Clyde McGregor, the fund
manager of the Oakmark Equity Income Fund, recently held a conference call covering
the period ending March 31, 2012. Below we summarized what we thought were some
of his key points.
McGregor invests in
companies that he believes trade at a substantial discount to what he considers
to be their true business value (which is the approach employed by all the
investment professionals at Harris Associates, the fund’s investment manager). Every stock purchase is viewed as buying a
piece of a business, not just a stock certificate. Also, having a smaller, more focused portfolio
of stocks (15-60, for example, rather than 100-150) allows the manager’s best
ideas to have a meaningful impact on investment performance.
The Equity and Income Fund
has assets under management (AUM) of about $20 billion. It is a low cost fund
with an annual management fee of 0.67%. Morningstar calculates that the average
fund in the category has an expense ratio of 0.77%. The fund currently holds 53
equities. Its asset allocation is about
70% stocks and 30% bonds; representing the highest equity weighting the fund
attains.
The Equity and Income Fund
is an all-cap fund on the stock side with the 21 person research staff going
wherever value takes them. The highest market cap stock in the fund is about
$207 billion and the lowest $306 million. During this quarter, the median
market cap of the fund reached a new high of $9 billion. At quarter’s end 62% of the portfolio was invested
in large cap stocks with 14% of the equities being international.
The fixed income or bond
portion of the fund is composed of 13% US Treasuries, 9% non-US sovereign debt,
7% in Treasury Inflation Protected Securities (TIPS), 1% in corporate bonds and
just a sliver of agency debt. The
duration of the fixed income portfolio is a short 1.65 years. (Duration measures sensitivity to interest
rates. Technically, if interest rates
were to rise by 1%, the value of the fund’s bond holdings should decline by
1.65 %.) They have kept duration short
for some time now.
The fund was up 8% for the
quarter ending March 31 about even with its peer group. The fund was underweighted
in a few stronger market segments - financials and technology – but benefitted
from good stock selection in names like United Health, Diageo, Texas
Instruments and TJX.
The fund added 8 new equity
names to the portfolio while selling 4; they sold 3M, Sara Lee, L3, and Tractor
Supply. The eight new additions during
the quarter were: Ebay, Illinois Tool Works, Parker Hannifin, Republic,
Staples, Ameritrade, Lear, and Northrop Grumman. Unfortunately the buying
window on a number of these stocks was very small so the fund was unable to
build very large positions. This also
had the effect of lowering the turnover of the fund to 30% (turnover for the
average fund in this category is above 60%).
One fund holding, Pentair,
is going to merge with a division of Tyco international. Pentair is going to be
the name of the combined firm while Tyco shareholders will own a majority of
the new company’s shares.
McGregor noted he has been
trying to add income to the portfolio without overpaying for it, which he
stated has been difficult because “income is overpriced today,” a distortion he
believes is created by the Federal Reserve. He also mentioned that he does not find a lot
of value in Real Estate Investment Trusts (REITs) or Master Limited
Partnerships ( MLPs)two sectors that yield-focused investors have long found
attractive given that their unique tax structure which has led to higher
distributions.
In the current environment
with extremely low interest rates (that are likely to rise) and companies at
average valuations (as measured by PE ratios), McGregor expects that equities
will likely not advance much going forward. He did point out that today American business
and industry is managed much better than the recent past with technology
helping managers run their businesses more effectively resulting in greater
profitability than in the past. This could
be more supportive of valuations expanding.
While the fund has had a
10.94% average annual return since inception, McGregor thinks it more realistic
to expect mid to single digit compound rate of returns going forward. While he
will work very hard to maintain that 10% return going forward it would require
a substantial return from stocks given low bond yields. For the reasons given above he expects that to
be unlikely.
We continue to like the Oakmark
Equity & Income Fund. The fund’s
research-driven, consistent pursuit of the best values in United States and
overseas equity markets coupled with a protective high-quality bond portfolio has
generated solid returns with much less volatility than an all stock portfolio. We
think the fund is a relatively conservative way to get stock exposure. We view the
fund as an attractive investment option for retirement plans and a core fund
for many of our clients with smaller account balances.
Returns through 3/31/2012
|
|
YTD
|
1 Year
|
3 Years
|
5 Years
|
Since Inception*
|
|
Equity and Income
|
7.91%
|
3.74%
|
14.89%
|
5.32%
|
10.59%
|
|
Lipper Balanced Index
|
7.88%
|
4.60%
|
16.79%
|
3.04%
|
6.62%
|
Sources are Morningstar and
Oakmark
*
Inception is 11/1/1995
Assistance
on this post was provided by Grace Guo
(Harvest Financial Partners owns the Oakmark Equity
& Income fund in client portfolios and uses it as a default investment
option in a number of retirement plans where Harvest is the investment
advisor. The authors own it and other
Oakmark Fund in their personal portfolios.
Positions may change at any time)
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