Wed, 23 Oct 2013
Oakmark International manager David Herro's closure of the fund is a preemptive move to taper asset flows and put shareholders first, says Morningstar's Shannon Zimmerman.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Oakmark International recently announced that its closing to many investors. Joining me to discuss what the news means for current and prospective shareholders is Shannon Zimmerman. He is associate director of fund analysis with Morningstar.
Shannon, thank you so much for being here.
Shannon Zimmerman: Good to be with you, Christine.
Benz: Shannon, on Oct. 4, Oakmark announced this news. The fund is not closing to all investors. Let's talk about what channels it is shutting itself off to.
Zimmerman: It's going to be available directly through the Oakmark website. If you want to open a new account, you're able to do that as a new investor. If you have Oakmark International in your 401(k) plan, you'll be able to continue to invest in it via that platform, as well. But otherwise, new investors are going to have a hard time getting into this fund. Current investors can continue to send new dollars, however.
Benz: David Herro runs Oakmark International and other sums of money in a similar style. Let's talk about how large Oakmark International is as sort of a percentage of all of the money that he runs in total.
Zimmerman: Oakmark International now [is at] $24 billion which is the largest the fund has ever been. But that's not all the money that he runs in that strategy. We've talked about this before. Fund managers often run money in the same style and the same strategy, the same portfolio but in different vehicles--separately managed accounts, for instance. If you look at the fund assets, certainly the bulk of assets are in the Oakmark International strategy. But all-in, there's over $30 billion in the international strategy.
Benz: The closing then really isn't necessarily going to be a huge help, or how do you look at that issue if he's running all of these other assets over here?
Zimmerman: Right. And those aren't closed, right? I view it as tightening the spigot. It's restricting flows; that's a good thing. A hard close to me is always the best-in-class move, and clearly, he's making this move to soft close because he thinks there is some upper limit in terms of assets for this strategy.
The performance so far doesn't suggest that he's hit that. This seems like a preemptive move. But still the fact that it's the largest that it's ever been and there's a considerable sum outside the fund makes you wonder how much longer should flows continue to come in, in the way that they have. And I should say, too, it's not just the size of the assets in the fund; it's the pace with which the flows have come in--over $10 billion in last 12 months alone. He has to put all that money to work.
Again, performance hasn't slackened at all. [The move] seems to be preemptive, but at the same time it's obviously a move toward acknowledging the capacity of the strategy.
Benz: Let's talk about the logistics of running a very large pool of money. You note that in some of his largest holdings, the fund is actually one of the biggest shareholders. Let's talk about how sometimes swinging that much in assets around can translate into maybe watered-down performance or performance not playing out the way that one would hope it would.
Zimmerman: Sure. It's easier to see in smaller-cap funds. You're talking about market impact.
Zimmerman: You have these outsized positions. And Herro is a major fundholder in a number of his top holdings. It has multiple average trading days volume in some names, as well. So, if he wanted to exit a position very quickly, or if he wanted to initiate a position very quickly, he would have a hard time doing that given the amount of assets that he has to put to work.
I guess it's more problematic in terms of performance on trying to exit a position. In a fund like this, again, it isn't as easy to see as it would be in a smaller-cap fund. But the risk that a fund manager runs is they move a stock's price against the fund. So, you're trying to back out of this big position and you end up pushing the price down. Or if you're trying to build a position, you end up pushing the price up.
Now, Oakmark, even though it is a large-cap vehicle, it still has very stringent valuation requirements. To get a new name into the portfolio, it has to trade at a 40% discount to intrinsic value.
Those are stringent valuation requirements. The fact that the asset base is so huge and the fact that about one third of assets are in just 10 names alone--the concentration is certainly worth watching. And I'm sure that's one of the triggers that they looked at when they were deciding to soft close it.
Benz: Overall though, Shannon, you think that this is pretty good news for current shareholders, and you think it also reflects well on Oakmark as a steward of shareholder assets. Why is that?
Zimmerman: I do. I think just broadly that closures are good for current investors. I think it is a proxy for stewardship. Does the firm have its current shareholders' interests foremost in mind? Any shop can pump up assets, and that's the way the business model works.
Benz: Especially when performance is good like it has been here.
Zimmerman: Exactly right, and that's why [there have been] torrential inflows [into the fund], the $10 billion over the last 12 months. They can continue to pump up assets, and they get additional revenue in the form of fees and a bigger asset base.
When a shop decides, "We're not going to do that; what we're going to do is preserve the ability of the manager to work his process in the way that he has so effectively over the course of many years," that really is a sign that they are putting the interests of shareholders first. In terms of a proxy for stewardship, it's almost not even a proxy, it's an active good stewardship.
Benz: You also note though that you would like to see expenses come down a little bit; that they haven't quite matched the velocity of inflows at the fund.
Zimmerman: At all, at all. You look at the price tag of Oakmark International, and the expense ratios that we show on Morningstar.com are from the annual report. That's the audited figure, and that's a year old. So we'll see what happens when the next annual report comes out.
But at 1.06%, it seems at a glance, reasonable, right? It's below the broad category average. It's average relative to its, what we call, the fee-level comparison group, that takes into account not just the fund type but also the channel through which it's sold.
But if you stack it up in terms of assets, it's expensive. Among funds of that size, working in that part of the market, it's one of the pricier ones.
Benz: What's your counsel then, Shannon, to people who own the fund currently as well as people who are thinking, "Well, even though they're closing to these brokerage channels, maybe I should just buy the fund directly from Oakmark"? What should those people have in mind when they're evaluating this news?
Zimmerman: That's a good question. Let me sort of lean into it this way. In terms of the research that we've done, there's really no advantage to getting into a fund just as it's about to close, or in this case, you would be able to go to the Oakmark website and open a new account.
Just in general, we find that there's not a big performance gain; in fact, it's sort of flat to subpar relative to its previous showing. However, this remains a Gold-rated fund. And David Herro is obviously a proven manager over the course of many years in this strategy, in a small-cap strategy, and a concentrated vehicle that he runs with Bill Nygren, his colleague at Oakmark.
He's a talented manager. I cover all these funds, obviously, and I get emails from folks who are invested in them. There's nothing fancy about what [Oakmark] does at all. Just plain-vanilla, bottom-up, fundamental homework. They just do it better than most.
Benz: Shannon, thank you so much for being here.
Zimmerman: Good to be with you.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.