A Superb Value Manager Rebounds From a Multiyear Slump

The following is our latest Fund Analyst Report for Oakmark Select OAKLX

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True to form, Oakmark Select has rebounded. It receives a Morningstar Analyst Rating of Silver.

The strategy is recovering from a multiyear slump. A rough patch during early 2020's pandemic-induced sell-off was disappointing but not uncharacteristic. The portfolio's value tilt relative to its S&P 500 benchmark and former large-blend Morningstar Category peers proved disadvantageous in the narrow growth-led market of recent years. But an inability to get the team's most successful stock picks into this focused portfolio particularly stung versus its more-diversified sibling Oakmark OAKMX.

The tides have turned as traditional value stocks, including this strategy's favored financials, roared back in late 2020. Meanwhile, a move to the large-value category following Morningstar Style Box methodology changes gave the strategy a more appropriate home. The investor shares' 75.7% gain for the trailing year through April 2021--30 percentage points higher than its benchmark--catapulted it to the top of the category.

Along the way, Oakmark has stuck to its knitting. Rigorous company-level analysis and a nuanced valuation approach give the strategy an advantage. Patience remains a key ingredient. As during previous challenging periods, the team didn't flinch or alter its process when its picks proved unpopular in recent years, though it did appropriately stress-test holdings during the pandemic downturn and opportunistically buy unduly hit firms. Such perseverance has paid off for long-term investors with similar mindsets. The strategy also had big rebounds after the early-2000s tech bubble and the 2007-09 financial crisis.

Even so, the portfolio's concentrated, volatile style isn't for everyone. With just 23 holdings as of March 2021, and wide-ranging sector exposures, the fates of each holding are amplified. The managers were overly patient with languishing stock Qurate Retail QRTEA (since sold) and previously held a healthy stake in bankrupt energy firm Weatherford International. Some mistakes are expected for active managers, but the stakes are higher in such a concentrated portfolio.

Process | Above Average

Oakmark Select's patient, focused, and contrarian approach earns an Above Average Process rating. It's not without risks, though: The fund's concentration in about 20 companies, individual positions as high as 10%, and lack of sector constraints court volatility and require a long-term mindset.

Valuation underpins Oakmark's analysis, but it's not a deep-value shop. Rather, the team looks to find companies poised to grow per-share value that are mispriced relative to what a rational buyer would pay to own the entire business. The management team's willingness and ability to use a wide variety of valuation methods, including sum-of-the-parts analysis, private-market multiples, merger-and-acquisition activity, discounted cash flow models, price/subscriber growth, and consideration of intangibles, helps set the approach apart. Looking cheap on one or more of these metrics is not enough, though; the team also wants to own companies with ample free cash flow and predictable earnings run by managers who act like owners and invest alongside shareholders.

Analysts pursue ideas across sectors and have reasonably sized coverage lists of 12-15 names to allow for in-depth research. The analysts present their picks to a U.S. stock-selection committee that adds names to an approved list when two of the three members agree; managers draw ideas from this list.

The approach produces a unique portfolio, with 90% active share versus the S&P 500 as of March 2021 and more mid-cap exposure than its more-diversified sibling, Oakmark. The managers have a long-term mindset, as evidenced by turnover typically below 45%.

The managers sold financially shaky companies such as American Airlines AAL and Concho Resources during the coronavirus sell-off, instead buying companies owned in the more-diversified Oakmark that had traded down, including Facebook FB, Booking Holdings BKNG, and Constellation Brands STZ.

Financials remained the most dominant sector at 29% of assets as of March 2021, more than double the S&P 500's stake. The portfolio's energy stake was about double the benchmark's, too, though that sector hasn't consistently been a strong area of expertise, particularly in a concentrated portfolio. Past missteps include Weatherford International, a 3% position as of late 2018 that went bankrupt in 2019.

The team also considers nontraditional value stocks such as Netflix NFLX. Manager Bill Nygren says traditional metrics such as price/earnings do a bad job showing how the firm's value has changed over time; he thinks it's reasonably priced on a price/subscriber basis, particularly relative to AT&T's T since-unwound acquisition of HBO parent Time Warner; the ability to raise its prices helps.

