Oakmark Funds’ Jason Long on why Oakmark like select European financials.
Jason Long is a partner and an International Investment Analyst at Harris Associates. He joined the firm in 2011. Jason has held previous roles at Security Global Investors, Carmel Capital Partners and Brandes Investment Partners. He has a BA from San Diego State University and is a CFA charterholder.
Regulatory pressures, a challenging macroeconomic environment, and remnants of the financial crisis have led many investors to conclude that European financial institutions should be avoided at all cost. While we agree that the sector will continue to encounter challenges, we believe it is important to distinguish between weaker institutions and those that have the business models and balance sheets necessary to succeed in this new operating environment. Our bottom-up analysis has resulted in positions in several financial institutions that we believe possess excellent business franchises, good management teams, strong balance sheets, and very attractive valuations.
In our analysis of European banks, we previously identified several headwinds facing the industry, including: increased capital requirements, higher wholesale funding costs, and slowing economic growth. Given these headwinds, we felt that banks with less capital-intensive businesses, such as asset management or advisory, would be attractive as they could more easily navigate these higher capital requirements. We also believed that increased capital requirements would result in a lower return on equity, which we incorporated into our valuations. Also, it became evident that banks with strong deposit franchises and liquidity would have a funding cost advantage over wholesale-funded banks and be better positioned during times of crisis. Finally, we felt banks with significant scale would be able to deliver products and services more efficiently than their peers.
Oakmark Funds: European and Swiss bank holdings
Our European bank holdings possess many of these competitive advantages while trading at what we believe are very compelling valuations. Our Swiss banks (Credit Suisse and Julius Baer) have very large and profitable private banking operations, which we believe are both low risk and generate a tremendous amount of free cash flow. Despite this advantaged business model, our two Swiss banks trade at very low multiples of their normal earnings power. We think the market has mistakenly grouped these Swiss private banks with the rest of the European banks, and we are only too happy to hold what we consider valuable franchises with strong balance sheets until more rational thoughts take place.
Oakmark Funds: Traditional bank holdings
Our more traditional bank holdings include BNP, Lloyds, and Intesa Sanpaolo. All three of these banks possess dominant retail banking franchises, which allows for scale and cost of funding advantages versus their smaller peers. They have also significantly improved their risk profiles by exiting riskier business lines, increasing capital levels and boosting liquidity. Despite their improved risk profile, BNP, Lloyds, and Intesa still trade at low levels of adjusted book and earnings. We see several potential opportunities for an improvement going forward. First, all three banks have internal cost savings prospects, which should allow for growth in earnings power despite the challenging regulatory and macroeconomic environment. Second, the strength of their balance sheets enables an increasing portion of free cash to be paid out as dividends. Third, their current earnings stream is negatively impacted by legacy expenses and an abnormally low interest rate environment. While we don’t know the precise duration of these two headwinds, we believe neither of these issues will remain a headwind forever.
We are unsure exactly when the macroeconomic or regulatory environment will improve. What we do know is that indiscriminate behavior by investors has led to attractive individual opportunities within the European financial sector. With strong profitable franchises, formidable balance sheets, and very attractive valuations, we think these select European financials will continue to improve their competitive positions and create additional value for our shareholders.
As of December 31, 2014, the following equities were held as a % of the total net assets:
|Credit Suisse Group||5.1%||0%||4.9%||4.9%|
|Julius Baer Group||0%||4.6%||4.2%||0%|
|Lloyds Banking Group||2.3%||0%||0%||0%|
Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
Click here to access the full list of holdings for The Oakmark International Fund as of the most recent quarter-end.
Click here to access the full list of holdings for The Oakmark International Small Cap Fund as of the most recent quarter-end.
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Click here to access the full list of holdings for The Oakmark Global Select Fund as of the most recent quarter-end.
Oakmark International and Oakmark Global Funds: The Fund’s portfolio tends to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.
Because the Oakmark Global Select Fund is non-diversified, the performance of each holding will have a greater impact on the Fund’s total return, and may make the Fund’s returns more volatile than a more diversified fund.
Investing in foreign securities presents risks that in some ways may be greater than U.S. investments. Those risks include: currency fluctuation; different regulation, accounting standards, trading practices and levels of available information; generally higher transaction costs; and political risks.
Oakmark International Small Cap Fund: The stocks of smaller companies often involve more risk than the stocks of larger companies. Stocks of small companies tend to be more volatile and have a smaller public market than stocks of larger companies. Small companies may have a shorter history of operations than larger companies, may not have as great an ability to raise additional capital and may have a less diversified product line, making them more susceptible to market pressure.
The discussion of the Fund’s investments and investment strategy (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) represents the Fund’s investments and the views of the portfolio managers and Harris Associates L.P., the Fund’s investment adviser, at the time of this letter, and are subject to change without notice.
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