Bill Nygren Oakmark Select Fund Q3 letter to investors
For the quarter, the Oakmark Select Fund gained 6%, compared to 5% for the S&P 500. This brings the Fund’s fiscal year (September 30) return to a strong absolute and relative return of 28%, compared to 19% for the S&P 500. As we’ve stated in the past, our investors should not expect this magnitude of absolute and relative performance every quarter or year, but we hope you enjoy them, as we do as fellow investors in the Fund.
These strong fiscal-year results were primarily due to stock selection and our relatively large weighting in more economically sensitive sectors such as consumer discretionary and financials. Our five largest contributors were TRW Automotive Holdings (up 63%), TE Connectivity (56%), Bank of America (57%), AIG (49%) and MasterCard (50%). You may have noticed that many of our top 5 contributors to performance remain among our largest holdings. This is not by accident. We are constantly evaluating the upside of our holdings relative to our estimate of intrinsic value on a risk-adjusted basis. Despite the strong price performance, we believe these investments remain attractive enough to warrant above average weights in the portfolio. Our largest two detractors were both energy related. Newfield Exploration (down 13%) and Cenovus Energy (down 12%) were the only two current holdings that generated negative returns over the past 12 months.
During the past fiscal year, we eliminated three positions in the Fund (Discovery Holdings, Dell, BMC Software) and added three new positions (Forest Laboratories, Kennametal, Oracle). Although this is less change than the Fund normally experiences, we neither wear this with a badge of honor nor manage the portfolio to a non-economic metric such as a turnover ratio. Position changes are simply the result of applying our investment process, which is to buy businesses at substantial discounts to our estimate of intrinsic value, where we see a clear path to that value growing on a per share basis, and management is focused on maximizing per share value. We sell a stock when we believe one or more of these criteria are no longer met.
We have discussed our thoughts on the Discovery and Dell sales in past letters, but we did receive a worthy update on BMC (BMC) since we sold it in the fourth quarter of 2012. Recall that BMC management conducted a strategic review during the second quarter that we owned the stock and decided to remain an independent company. Given the lack of a compelling purchase offer for BMC during the review, we exited our position because we no longer believed it was selling at a significant discount to private market value. Our opinion has since been validated. On September 10, 2013, BMC management sold the company for $46.25 per share—roughly 12% above our average sale price. During that same time, the Oakmark Select Fund and the S&P 500 returned 25% and 20%, respectively—both well in excess of BMC’s modest price increase.
In the past fiscal year, we purchased Forest Laboratories, Kennametal, and Oracle, which were all discussed in prior letters. Forest (FRX)’s many new drug launches remain on track with our original estimates and we look forward to this value being demonstrated in the income statement as sales ramp relative to expenses over the next several years. Kennametal (KMT) is still operating well below our estimate of mid-cycle earnings though managing expenses consistent with our expectations such that incremental profits from an eventual recovery in demand ought to result in substantial profit improvement. In the quarter we have owned Oracle (ORCL), it has had more difficulty keeping up with Wall Street’s expectations than with ours. We continue to view the shares—selling at approximately 10x free cash flow—as significantly undervalued. Meanwhile, management is doing the right thing by aggressively repurchasing shares at what we believe to be a terrific price.
One year ago in this letter we discussed our view that equities remained the most attractively priced asset class despite having returned 30% in the prior year. One year later, the S&P gained another 19%, and Oakmark Select returned 28%, while the Barclays Index experienced a decline of 2%. While it’s personally rewarding to see our analysis confirmed, you are likely (and rightly) more concerned about whether our opinion has changed. In short, it has not. While equities may be less undervalued than they were one year ago, we believe they are still reasonably priced, particularly when compared to bonds, which continue to offer historically low yields.
Thank you for your continued investment in the Fund.
William C. Nygren, CFA
Anthony P. Coniaris, CFA
As of 9/30/13, TRW Automotive Holdings Corp. represented 8.1%, TE Connectivity, Ltd. 6.8%, Bank of America Corp. 6.0%, American International Group, Inc. 5.7%, MasterCard, Inc. Class A 5.4%, Newfield Exploration Co. 2.9%, Cenovus Energy, Inc. 3.1%, Discovery Communications, Inc. Class C 0%, Dell, Inc. 0%, BMC Software, Inc. 0%, Forest Laboratories, Inc. 4.5%, Kennametal, Inc. 3.3%, and Oracle Corp. 4.2% of the Oakmark Select Fund’s total net assets. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks