David Herro’s Oakmark International Small Cap Fund letter to investors for the fourth quarter 2014.
The Oakmark International Small Cap Fund declined 2.7% for the quarter ended December 31, 2014, slightly less than the MSCI World ex U.S. Small Cap Index, which declined 3.4% for the same period. For the year ended December 31, the Fund declined 8%, and the MSCI World ex U.S. Small Cap Index declined 5%. Since the Fund’s inception in November 1995, it has returned an average of 10% per year.
David Herro’s Oakmark International Small Cap Fund – Top performer: gategroup
The top performing stock in the Fund this past quarter was gategroup (“Gate”), a Swiss company that provides services to the travel industry, including flight catering, airport services and lounge operation. During the quarter Gate reported its third quarter results, which showed that its multiyear restructuring program was beginning to have a positive impact on group margins. Furthermore, 2014 proved to be one of the better operating environments for the airline industry (Gate’s key customers) since the financial crisis due to robust passenger growth and recent declines in oil prices, which have helped airline profitability. The more favorable macro backdrop should benefit Gate into 2015, but the key driver to value creation will be the continued execution of its cost-reduction plans. In November, Gate’s board appointed Christoph Schmitz as its new Chief Financial Officer, which we hope leads to better execution of the cost-reduction plan and increased focus on improving the cash conversion of the business.
David Herro’s Oakmark International Small Cap Fund – Largest detractor: DGB Financial Group and Fugro
The Fund’s largest detractor for the quarter was DGB Financial Group, a regional South Korean financial holding company that provides a full range of consumer and commercial banking-related financial services. Late in October, DGB released its third quarter results, which were only slightly below our estimates but were weaker than its peers in South Korea. In mid-November, DGB announced a rights issuance, which ignited a significantly negative market response. DGB plans to use the additional capital to accommodate growing its loan business, to initiate an auto finance business and to acquire Woori Aviva Life Insurance Company. We also have concerns about the issuance, as the use of capital appears to be suboptimal and is counter to DGB’s previously stated intentions of slowing growth in order to focus on harvesting better margins. However, we continue to believe DGB’s primary business region and its current undervaluation support the stock’s attractiveness.
Netherlands-domiciled geological engineering company Fugro was the largest detractor from performance for the calendar year due to continued declines in oil prices, which led to further postponements/cancellations of off-shore projects. During the fourth quarter Fugro announced another significant downgrade to its earnings outlook as well as a host of restructuring/impairment charges, which put into question its ability to comply with financial covenants. As the quarter progressed, Fugro’s balance sheet improved as Royal Boskalis Westminster acquired nearly a 15% stake in the company and Fugro secured amendments to its financial covenants. However, falling oil prices could make the operating environment in 2015 even more challenging than it was in 2014.
Fugro is a highly operationally-geared business, and our original investment thesis assumed a continuation of high single-digit growth in off-shore exploration and production capital expenditures (E&P CAPEX), which has proven to be inaccurate. Because we miscalculated the operating environment for Fugro, over the past six months we have significantly reduced our estimate of Fugro’s intrinsic value. However, even with the challenges Fugro faces, we believe that off-shore E&P CAPEX trends will eventually improve and that Fugro’s market positions are strong, Thus, we remain invested in the name.
David Herro’s Oakmark International Small Cap Fund – Adds Applus Services
We added one new security to the Fund during the quarter, Spain-based Applus Services. Applus is a leading global certification company specializing in testing, inspection and certification services. The company provides solutions for clients in all sectors to ensure that their assets and products comply with environmental, quality, health and safety standards and regulations. During the quarter we sold Nifco and Yamaha Motor from the Fund.
Geographically we ended the quarter with 20% of our holdings in Asia, 65% in Europe and 12% in Australasia. The remaining positions are in North America (Canada and the U.S.), Latin America (Brazil) and the Middle East (Israel).
While the U.S. dollar has strengthened, we still maintain hedge positions on three of the Fund’s currency exposures. As of the recent quarter end and as a result of the strengthening dollar, we decreased the Fund’s Australian dollar hedge to 24%, the Norwegian krone exposure to 19% and the Swiss franc exposure to 25%.
We thank you for your continued confidence and support and wish all of you a very happy and healthy 2015!
David G. Herro, CFA
Michael L. Manelli, CFA
As of 12/31/14, Gategroup represented 1.6%, DGB Financial Group, Inc. represented 1.9%, Woori Aviva Life Insurance Company 0%, Fugro NV 0.9%, Royal Boskalis Westminster 0%, Applus Services SA 0.3%, Nifco 0% and Yamaha Motor 0% of the Oakmark International Small Cap Fund’s total net assets. 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 Small Cap Fund as of the most recent quarter-end.
The MSCI World ex U.S. Small Cap Index (Net) is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance, excluding the U.S. The MSCI Small Cap Indices target 40% of the eligible Small Cap universe within each industry group, within each country. MSCI defines the Small Cap universe as all listed securities that have a market capitalization in the range of USD200-1,500 million. This benchmark calculates reinvested dividends net of withholding taxes using Luxembourg tax rates. This index is unmanaged and investors cannot invest directly in this index.
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.
Oakmark International Small Cap Fund: The percentages of hedge exposure for each foreign currency are calculated by dividing the market value of all same-currency forward contracts by the market value of the underlying equity exposure to that currency.
Oakmark International Small Cap 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.
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.