People | High

Bill Nygren's experience and valuable insights, along with a strong supporting cast at Harris Associates, support a High People rating. Nygren is the public face of Oakmark's U.S. equity strategies. He communicates his approach and explains the strategy's positioning in compelling and thoughtful shareholder letters. Nygren, who joined Harris as an analyst in 1983, has run this fund since 1996. He also manages Oakmark, Oakmark Global Select OAKWX, and other related Natixis strategies.

The firm's up-and-coming talent has taken on additional responsibilities here in recent years. Tony Coniaris, co-chairman of Harris, has comanaged this fund since 2013 and Oakmark Global OAKGX and Oakmark Global Select since 2016. He's also part of the U.S. stock-selection group with Nygren and nearly 40-year Harris veteran Clyde McGregor that vets ideas for the approved list from which managers draw ideas. Director of research Win Murray, at Harris since 2003, also joined the roster in 2013. Unlike Coniaris and Nygren, he still covers a full load of companies. All managers invest more than $1 million here.

The 15-person U.S. team features members with a range of experience; all are generalists. Murray has worked to grow talent internally, a deviation from Oakmark's earlier history of hiring analysts with industry experience. Two associates were promoted to analyst in 2020-21, while one longtime analyst left.

Parent | Average

Paris-based Natixis Investment Managers is the parent to more than 20 asset managers of very different sizes globally, including Ostrum (its largest affiliate) and H2O in Europe and Loomis Sayles and Harris Associates in the United States. These affiliated companies have maintained a large degree of operational autonomy, including in their investment philosophies. The quality of investment culture is uneven from one subsidiary to another, resulting in a Neutral Parent Pillar rating overall. The results of the teams at Loomis Sayles and Harris Associates, manager for the U.S.' Oakmark funds, for example, are excellent, communications with investors are of high quality, and fund launches have been minimal. France-based affiliate DNCA has also improved its funds' fee structures to some extent since joining the fleet in 2015. On the other hand, the results obtained by Ostrum are more mixed, with a history of fund lineup churn. Since 2018, Ostrum has embarked on a large cost-cutting plan that should significantly reduce both head count and the number of funds offered to investors. However, it is still too soon to tell whether these changes will produce better outcomes for fund investors. Ultimately, Ostrum still needs to demonstrate its ability to attract and retain talented investment professionals, and we'd also like to see its cost-cutting efforts shared with investors in the form of lower fees across the board.

Performance

This volatile fund endures rough patches that can weigh on long-term results and requires the utmost patience. From manager Bill Nygren's November 1996 start through April 2021, the biggest share class gained 12.3% annualized, trouncing the prospectus benchmark S&P 500's 9.6% and category benchmark Russell 1000 Value Index's 9.0%.

Results are boom-and-bust, though. The fund fell hard in the coronavirus drawdown. It lost 9 percentage points more than the S&P 500 from Feb. 19, 2020, to March 23, 2020, as its financials stake and consumer sensitive stocks cratered. Before that, missteps in energy hurt, including bankrupt Weatherford International. Other laggards over the past five years include the embattled General Electric GE and the since-sold Adient ADNT and Qurate Retail.

Results have rebounded sharply as value came back into favor in late 2020. The investor shares' 75.7% gain for the trailing year through April 2021 landed near the top of the large-value category and beat the S&P 500 and Russell 1000 Value Index by 30 percentage points. The fund has endured famines before and come out ahead. It followed the 2007-09 financial crisis with a 52% gain in 2009, nearly twice the benchmark's. The strategy is volatile and not always a strong downside performer, so investors must be risk-tolerant.

Price

It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its category's second-costliest quintile. That's poor, but based on our assessment of the fund's People, Process, and Parent Pillars in the context of these fees, we still think this share class will be able to overcome its high fees and deliver positive alpha relative to the category benchmark index, explaining its Analyst Rating of Silver.