As people look to the new year-or decade-ahead, many commemorate traditions to celebrate the occasion. While time-honored customs are particularly top of mind around the holidays, we embrace a ritual of our own at Oakmark with our quarterly letters.
Our shareholders can expect every letter to start with the investment tenets that have remained the same since our firm's founding. We can also anticipate the part in the first paragraph that describes the Fund's strong long-term record.
And we are proud to say that both are still true today. In fact, the Oakmark Fund has delivered a 12% annual return over the last 10 years, a return in line with the level since inception in 1991. However, at this snapshot in time, the Oakmark Fund has lagged the S&P 500 over the last 10 and 15 years. I wanted to pen a note to illustrate that what has made the Oakmark Fund successful since its founding is still intact.
The Oakmark U.S. investment team is experienced with an average of 20 years in the industry. They have a history of working together, with portfolio managers Bill Nygren (Trades, Portfolio) and Kevin Grant joining Harris Associates in 1983 and 1988, respectively. As we enter 2020, we believe our team is deeper than ever.
Our singular philosophy is value investing, which we have practiced since our firm's founding in 1976.
For more than 40 years, our investment process has been grounded in fundamental, bottom-up research. The output of this process is an estimate of intrinsic value that combines our team's collective wisdom on each stock. We do not limit our universe based on strict quantitative metrics, like low price-to-book value or price-to-earnings ratios. Rather, our private equity-like approach has always valued tangible and intangible assets.
We believe our disciplined long-term approach allows us to add value via stock selection. We seek to maximize our probability of outperformance by weighting the portfolio by conviction and not by benchmark weights. We at Oakmark are proud to be among the cohort of managers who follow this "Patient Capital" investment discipline.
Now for the main topic of conversation. Chart 1 below gives support to shareholders' decision to invest with us over the last 20 years. As of the end of 2019, the 20-year excess performance has been 2.9% versus the S&P 500. However, the Oakmark Fund has underperformed this index over the last 15 years.
Timing is certainly important to this analysis. So, to control for this, we looked at every one-year rolling period (329 periods since inception in 1991) to see how often we underperformed the S&P 500. Chart 2 below reveals the Oakmark Fund has only outperformed 48% of the time on a one-year basis. But Chart 2 also shows a trend; the probability of outperformance increased when the Fund was given time to work. The Fund outperformed over 75% of the time in every 10-, 15- and 20-year period.
This indicates to us that to generate desired client outcomes, we must have the courage to stick to our investment process, even if it produces short-term underperformance.
So why the underperformance? As a value manager, we have certainly had a headwind to performance versus a benchmark (S&P 500) as value has underperformed growth for more than a decade. A recent AQR study1 estimates that value currently sits at the 97 percentile of cheapness. In fact, the value factor has only been cheaper during the internet bubble, when valuations didn't matter to too many investors. Chart 3 below corrects for this headwind by comparing the Fund to a value benchmark. Looking at the same time period as above, the Oakmark Fund has beaten the Russell 1000 Value Index in every time period.
While this gives us little consolation as we aim to outperform the S&P 500 Index over the long term, even as a value manager, we are optimistic. We believe our portfolio currently looks more undervalued than it normally does and, despite the market rebound in 2019, we expect a more narrow gap between business values and stock prices to come.
We believe that the consistency of our investment team and strict adherence to our philosophy and process have contributed to our long-term returns. These pillars are still in place and we don't have plans to end this tradition any time soon. Thanks for your continued support.
1Asnes, Cliff. (2019) It's Time for a Venial Value-Timing Sin. Cliff's Perspective. https://www.aqr.com/Insights/Perspectives/Its-Time-for-a-Venial-Value-Timing-Sin
Past performance is no guarantee of future results. The performance data quoted represents past performance. Current performance may be lower or higher than the performance data quoted. The investment return and principal value vary so that an investor's shares when redeemed may be worth more or less than the original cost. To obtain the most recent month-end performance data, view it here.
The Oakmark 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.
Daniel Nicholas is a Client Portfolio Manager at Harris Associates across all of the firm's investment strategies. Prior to serving in this role, he was the Director, Institutional Sales for the firm. Before he joined Harris Associates in 2012, he was an Executive Director at Morgan Stanley as well as UBS. He holds an MS in Finance from the University of Wisconsin-Madison (2001) and a BBA from the University of Wisconsin-Madison (1999).
This article first appeared on GuruFocus.