Commentary

Oakmark International Small Cap Fund: Fourth Quarter 2020

December 31, 2020

Oakmark International Small Cap Fund – Investor Class
Average Annual Total Returns 12/31/20
Since Inception 11/01/95 8.91%
10-year 5.22%
5-year 7.20%
1-year 5.02%
3-month 25.99%

Gross Expense Ratio: 1.39%
Net Expense Ratio: 1.37%

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 Oakmark International Small Cap Fund returned 26.0% for the quarter ending December 31, outperforming the MSCI World ex U.S. Small Cap Index, which returned 17.6% for the same period. Since its November 1995 inception, the Fund has returned an average of 8.9% per year.

Despite an extremely challenging and volatile 2020, the year ended positively on the whole. Following a 38% drop in the first quarter, the Fund generated positive returns the next three quarters, producing a 5% return for the full year. Although this trailed the index, which returned 12.8% for the year, we were encouraged by fourth-quarter results as investors showed renewed interest in business fundamentals and valuations, which had been mostly ignored. In addition, markets reacted positively to news of the approval of two Covid-19 vaccines and the finalization of a trade agreement between the U.K. and European Union that concluded Brexit. Not surprisingly, some of the Fund’s strongest performers were our industrial and financial holdings, which came under considerable pressure during the first quarter but have recovered significantly since then. Even with the recent rally, we believe the portfolio still holds significant value and that many of our largest holdings are well positioned to gain market share as the global economy returns to normal as the vaccines roll out more broadly.

BlackBerry, a Canadian software and services technology firm, was one of the largest contributors to the Fund’s return for the fourth quarter. The company’s share price surged early in December on news that management signed a multi-year agreement with Amazon to develop and market an intelligent vehicle data software platform called IVY. Cloud-connected IVY enables auto manufacturers to securely and consistently collect standardized data from vehicle sensors to improve performance and develop new value-enhancing features and services for drivers. This product will not arrive in vehicles before 2023, but we believe it has the long-term potential to buttress BlackBerry’s strong position in automotive software with a potentially dominant data platform. The company’s core operations continue to progress in line with our turnaround expectations as BlackBerry firms its new product lineup and realigns its sales force. Recent-quarter results were slightly ahead of market forecasts, but continue to be negatively impacted by Covid-19, with year-to-date sales down 13%. The company is delivering on cost control, driving a 177% rise in EBITDA and positive year-to-date cash flow. CEO John Chen anticipates that the restructuring of the sales force and the lineup of new product launches will drive strong growth for the company in the coming year. We believe that these factors, as well as the longer term opportunities represented by IVY, continue to make BlackBerry an attractively valued holding.

Software AG, a German software and services technology company, was one of the Fund’s largest detractors for the fourth quarter. In October, the company reported a ransomware attack conducted by Clop, a malware organization that claimed it took possession of corporate files and employee information. Clop demanded a ransom payment of $23 million to prevent release of highly sensitive and confidential data from Software AG’s internal network and employee laptops. Later, management disclosed that some of the data was released, though services to customers apparently were not disrupted. Still, investors were unnerved by the attack, and Software AG’s share price fell. Soon after, the company reported preliminary third-quarter revenue and earnings that were lower than market expectations by roughly 6% and 23%, respectively, prompting a further selloff of shares. This caused management to accelerate its shift to a subscription-based business model, which we support, a move that will likely depress near-term revenue and earnings but should materially improve the company’s value over the long term. New business bookings—a critical metric for the company—performed in line with expectations, and overall, the company’s results matched our expectations. In particular, Software AG’s IoT (Internet of Things) and Adabas & Natural (A&N) businesses performed well, and management increased full-year bookings growth guidance across segments. We think the raised guidance was warranted as the company’s Digital Business Platform and A&N segments each added a large, high profile client in the fourth quarter. In addition, management stated that it had effectively contained the malware attack, and the company’s bookings momentum suggests that the attack has not adversely impacted customer relationships. We believe that Software AG remains a solid business that has the right fundamentals and business strategy to overcome its near-term challenges.

We added one new position during the quarter in TIS, Inc., the fourth-largest system integrator (SI) in Japan. SIs specialize in automation and in bringing together component subsystems so that they function properly together. In our view, Japan lags behind most developed nations in terms of digitizing its economy. This fact, combined with the country’s shortage of IT engineering talent, should bode well for the Japanese SI market’s structural growth. TIS has strong roots in the financials sector and its 2008 merger with Intec fortified the company’s balance sheet and increased scale. We believe recent integration efforts by Chairman Kuwano-San and business mix improvements will allow for additional margin expansion and healthy free cash flow generation.

We sold two positions during the fourth quarter as stock prices approached our estimates of intrinsic value (albeit over very different holding periods). Spanish-headquartered Fluidra, purchased in mid-2019, develops and sells equipment for residential and commercial swimming pools. In addition to completing a successful merger with U.S.-based competitor Zodiac, Fluidra has skillfully navigated the pandemic, shifting from lock-down damage control early in the year to a swift ramp up of global manufacturing to capitalize on a massive surge in market demand for pool products. Freightways, which the Fund has owned since 2006, is a New Zealand-domiciled provider of express package and business mail services. Freightways has benefitted from increased business-to-consumer shipments as Covid-19-related stay-at-home mandates have driven growth in online orders.

Geographically, we ended the quarter with approximately 70% of our holdings in Europe and the U.K., 10% in Asia, and 8% in Australasia. The remaining positions are in the Americas with 7% in Latin America (Mexico) and 5% in North America (Canada). We believe the Swiss franc remains overvalued versus the U.S. dollar, and we ended December with hedges on 15% of the Fund’s franc exposure.

Thank you for your continued confidence and support during this unprecedented year.

The securities mentioned above comprise the following preliminary percentages of the Oakmark International Small Cap Fund’s total net assets as of 12/31/20: Amazon 0%, BlackBerry 1.5%, Fluidra 0%, Freightways 0%, Software AG 1.8% and TIS Inc 0.2%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

Access the full list of holdings for the Oakmark International Small Cap Fund as of the most recent quarter-end.

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.

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 percentages of hedge exposure of 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 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 12/31/2020 unless otherwise specified.

David Herro- Portfolio Manager- Headshot
David G. Herro, CFA

Portfolio Manager

Mike Manelli- Portfolio Manager- Headshot
Michael L. Manelli, CFA

Portfolio Manager

Justin Hance- Portfolio Manager- Headshot
Justin D. Hance, CFA

Portfolio Manager