Tue, 22 Apr 2014
The fund's plain-vanilla focus on company fundamentals allows it to uncover value in any kind of stock and has contributed to its long-term outperformance, says Morningstar's Shannon Zimmerman.
Jason Stipp: I'm Jason Stipp for Morningstar. It's Beat the Market Week on Morningstar.com and one of the managers we are profiling this week is David Herro of the Gold-rated Oakmark International fund. Joining me to talk about that fund and why it's been so successful is analyst Shannon Zimmerman.
Shannon, thanks for being here.
Shannon Zimmerman: Good to be with you.
Stipp: This fund really has a phenomenal longer-term track record over the three-year, five-year and 10-year periods. It's number one in the category. Over the 15-year period, it's number five, which just almost seems unreal. What's the secret in the sauce here? Is it strategy? Is it execution? How has it been able to be so successful?
Zimmerman: Well the secret is hiding in plain sight. It's the most plain-vanilla strategy you could possibly imagine. Oakmark is very fundamentals focused. They don't do anything at the level of sectors. There's nothing top-down; there's nothing factor-driven. As we were talking before the segment began, they do have these exposures, but that's not how they think about things. [The strategy is] company-by-company, brick-by-brick, looking for any company that they see as having a big valuation gap in terms of where the market is priced at and what they think it's worth.
A number of Oakmark portfolios now are in the large-growth square of the Morningstar Style Box, even though the shop has a reputation for value investing. But that's because the strategy is an absolute-value strategy. Any stock can be a value stock for those guys, provided the gap between what they think is worth and what the market has priced it at is sufficiently wide.
Stipp: A lot of managers will say, "We look for great companies at good valuations." Is this really an issue of execution? [Does Oakmark] just do it better than most of their peers?
Zimmerman: I think so. In active-strategy mutual funds, plain-vanilla is the most common strategy. [The funds are going to conduct] fundamental, bottom-up analyses and try to find these valuation gaps opportunistically. And Oakmark, yes, has done it better over time.
Stipp: The interesting thing about this is you say in your recent Analyst Report on this fund that this process is clearly repeatable. A lot of processes might work for a while and then other people say, "Hey, I'm going to do that, too." [Then the process] is arbitraged away and then the opportunity is gone. But clearly it has been repeatable. Why do you think it's going to continue to be a durable process?
Zimmerman: In part, because there is nothing fancy about it. So what makes it repeatable? When you look at the track record of all the funds at the Oakmark family--there are seven of them--they all have impressive long-term track records. This one perhaps most of all, Herro has managed it since 1992, and it is beaten both the index and the typical fund in its category over 80% of the time in the 60-month rolling period.
So clearly it has been repeatable. To me, in thinking of the shop and interviewing the managers and meeting with some of them, it's the training of the research analysts because the portfolio managers and the research analyst team work very closely together. Herro on the international side and Bill Nygren on the domestic side were really the architects of the process that's in place there. And it is, as I say, it is just as plain-vanilla as it could be, company-by-company, looking at the fundamentals.
But what I will say, they have the storied reputation as a value house. But again any company can be a value stock for those guys. At least in terms of the value-oriented managers that I cover, they are more focused on growth prospects maybe than most because what they are trying to look at are not relative valuations certainly, except at the level of the individual company. Relative to this company's growth prospects, is this price that the market has of that in the ballpark of reality? And when they see that it isn't, that's when they invest.
Stipp: As with any active management strategy, if it's truly active, it is going to look different than the market. The performance patterns might be a little bit different. Talk to me about how this fund looks in different kinds of market environments?
Zimmerman: Yes. Now this is an excellent question because there is a contrarian streak that runs across at Oakmark and certainly at Oakmark International. Sometimes investors will need to be patient because they are patient with their holdings. In every market cycle there are going to be some names that they like in terms of the fundamentals, but time arbitrage is what they try to practice, as well.
If the holding period is longer, and if their investment thesis is correct, they don't mind being patient. In fact they will often go where the volatility is or where other investors are reluctant to go. A good example of that with David Herro at Oakmark International is Japan. After the earthquake and tsunami in 2011, he did up his stake marginally. But he stocks sold offs and he brought [is weighting] back to where it was. And here was an overweight prior to that.
His argument was, "My companies aren't affected by this in terms of their fundamentals at all. And so if I believe that their growth prospects and my investment thesis are intact, then I like them more now that they're cheaper."
So he got back in a big way and brought his, as I say, it was a modest overweight relative to where it was, but definitely he brought it back on line. He stayed heavily exposed to Japan and he started to dial that down, as you would expect he would, as the prices rose.
Stipp: What kind of investor is this a good fund for? We know that investors can find great funds but then use them poorly. So what kind of investor should you be if you are going to be looking at this fund or what do you need to know in order to use it well?
Zimmerman: Sometimes you will have to be patient as the contrarian thesis plays out. If you're a quarterly performance junkie and you are looking at Japan in the aftermath of the earthquake and tsunami, then maybe this fund's going to keep you up at night, but if you're a patient long-term investor, you know that that's where Herro thrives. And that's how the fund has generated a lot of its outperformance.
And investors actually have used this fund very, very well. If you look at the, what we call, investor returns, dollar-weighted returns, that track flows into and out of funds, you can see how savvy investors have been in terms of timing their purchases and sales of the fund. They have done remarkably well, in the top decile, across most trailing periods, and in top quintile across a couple of others. But still it has been a good fund for downside protection. Upside risk is an oxymoron. Investors don't worry about upside risk. But downside risk, this fund has been a good steward of capital in terms of protecting shareholder wealth.
Stipp: That's gotten shareholders through some of the rougher periods.
When I looked at your Analyst Report, Shannon, all of the pillars for the fund were positive except one, and that was the Expense Pillar. What's your take on the expenses of this fund?
Zimmerman: My take there is that, so right now, we have the fee-level comparison group, which looks at how the fund's price tag stacks up relative to funds that are comparable, international large-cap funds that are no-load. We get the distribution channel, and we get the fund type. And it actually has a below-average fee-level rating. But no one data point is determinative. To me, what you have to do is look at the companion variable. What is the companion variable for expense ratio? Well it's assets.
This fund is now at $31.2 billion in assets. There is an additional roughly $15 billion outside the fund being run in the same strategy. It's the biggest it's ever been. And so to me, good, they brought the price tag down year over year, and that's a step in the right direction. But relative to the assets under management of the fund, Oakmark could share more of the economies of scale with investors.
Stipp: Last question for you. This fund is closed to new investors and size is probably a big part of the reason that it's closed to new investors. If I want to find a great international fund, one that has a good track record, what are some alternatives I might take a look at right now?
Zimmerman: It depends on the risk profile you have as an individual investor, but I will mention two. One is another Oakmark fund, Oakmark Global Select, which is a concentrated fund that Herro runs half of and Bill Nygren, his colleague at Oakmark runs the domestic sleeve of. It has about 20 stocks total though, so it is quite concentrated. Assets are very reasonable, certainly relative to Oakmark International. It's not a one-for-one match, however. Oakmark International fund is foreign large-blend. Oakmark Global Select is a world-stock fund. So it's not really a one-for-one match.
Closer would be Dodge & Cox International Stock. It's not as concentrated and more comparable in that sense to Oakmark International. But Dodge & Cox also has a storied long-term reputation for being really good value hounds and doing something similarly successful to what Oakmark has done, too. That might even be a closer match for Oakmark International versus Global Select.
Stipp: Shannon, some great insights on what has been a great fund for investors. Thanks, for joining me.
Zimmerman: Good to be with you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.