Oakmark Fund Plans for the Future

The following is our latest Fund Analyst Report for Oakmark Fund OAKMX.

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Oakmark’s commitment to its time-tested approach and succession-planning progress earn its cheapest share classes a Morningstar Analyst Rating of Gold while the pricier ones are rated Silver.

Analyst Michael Nicolas’ promotion to comanager in January 2020 provides needed clarity on the strategy’s future. While the appointment doesn’t mean longtime manager Bill Nygren or comanager Kevin Grant will retire soon, they are in the later stages of their careers. Nicolas, an analyst here for seven years after stops at other investment shops, should have ample time to settle into the role. As a generalist, his coverage list has provided a broad range of experience.

Underperformance during the pandemic-fueled market downturn in February-March 2020 was disappointing but not uncharacteristic. The portfolio’s value tilt relative to its large-blend Morningstar Category and S&P 500 benchmark and long-standing bet on financials were pain points, along with some consumer-related picks such as MGM Resorts MGM.

The managers executed as expected in the downturn. They bought a handful of hard-hit companies with reasonably healthy balance sheets from their list of approved picks, including American Express AXP. The additions of Workday WDAY, Match Group MTCH, and Pinterest PINS indicate their continued willingness to consider a wide range of opportunities, supplementing other out-of-the-box holdings such as Netflix NFLX that provided much-needed ballast in the recent sell-off. While nontraditional, the team’s valuation approach extends well beyond basic price multiples and incorporates deep analysis of companies’ business models. Still, the strategy’s value roots remain deep, as shown by its factor profile.

The strategy is trying to get back to the top. Returns in recent years haven’t kept up with the S&P 500 but have looked better versus the Russell 1000 Value Index, to which they're equally correlated. Encouragingly, performance has picked up since the market’s March low, and the strategy has staged comebacks before, including in 2009. It retains appeal for those who can be patient.

Process: High | by Katie Rushkewicz Reichart June 1, 2020 Oakmark succeeds with a patient, focused, and flexible approach, earning a High Process rating. Valuation underpins Oakmark's analysis, but it's not a deep-value shop. Rather, the team looks to find companies that are poised to grow per-share value and are mispriced relative to what a rational buyer would pay to own the entire business. Prolific methods for valuing different types of businesses, including sum-of-the-parts analyses, private-market multiples, merger-and-acquisition activity, discounted cash flow models, price/subscriber growth, and consideration of intangibles not included on the balance sheet (such as research and development), help set the fund apart as one that can unlock value in ways beyond traditional price multiples. The team opts for companies where management has an owner mentality and invests alongside shareholders, preferring those with ample free cash flow and predictable earnings.

Analysts are free to pursue ideas across sectors and have reasonably sized coverage lists of 12-15 names to allow for in-depth research, particularly important given the portfolio owns fewer than 60 names. To ensure stringent vetting, two of the three members of the U.S. stock-selection group must agree to add a name to the approved list from which managers draw ideas. Regular team-level devil's advocate debates help challenge portfolio holdings. Patience is reflected in turnover typically below 30%.

The team follows an active approach, with 82% differentiation from the S&P 500 as of March 2020. Value-oriented sectors such as financials are favored, but the team pursues a wide range of companies--even those not considered traditional value havens.

The strategy has owned Netflix, a name more associated with growth funds, since 2017. Manager Nygren says traditional metrics such as price/earnings do a bad job showing how the firm's value has changed over time; he thinks on a price/subscriber basis it's reasonably priced, particularly relative to AT&T's T acquisition of HBO parent Time Warner, and the ability to raise its prices helps. The team bought Facebook FB in early 2018 following negative press about privacy concerns. It added similar types of companies during the coronavirus-driven sell-off in 2020’s first quarter, buying Match Group and Pinterest on optimism about their ability to monetize their subscriber bases. The team also bought cloud-based human resources platform Workday as its price dipped.

There are plenty of more-traditional value names in the portfolio. Financials remain the most dominant sector at 30% of assets, with Citigroup C and Bank of America BAC as prominent positions. Its energy stake, which has stymied its more concentrated sibling, Oakmark Select OAKLX, is benchmark-like.

People: High | by Katie Rushkewicz Reichart June 1, 2020 Nygren's experience and valuable insights, along with strong supporting resources and clarity on succession plans, support a High People rating. Nygren is the public face of Oakmark's U.S. equity strategies. He effectively communicates his approach through thoughtful shareholder letters. Nygren, who joined Harris as an analyst in 1983, has run this strategy since March 2000. Comanager Kevin Grant, who joined the firm in 1988, consults with Nygren on portfolio positioning but also devotes time to the business side of Harris.

The addition of Nicolas as comanager in January 2020 provided needed clarity on succession planning, though Nygren doesn’t expect to retire soon. Nicolas, an analyst at the firm for seven years after two previous stops, has spent the past year informally training with Nygren on portfolio-level matters. He’s covered a range of holdings, from Bank of America to Facebook to Constellation Brands STZ, and should have ample time to settle into his new role.

Nygren, Tony Coniaris, and Clyde McGregor form the stock-selection group that vets ideas for the approved list from which managers draw ideas. The 14-person U.S. team features members with a range of experience; all are generalists. Director of research Win Murray has worked to grow talent internally, a deviation from Oakmark's history of hiring analysts with industry experience.

Parent: Average Feb. 13, 2019 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 philosophy. 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 headcount 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 The fund has a stellar but bumpy record under manager Nygren. From his March 2000 start through May 2020, the fund's 8.9% annualized gain nearly doubled the average large-blend category peer and trounced the S&P 500's 5.8%. The fund retained its edge on a risk-adjusted basis.

During Nygren's tenure, the fund has lost just 91% as much as the benchmark in down markets while gaining 105% as much in upturns. It significantly outperformed in the early-2000s bear market and held its ground in the 2007-09 financial crisis. But the fund shouldn’t be considered defensive. It posted a steeper loss in the July 2015-February 2016 and fourth-quarter 2018 sell-offs. It fell hard in the pandemic-induced drawdown from Feb. 19 to March 23, 2020, losing 41% to the benchmark’s 33.8%. Its heavy financials stake weighed heavily on results, as well as MGM Resorts, Fiat Chrysler FCAU, and American Airlines AAL. It has edged the benchmark from the March low through May, reminiscent of its post-financial-crisis rebound in 2009.

The fund can look out of favor for long stretches: Its three- and five-year returns through May significantly lagged the S&P 500. Performance during those periods is more in line with the Russell 1000 Value Index, to which it’s equally correlated. However, Nygren's patience with his picks has benefited investors in the long run.