The Oakmark International Small Cap Fund (OAKEX) recently celebrated its 25th anniversary. The Fund was founded in November 1995 by Co-Managers David Herro (still a co-manager today) and Adam Schor as the Oakmark International Emerging Value Fund. It initially focused on small-cap companies in developed markets and companies of all sizes in the emerging world. While the Fund produced strong absolute returns during its first few years, commercial success was limited given its unique mandate and lack of direct peers and global benchmarks.
In January 1997, the Fund’s name was changed to the International Small Cap Fund and was given a more traditional small-cap mandate. Since then, OAKEX has typically owned 50-60 stocks across all global markets, excluding the United States. The Fund utilizes the same value investment process and analyst team as its large-cap brother, the Oakmark International Fund.
Sell-side coverage and information flow in the small-cap space have improved over the past 25 years, but it’s still significantly less well followed than the large-cap universe. Our analysts’ extensive travel and detailed due diligence provides opportunities to identify businesses that are not widely known to the broader investment community. Given the small size of some of the companies we invest in, it’s not uncommon for OAKEX to own over 5% of the outstanding equity of some companies. Our detailed understanding of both the business model and management gives us confidence to own these more focused positions.
Finding managers who efficiently operate a company’s assets and deploy capital in a value-enhancing manner is a crucial part of the investment process at Oakmark. That said, the ability for a manager to quickly implement meaningful change is usually greater at small cap-companies due to their smaller size. The space also features a significant number of family-controlled businesses, which have been some of the most well-managed ones we’ve seen over the past 25 years since their names are often on the door and they truly are owners. That said, we’ve also come across many families we’ve not been comfortable investing alongside as they haven’t respected rights of minority shareholders, treated the business as their own family employment agency or have been unwilling to make necessary changes to operate their assets in most efficient manner possible. We believe this is an area a skilled active manager can add considerable value.
While small-cap stocks are usually more volatile than their large-cap peers, they also typically produce outsized returns over the long term. OAKEX’s primary benchmark, MSCI World ex U.S. Small Cap, has generated 7.2% annualized returns over the past 20 years (note that the index didn’t exist at time of the Fund’s inception) versus the MSCI World ex U.S. Index, which has returned 3.6% over the same period. OAKEX has delivered a 7.9% return over that time frame, outpacing its benchmark by 70 bps per annum. While pleased with our long-term performance, we’d be remiss to not acknowledge the recent performance struggles as the Fund has underperformed its primary benchmark by 4.6% per annum over the past five years. There are several factors that account for the near-term performance challenges but by far the biggest driver has been the valuation spread between growth and value stocks rising to a 20-year high. Many of the companies we own have grown revenue, earnings and free cash flow (FCF) over the past five years yet are trading at considerably lower multiples today than five years ago. We don’t believe this valuation gap will persist into perpetuity and, thus, are highly enthused about the positioning of the portfolio today and return potential going forward.
We thank you for your interest in OAKEX and we look forward to many more years of partnership. We’d also like to thank Co-Portfolio Managers David Herro and Justin Hance along with former Portfolio Managers Chad Clark, Michael Welsh and Adam Schor and all of those who have contributed to the Fund’s success.
Average Annual Total Returns (as of 09/30/2020):
|Fund||3 Month||1 Year||3 Year||5 Year||10 Year||Inception|
|MSCI World ex US Small Cap Index||10.12%||6.88%||1.42%||7.35%||6.55%||n/a|
|MSCI World Index ex US Index||4.92%||0.16%||0.62%||5.32%||4.37%||4.87%|
Gross Expense Ratio (as of 09/30/2019): 1.38%
Net Expense Ratio (as of 09/30/2019): 1.38%
Fund Inception: 11/01/1995
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.
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 MSCI World ex U.S. Index (Net) is a free float-adjusted, market capitalization-weighted index that is designed to measure international developed market equity performance, excluding the U.S. The index covers approximately 85% 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 Oakmark International Small Cap 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.
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.
Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.
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.