A Bold--and Exceptional--International Choice

The following is our latest Fund Analyst Report for Oakmark International Investor OAKIX.

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Oakmark International has tried investors' patience, but its contrarian style also has rewarded them in the past and can do so again; it retains a Morningstar Analyst Rating of Gold. The market sometimes turns this high-conviction, contrarian value strategy into roadkill. In 2020's first half, the strategy resembled Wile E. Coyote after an anvil encounter. Its institutional shares' nearly 23% loss for the year through June 30 was almost 12 percentage points more than the MSCI ACWI ex-USA Index and placed at the foreign large-blend Morningstar Category's bottom. Peak to trough, the strategy's 46% plunge from index's Jan. 17, 2020, top through March 23 dragged its trailing five-year results into negative territory, even though the fund had finished three of the last five calendar years in the peer group's top fourth and four of those years ahead of the index. That's volatility. Lead manager David Herro, however, has brought the fund back numerous times. Herro, one of the industry's most tenured and decorated non-U.S. stock-pickers, also has a team of nearly 10 analysts and managers who also are committed to his version of advisor Harris Associates' absolute value style. Comanager Michael Manelli, for example, has been with the firm for 15 years and has comanaged Bronze-rated Oakmark International Small Cap OAKEX since 2011. Not counting Herro, the team averages about 13 years of industry and seven years of firm experience. Markets change, but Herro and his team don't. They still buy stocks at discounts to their intrinsic value estimates, which often involves investing amid dire company or economic news. They're not knee-jerk contrarians, though. They often take years to study businesses and balance sheets before adding them to a list of companies approved for purchase. Then they wait for share prices to fall below their underlying companies' values. Herro and team regularly update those estimates and manage positions based on discounts. For example, Herro recently contended European banks and automakers' shares have suffered more than their earnings. It's a bold approach. Process | High Manager David Herro and team's disciplined approach to contrarian investing earns a High Process Pillar rating. The managers seek stocks trading at deep discounts to their assessments of companies' intrinsic values. They're contrarian, but not "cigar butt" value investors. They gravitate to the shares of companies that are out of favor but that are still growing, generating cash flow, and reinvesting that money in profitable ways. They like management teams that own a lot of the companies they run and that run those companies like they are owners. The fund's managers and analysts travel often and widely to meet with businesses and their customers, competitors, and suppliers; but they avoid countries where the rule of law is suspect, such as Russia. The team resorts to a variety of valuation metrics, including price/net asset value, enterprise value/operating income, and returns on capital employed. They'll also reference corporate buyouts of similar companies. Analysts present their bottom-up research to a stock-selection committee composed of Herro, comanager Michael Manelli, and rotating members Justin Hance, Eric Liu, and Jason Long. They curate an approved list of companies to buy when their shares are discounted. Herro and team are willing to wait three to five years for those valuation gaps to close. Annual portfolio turnover is below average relative to peers'. People | High The fund's accomplished, veteran leader and solid supporting cast of managers and analysts earn a High People rating. David Herro has managed this fund since its 1992 inception and has generated a stellar record during his tenure. Michael Manelli has comanaged the fund since November 2016 and also has comanaged Bronze-rated Oakmark International Small Cap with Herro since 2011. Manelli has been an analyst at the fund's subadvisor, Harris Associates, since 2005. Seven other managers and analysts with an average of five years of experience at Harris and 12 years of investment experience support Herro and Manelli. The team has lost some good analysts over the years, including those who have become successful managers of other funds. But it also done a good job deepening and seasoning itself in recent years. Harris' deep bench should help make it more resilient in the future, too. Herro's long tenure and record demonstrate his value to this strategy. There is some key-man risk here; Herro, 60, has no plans to retire, but he has delegated some responsibility in recent years. He and Manelli serve on the strategy's stock-selection committee with a rotating cast of team members, including Justin Hance, Jason Long, and Eric Liu. Hance, Long, and Liu are comanagers on Oakmark International Small Cap, Oakmark Global OAKGX, and Oakmark Global Select OAKWX, respectively. This is a strong team. 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 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. 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 Morningstar category's middle quintile. That's not great, but based on our assessment of the fund's People, Process, and Parent pillars in the context of these fees, we think this share class will still be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Gold. Performance Despite periodic rough periods, the fund has delivered excellent absolute, relative, and risk-adjusted returns since its inception and over the tenure of its lead manager. The fund gained 8.2% annualized between its Sept. 30, 1992, inception and June 30, 2020, beating the 5.5% of its MSCI World ex USA Index prospectus benchmark and the 5.4% of the typical foreign large-value category fund and the 5.1% of the average foreign large-blend rival. This is not a conservative strategy; as demonstrated in early 2020's coronavirus-ignited crash, when it shed 46% from Jan. 17 to March 23, it can be very volatile. It's willing to look very different from peers and benchmark and thus has experienced periods when its weak returns reflect how out of favor some of its stocks are. Over its history, though, the fund has captured more of the upside of its benchmark and category average than the downside. The fund has lost 100% as much as its typical peer in down markets while gaining 13% more in upturns. It has claimed 94% of its index's downside and 6% more of its upside. The ride at this compact and active fund will be bumpy. Big stakes in automakers and financials hurt in 2014, 2015, 2018, and early 2020. Over the long term, though, its risk-adjusted returns, as measured by its Sharpe and Sortino ratios, have been competitive. Portfolio This strategy isn't afraid of controversy and its portfolio remains distinct. Despite ranking near the bottom of its foreign large-blend category in 2018 and through the first six months of 2020, the fund has maintained big positions in the stocks, sectors, and regions that have hurt it the most. Worries about the coronavirus pandemic's affect on the global economy have hurt European automakers and car-part suppliers, but David Herro thinks the market has punished Daimler AG, Bayerische Motoren Werke AG, and others beyond their intrinsic values. Investors priced European banks BNP Paribas, Lloyds, and Credit Suisse as if their earnings would collapse with the global economy, but lead manager David Herro says their businesses are still profitable and in better shape than in the 2007 to 2009 crisis. There's evidence that Herro and his team aren't anchored to the theses that gets them into a stock. They think the pandemic has significantly weakened some businesses, such as U.K.-based Rolls Royce, where demand for the manufacturer's wide body airplane engines has dissipated with the ability and desire to travel internationally. It requires an iron will to consider and stick with such picks. Herro has demonstrated such a constitution by plucking successful investments from the midst of pessimism before. History doesn't repeat, but these selections rhyme with previous contrarian situations that Herro exploited.