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Why This Oakmark Fund Is No Longer Golden

Inconsistent execution at concentrated Oakmark Select has led to a Morningstar Analyst Rating downgrade to Silver from Gold.

The following is our latest Fund Analyst Report for Oakmark Select Fund (OAKLX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days. 

Oakmark Select can rebound from its slump, but stumbles with energy stocks and other errors of omission drop its Morningstar Analyst Rating to Silver from Gold.

The strategy can work for patient investors. Longtime manager Bill Nygren, joined by comanagers Tony Coniaris and Win Murray in 2013, relies on deep due diligence to find undervalued firms with shareholder-oriented management teams, an approach that's worked long term here and at the more diversified  Oakmark (OAKMX).

This 21-holding strategy, however, depends on standout stock-picking to succeed, and execution has not been consistent enough to merit the highest Morningstar Medalist rating. The team's unsuccessful venture into energy names (an all-time high stake of 11%) arguably doesn't play to the squad's bottom-up strengths. Predicting commodity prices and gauging macroeconomic risks aren't among the team's core competencies, yet those factors heavily influence these holdings. The team typically favors firms with reasonably predictable earnings, such as  Mastercard (MA). By contrast,  Apache's (APA) calendar-year net income during the past decade has ranged from negative $23 billion to $4.6 billion, making it harder to accurately analyze and predict its operating performance. Plus, the strategy has a mixed record in energy, owning just four other names since its 1996 inception, including former laggards Newfield Exploration (NFX) and  Cenovus Energy (CVE).

Furthermore, it's not clear that the team's best ideas consistently make it into this focused strategy. It hasn't owned some of its more diversified sibling's biggest recent winners, including  UnitedHealth Group (UNH),  Apple (AAPL), and others. That has sapped the portfolio's ability to compensate for its duds. As a result, it underperformed Oakmark by nearly 2 percentage points annualized during the trailing 15 years through October and lagged the S&P 500.

The strategy can bounce back. It posted a huge gain in 2009 after the 2007-09 financial crisis, and it's beaten the S&P 500 by 3 percentage points annualized since Nygren's 1996 start. Investors should stay the course.

Process Pillar: Positive | Katie Rushkewicz Reichart, CFA 11/07/2018
Oakmark Select's patient, focused, and contrarian approach earns a Positive Process rating. It’s not without risks, though: The fund's concentration in about 20 companies, positions as high as 10%, and lack of sector constraints court volatility and require a long-term mindset.

Valuation underpins Oakmark's analysis, but it's not a deep-value shop. Rather, the team looks to find companies poised to grow per share value that are mispriced relative to what a rational buyer would pay to own the entire business. The management team's willingness and ability to use a wide variety of valuation methods, including sum-of-the-parts analysis, private-market multiples, merger-and-acquisition activity, discounted cash flow models, price/subscriber growth, and consideration of intangibles, helps set the approach apart. Looking cheap on one or more of these metrics is not enough, though; the team also wants to own companies with ample free cash flow and predictable earnings run by managers who act like owners and invest alongside shareholders.

Analysts pursue ideas across sectors and have reasonably sized coverage lists of 12-15 names to allow for in-depth research. The analysts present their picks to a U.S. stock-selection committee that adds names to an approved list when two of the three members agree; managers draw ideas from this list.

The approach produces a unique portfolio, with 92% active share versus the S&P 500 as of September 2018 and more mid-cap exposure than its more diversified sibling, Oakmark. The managers are willing to look different for a long time, as evidenced by the strategy's 30% average turnover for the trailing decade.

The fund's 11% energy stake as of September 2018, nearly twice the S&P 500's, was an all-time high. The managers bought Apache,  Chesapeake (CHK), and  Weatherford International (WFT) between 2013 and 2017 because they considered them undervalued. These contrarian picks may still pan out, but, to date, they have hindered performance. Venturing deeply into positions so closely tied to fickle commodity prices and macroeconomic factors are arguably not this bottom-up team's forte. The team hasn't had consistent success here; this strategy has owned only four other energy names since its 1996 inception, including former laggards Cenovus Energy and Newfield Exploration. Meanwhile, this fund hasn't owned some of Oakmark’s big winners, such as UnitedHealthGroup.

