interest.
The Equity and Income Fund earned 5% in the quarter, which contrasts to a 1% gain for the Lipper Balanced Fund Index, the Fund’s performance benchmark. For calendar 2016 as a whole, the Fund gained 11%, compared to 7% for the Lipper Index. As always, we are pleased to report that the annualized compound rate of return since the Fund’s inception in 1995 is 10% while the corresponding return to the Lipper Index is 7%.
The largest contributors to portfolio return in the quarter were Bank of America, General Motors, Baker Hughes, TD Ameritrade and Comerica. CVS Health, Nestlé, Diageo, FNF Group and Philip Morris International detracted most. It is interesting that the Fund’s three consumer staples holdings with dominant international franchises detracted significantly in what was a strong period in the U.S. This reflected dollar strength, comparatively poor results in non-U.S. markets and a general move away from consumer staples stocks. For all of calendar 2016, Bank of America, Glencore, UnitedHealth Group, Dover and Comerica led the contributors while CVS Health, BorgWarner, HSN, Goldman Sachs (sold) and Oceaneering International (sold) detracted most from return.
Our transaction activity was modest in the quarter, at least in terms of new equity names or eliminations, which equaled one of each. Relative to fixed income, we increased the Fund’s corporate bond allocation as interest rates rose during the quarter. These purchases, however, had only a modest impact on portfolio duration, the measure of sensitivity to changes in interest rates. Should interest rates continue to drift upward, we will consider increasing portfolio duration.
The new equity purchase is VWR Corporation, the second largest distributor of laboratory equipment and supplies. Laboratory equipment is a fragmented industry, both in terms of manufacturers and distributors. Of the few larger distributors, VWR stands out for being manufacturer-agnostic because it does not manufacture branded product itself. This position can be advantageous when looking to make “tuck-in” acquisitions of smaller industry players, and growth through acquisitions is an important strategy for VWR. In our opinion, VWR is undervalued given its high returns, low capital requirements and solid cash generation.
The one elimination was Manitowoc Foodservice, the spinoff from Manitowoc Company. When we purchased the pre-spinoff company, we did so believing that the two divisions were separable and that the two parts were worth more than the combined whole. As it happened, company management came to share this point of view and split the company into two parts in March 2016. The Foodservice piece has enjoyed a strong reception in the market and attained our sell target late in the year.
As always, we thank our fellow shareholders for investing in the Equity and Income Fund.
The securities mentioned above comprise the following percentages of the Oakmark Equity and Income Fund’s total net assets as of 12/31/16: Bank of America Corp. 4.5%, General Motors Co. 4.4%, Baker Hughes, Inc. 1.5%, TD Ameritrade Holding Corp. 1.5%, Comerica, Inc. 1.0%, CVS Health Corp. 2.4%, Nestlé SA ADR 2.8%, Diageo PLC 1.6%, FNF Group 1.3%, Philip Morris International, Inc. 1.8%, Glencore PLC 0.8%, UnitedHealth Group, Inc. 2.2%, Dover Corp. 2.6%, BorgWarner, Inc. 1.8%, HSN, Inc. 0.3%, The Goldman Sachs Group, Inc. 0%, Oceaneering International, Inc. 0%, VWR Corp. 0.4%, Manitowoc Foodservice, Inc. 0% and The Manitowoc Co., Inc. 0.2%. 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 Equity and Income Fund as of the most recent quarter-end.
The S&P 500 Total Return Index is a market capitalization-weighted index of 500 large-capitalization stocks commonly used to represent the U.S. equity market. All returns reflect reinvested dividends and capital gains distributions. This index is unmanaged and investors cannot invest directly in this index.
The Lipper Balanced Funds Index measures the performance of the 30 largest U.S. balanced funds tracked by Lipper. This index is unmanaged and investors cannot invest directly in this index.
The Fund invests in medium- and lower-quality debt securities that have higher yield potential but present greater investment and credit risk than higher-quality securities, which may result in greater share price volatility. An economic downturn could severely disrupt the market in medium or lower grade debt securities and adversely affect the value of outstanding bonds and the ability of the issuers to repay principal and interest.
The Oakmark Equity and Income 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 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 12/31/2016 unless otherwise specified.