Commentary

Oakmark Select Fund: Third Quarter 2022 and Fiscal Year-End

September 30, 2022

Oakmark Select Fund – Investor Class
Average Annual Total Returns 09/30/22
Since Inception 11/01/96 10.67%
10-year 8.42%
5-year 1.82%
1-year -23.64%
3-month -5.95%

Expense Ratio: 0.98%

Expense ratios are based on estimated amounts for the current fiscal year; actual expenses may vary.

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 Select Fund decreased 23.6% for the fiscal year ended September 30, 2022, underperforming the S&P 500, which was down 15.5% over the same period. The Oakmark Select Fund declined 5.9% in the third quarter of 2022, roughly in line with the S&P 500. If you were paying attention to markets during the waning summer months, the quarter may have felt a lot worse than a 6% loss and for good reason. By mid-August, the Oakmark Select Fund and the S&P 500 were both up nearly 15% quarter to date, but both gave up those gains and then some over the following six weeks. This is the second-largest intra-quarter gain the S&P 500 has surrendered to end with a loss in its history. Rather than try to time the market, which, in our opinion, is a fool’s errand, we used the significant volatility during the quarter to reposition the portfolio as discussed several paragraphs below.

The largest detractors from performance during the fiscal year were Charter Communications (-57%), Meta Platforms (-60%) and Alphabet (-28%). The largest contributors to performance were EOG Resources (+50%), APA (+62%) and Constellation Brands (+17%).

The largest detractors from performance during the quarter were Charter Communications (-33%), Alphabet (-12%) and Lithia Motors (-22%). Charter has suffered from dramatic multiple compressions as broadband subscriber growth has slowed. The fundamentals have been largely consistent with our expectations, so we used this opportunity to increase our position in Charter by more than 25% during the quarter.

As if we need another reminder of just how volatile markets can be, Netflix (+35%), which was our largest detractor last quarter, became the largest positive contributor to performance during the third quarter, followed by First Citizens Bancshares (+22%) and Booking Holdings (+9%).

As discussed last quarter, business values are far more stable than stock prices. In volatile markets like this, you can expect increased portfolio activity. We purchased four new companies in the quarter and sold out of three. Let’s start with the purchases in alphabetical order.

KKR is one of the largest alternative asset managers in the world, managing $491 billion in assets across various investment vehicles. Approximately 80% of the company’s assets under management (AUM) are held under capital commitments of eight years or longer. This creates a highly stable management fee stream that has grown for 20 consecutive years. KKR’s AUM has been growing at double-digit rates as the company has drawn on its established brand and relationships to expand into new strategies and geographies. Over the past decade, KKR has expanded from 6 to 28 strategies, and we believe many of these have considerable runway for future growth. Furthermore, we think the market is undervaluing the company due to its large balance sheet investments and the volatility of its performance fees. We estimate that KKR’s investments are worth ~$17/share today or 38% of its current market capitalization, which is considerably higher than its peers. After adjusting for these factors, the company’s shares trade at a high-single-digit multiple of our forward earnings estimate. In fact, KKR trades at just 14.5x our estimate of its fee earnings – before ascribing any value to carried interest earnings or the company’s insurance unit. We find this valuation too cheap for a business with KKR’s growth outlook and return profile.

Salesforce has become a dominant global player in sales, customer service, commerce and marketing software over the past 20 years. The company earns 80% gross margins and grows 20% organically. Plus, virtually all of its revenue is recurring. We see Salesforce as a great business that we’ve admired from afar for a long time. More recently, the organization has made some changes at the top that prompted us to take a closer look at the stock. New CEO Bret Taylor and CFO Amy Weaver are bringing a culture of financial discipline. We believe this renewed focus on profitability and capital return, combined with Salesforce’s strong underlying business characteristics, will yield strong results. The current valuation of 3.9x next year’s revenues represents a significant discount compared to publicly traded peers and recent private market values in the software space that have similar growth profiles. We view this discount as an opportunity to invest in a great business at a good value.

Warner Bros. Discovery was created through the merger of Discovery, Inc., and Warner Media earlier this year. The combination created one of the largest media companies in the U.S. with a massive back catalog of valuable content from the Warner Bros. Studio, HBO, and the Discovery and Turner television networks. The company is on pace to earn around $1.50 per share this year despite directing much of its content catalog toward its streaming services HBO Max and discovery+, which are collectively generating significant losses. We believe that this content catalog will be profitably monetized over time—whether through the company’s own streaming services or through licensing content to other platforms. Either path will significantly bolster earnings from current levels. Meanwhile, the combination will also allow for significant cost reductions across the cable network and streaming businesses, thereby further boosting profits. Warner Bros. shares are currently trading at just a mid-single digit multiple of our estimate of underlying earnings power after accounting for these factors. We believe that is far too cheap given the quality of its content assets.

Wells Fargo has been a long-time holding in the Oakmark Fund. Despite the positives of higher interest rates and the company making good progress on reducing expenses and regulatory consent orders, Wells Fargo shares have fallen one-third from their highs earlier this year to roughly 6.5x our estimate of normalized earnings power, and the stock ended the quarter at ~1x next year’s tangible book value. We find this is far too cheap for a strong banking franchise capable of tangible returns in the low-to-mid teens across business cycles.

We sold our positions in Bank of America, Booking Holdings and General Electric during the third quarter. Though all of these names remain undervalued and are still held in the Oakmark Fund, we chose to deploy proceeds into the aforementioned companies that were even more undervalued, in our view.

Taxes: We are nearing that time of the year again. As you know, we take into consideration tax efficiency of the Fund to help maximize after-tax returns. We are happy to report that we do not anticipate paying a capital gains distribution this year.

Thank you, our fellow shareholders, for your investment and continued support of the Oakmark Select Fund.

The securities mentioned above comprise the following percentages of the Oakmark Select Fund’s total net assets as of 09/30/2022:   Alphabet Cl A 8.2%, APA 2.3%, Bank of America 0%, Booking Holdings 0%, Charter Communications Cl A 5.1%, Constellation Brands 0%, EOG Resources 3.8%, First Citizens Bcshs Cl A 6.2%, First Citizens Bcshs Cl B 0.3%, General Electric 0%, KKR 5.1%, Lithia Motors Cl A 4.1%, Meta Platforms Cl A 4.5%, Netflix 5.5%, Salesforce 4.1%, Warner Bros Discovery 3.0%, Wells Fargo 2.9%. 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 Select Fund as of the most recent quarter-end.

The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.

Because the Oakmark Select Fund is non-diversified, the performance of each holding will have a greater impact on the Fund’s total return, and may make the Fund’s returns more volatile than a more diversified fund.

The stocks of medium-sized companies tend to be more volatile than those of large companies and have underperformed the stocks of small and large companies during some 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.

All information provided is as of 09/30/2022 unless otherwise specified.

Bill Nygren- Portfolio Manager- Headshot
William C. Nygren, CFA

Portfolio Manager

Tony Coniaris portrait
Tony Coniaris, CFA

Portfolio Manager

Robert Bierig portrait
Robert F. Bierig

Portfolio Manager

Alex Fitch portrait
Alex Fitch, CFA

Portfolio Manager