Financials remain the most dominant sector at 23% of assets, but the team also considers nontraditional value stocks. In 2018, it bought  Regeneron Pharmaceuticals (REGN), its first biotech since the early 2000s, because Nygren likes its founder-led management team and thinks its research-and-development spending bolsters its long-term potential.

Performance Pillar: Neutral | Katie Rushkewicz Reichart, CFA 11/07/2018
The volatile fund endures rough patches that can weigh on long-term results. It's in the midst of one of those prolonged patches, leading its Performance Pillar to be downgraded to Neutral from Positive.

Missteps in energy have weighed on recent results. Chesapeake Energy, Apache, and Weatherford International posted steep losses in 2017-18. Other laggards included the embattled  General Electric (GE),  TE Connectivity (TEL), and  American International Group (AIG). The fund's 12.6% loss for the trailing year through October 2018 was far behind the S&P 500's 7.4% gain. Trailing one-, three-, and five-year results land in the large-blend Morningstar Category's bottom decile and lag the benchmark by wide margins. This slump has weighed on long-term results--the strategy's 15-year trailing return through October trailed the S&P 500 and category.

The fund has endured famines before and has come out ahead. Notably, it followed the 2007-09 financial crisis with a 52% gain in 2009, nearly twice the benchmark's. Returns since its 1996 inception under Bill Nygren remain impressive: Its 11.6% annualized gain through October beat the S&P 500 by 3.2 percentage points. Despite dismal returns over standard time periods, it has beaten the S&P in two thirds of the rolling five-year periods since inception. The strategy is volatile, and it's not consistently a strong downside performer, so investors must be risk tolerant.

People Pillar: Positive | Katie Rushkewicz Reichart, CFA 11/07/2018
Bill Nygren's experience and valuable insights, and the strong resources of subadvisor Harris Associates, support a Positive People rating. Nygren is the public face of Oakmark's U.S. equity strategies. He communicates his approach and explains the strategy's positioning in compelling and thoughtful shareholder letters. Nygren, who joined Harris as an analyst in 1983, has run this fund since 1996. He also manages Oakmark,  Oakmark Global Select (OAKWX), and other related Natixis strategies and invests over $1 million here.

The firm's up-and-coming talent has taken on additional responsibilities here in the past five years. Tony Coniaris, co-chairman of Harris, has comanaged this fund since 2013 and  Oakmark Global (OAKGX) and Oakmark Global Select since 2016. 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. Director of research Win Murray, at Harris since 2003, also joined the roster in 2013. Unlike Coniaris and Nygren, he still covers a full load of companies.

The talented 14-person U.S. team averages 21 years of experience and includes 10 generalist analysts who average 8.5 years at Harris. Murray has worked to grow some talent internally, a change from Oakmark's history of hiring analysts with industry experience.

Parent Pillar: Neutral | 08/03/2017
Paris-based Natixis Global Asset Management is the parent to a number of different asset managers globally, including Natixis AM in France and Loomis Sayles and Harris Associates in the United States. These affiliated companies have maintained a large degree of autonomy, both in operational terms and in terms of their investment philosophies. The quality of investment culture varies significantly from one subsidiary to another. 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. NGAM’s latest acquisition, DNCA, has also begun improving its funds’ fee structures.

On the other hand, the results obtained by Natixis AM are more mixed, and its teams are less stable. Furthermore, in July 2017, the French financial regulator Autorité des Marchés Financiers imposed a EUR 35 million fine on Natixis AM for failings relative to its range of formula-based funds, arguing that the firm had overcharged investors and had failed to adequately disclose charges in the funds’ filings. The sanction on Natixis AM thus weighs negatively on our assessment of the group’s stewardship, but we recognize that strengths in other parts of the organization, particularly in the U.S.-based affiliates, partly compensate for this weakness, resulting in a Neutral Parent Pillar rating.

Price Pillar: Negative | Katie Rushkewicz Reichart, CFA 11/07/2018
The fund earns a Negative Price rating because it's expensive. Nearly all of the fund's assets are in share classes priced above average relative to similarly sold peers (investor, Institutional, and Advisor shares). The service share class' price also is high.

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

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Katie Rushkewicz Reichart does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.