A Distinctive Large-Cap Choice

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Despite occasional rough patches, Oakmark retains its appeal and continues to earn a Morningstar Analyst Rating of Gold.

The managers are tried and true. Bill Nygren and Kevin Grant are part of a 13-person U.S. team that searches for companies trading below their business value. While key-person risk exists, the firm's model of having analysts work as generalists rather than sector specialists helps groom potential successors along the way.

The strategy is distinctive in a field cluttered with bland large-cap options. The 53-stock portfolio is focused, contrarian, and not overly benchmark-oriented, with 80% active share versus the S&P 500. Stock-picking drives the process, though favored areas emerge. For instance, the fund's 25% financials stake was recently almost twice that of the benchmark. But the team isn't exclusively hunting in traditional value havens: Until recently, the portfolio held an above-benchmark stake in technology companies, and it has benefited from growth-leaning picks such as Netflix NFLX and Mastercard MA in the past few years.

The portfolio remains value-leaning relative to the S&P 500, though. The Morningstar Risk Model indicates the portfolio has more exposure to valuation and looks less growthy. This posture hasn't helped in a largely growth-led market, but the team has also stumbled with some stock picks. While it hasn't piled into energy, stakes in Apache APA, Chesapeake Energy CHK, and National Oilwell Varco NOV (since sold) have weighed on results, with the sector not a proven forte for the team. Patience with longtime pick Qurate Retail hasn't paid off lately. The fund has lagged the benchmark by 10 percentage points for the trailing year through June, and its five-year results are middling.

Yet the same patience that the managers exhibit with their picks should be practiced by fundholders as well. Since the managers' 2000 start, the fund has doubled the gain of the large-blend Morningstar Category and stayed 3 percentage points annualized ahead of the benchmark. The team's stock-picking should win out over time.

Process: Positive | by Katie Rushkewicz Reichart, CFA July 15, 2019

Oakmark succeeds with a patient, focused, and flexible approach, earning a Positive 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 80% differentiation from the S&P 500 as of March 2019. Value-oriented sectors such as financials are favored, but the team pursues all sectors--even those not considered traditional value havens.

The fund has owned Netflix, a name more associated with growth funds, since 2017. 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 on a price/subscriber basis it's reasonably priced, particularly relative to AT&T's T acquisition of HBO parent Time Warner; the ability to raise its prices helps. The team bought Facebook FB in early 2018 following negative press about privacy concerns. The fund also owns Regeneron REGN, its first biotech since the early 2000s. Nygren says its research-and-development spending adds to its return on investment and likes its founder-led management team.

There are plenty of more traditional value names in the portfolio. Financials remain the most dominant sector at 25% of assets, with Citigroup C and Bank of America BAC prominent positions. The fund's energy stake, which has stymied its more concentrated sibling, Oakmark Select OAKLX, is modest at 6%, though picks such as Chesapeake Energy and Apache haven’t worked out.

Performance: Positive | by Katie Rushkewicz Reichart, CFA July 15, 2019

The fund has a stellar record under manager Bill Nygren, meriting a Positive Performance rating. From his March 2000 start through June 2019, the fund's 9.8% annualized gain more than 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 85% 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. However, the fund shouldn't be considered defensive. Its performance profile can vary given its fairly focused portfolio, which can look significantly different than the benchmark and peers. It posted a steeper loss in the July 2015-February 2016 and fourth-quarter 2018 drawdowns, for instance. For the trailing year through June, its bottom-decile 0.4% gain lagged the benchmark’s 10.4% because of laggards DXC Technology DXC, State Street STT, and Chesapeake Energy, among others. On the flip side, strong stock-picking buoyed it to the top of the category's top decile in 2012, 2013, and 2016.

The fund can look out of favor for stretches; its three- and five-year returns through June were mediocre versus peers and lagged the benchmark. However, Nygren's patience with his picks and history of good stock calls have benefited investors in the long run.

People: Positive | by Katie Rushkewicz Reichart, CFA July 15, 2019

Bill Nygren's experience and valuable insights, along with strong supporting resources, support a Positive People rating. Nygren is the public face of Oakmark's U.S. equity strategies. He effectively communicates his approach through shareholder letters that thoughtfully explain the fund's positioning. Nygren, who joined Harris as an analyst in 1983, has run this fund since March 2000. He also manages Oakmark Select OAKLX, Oakmark Global Select OAKWX, and other related Natixis strategies. He invests more than $1 million here.

Comanager Kevin Grant, who joined the firm in 1988, consults with Nygren on portfolio positioning but devotes time to the business side of Harris as co-chairman. While Grant is not Nygren's successor here, the firm's up-and-coming talent has taken on additional responsibilities at other funds. Tony Coniaris, co-chairman of Harris, comanages Oakmark Select and Oakmark Global Select. 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.

The talented 13-person U.S. team averages 21 years of experience and includes nine generalist analysts who average 8.6 years at Harris. Director of research Win Murray has worked to grow talent internally, a deviation from Oakmark's history of hiring analysts with industry experience.

Parent: Neutral | by Mara Dobrescu, CFA 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 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.

Price: Neutral | by Katie Rushkewicz Reichart, CFA July 15, 2019

Oakmark's fees aren't compelling, especially given a large asset base of $18 billion. With the majority of assets priced average relative to similarly distributed peers, it earns a Neutral Price rating.

Oakmark launched advisor and institutional share classes for all of its funds in late 2016, at which point this fund's I shares were renamed investor shares and the II shares received the "service" moniker.