When might equity markets return to pre-pandemic levels? What sectors are offering attractive value opportunities? How sustainable is value’s outperformance? Could inflation impact value stocks in 2021?

To gain insight into value investing as life slowly gets back to normal, the Natixis Access Series hosted Bill Nygren, Partner, Portfolio Manager, CIO-US Equities at Harris Associates, the Investment Advisor to Oakmark Funds. Highlights of his talk with Ken Herold, Head of Investment Strategies at Natixis Investment Managers, are below.

What do you look for in a company before investing in it?

Nygren: At Harris Associates, we are long-term value investors. Our portfolios are based on our fundamental analysis, and we look for three things in any company we consider investing in. We want the stock to be priced at a discount to our estimate of business value; we want business value to be growing as fast as other companies – as fast as the S&P 500® Index; and we want management teams that are aligned with their outside shareholders.

Clearly, stock selection is the strength we bring to the table. We are not market timers in any way and, in order to maximize the impact our stock selection has on the portfolios, we run very focused portfolios. The Oakmark Fund is our most diversified equity portfolio; it owns about 55 names. The Oakmark Select Fund, which I also co-manage, cuts that down to a favorite 20 names. Compare that to a typical mutual fund today that owns somewhere between 100 and 150 names. Each stock that we decide to own has a much bigger impact on our performance than it does for our peers.

We invest for a very long-term time horizon. If you have something that is undervalued and the value’s growing at least as fast as other companies – and management is aligned with outside shareholders – it gives us the luxury to think really long-term.

How long is your time horizon?

Nygren: Our analysts forecast out to a five to seven-year time horizon. I think of that as bringing a private equity perspective to investing in public equities. We’re looking at what a business looks like today, how different it might look five to seven years from now, and how differently investors might value that same company if it goes along the path that we expect it to over the next five years.

Many private equity firms typically buy poorly managed companies where they have to change out the management teams. We differ from them by trying to identify well-managed companies where we want to partner with the existing management teams. This helps us avoid getting into a situation where there could be somewhat of a race against time of the team destroying value while we try to change out management.

Has your investment analysis changed since Oakmark Funds was created in 1991?

Nygren: This is a business where you always need to stay a step ahead of the competition. What we did at Harris Associates when Oakmark started in 1991 would not be adequate for getting outperformance today. Thirty years ago, you could just buy a list of low price-to-earnings or low price-to-book value companies and expect mean reversion. Today, the valuation methodology needs to be more complex and consider things like intangible assets. Incorporating that into our process has been very important.

How did your high conviction approach help you during the Covid crisis?

Nygren: I recently read Jack Schwager’s book, Unknown Market Wizards. The chapter that spoke the most to me was about a commodity trader whose big idea was to take the Silicon Valley statement of “You need to have strong opinions, weakly held,” and apply it to investing. He believed in the importance of having conviction in order to take a position that’s different from the market, yet constantly be looking for new information that suggests that your original conviction might have been unwarranted.

That thinking has always been a big part of our process at Harris Associates, but it became even more important last year when our world turned upside down due to Covid. Suddenly, all our forecasts for our companies were completely off. There were some businesses whose growth was going to accelerate because of Covid and there were others that faced a couple of really tough years. I was really proud of our analyst team who, in about a week and a half, went from expecting normal growth in the economy to expecting a recession that would take a couple of years to exit.

We didn’t think 2021 would be a normal year – we thought that would take until 2022 – so we had analysts roll out their detailed forecasts through 2022, and we very quickly had an approved list that re-ranked the attractiveness of each of our companies. I think this quick reaction was one of the biggest reasons we were able to significantly outperform our value peers in the six months after March 2020 – before value really started to rebound.

When might equities be back to “normal” pre-pandemic levels?

Nygren: We believe that normal is going to come back much faster than people expect. So it’s not a question of if the economy is going to recover, it’s a question of when.

With the disruption in 2020, we immediately went to a severe recession scenario, thinking we wouldn’t see any recovery until the second half of 2021 – in hindsight we weren’t too far off, maybe a little bit too pessimistic – and that by 2022 we’d be back to normal levels. Forecasting out five to seven years from now that the world will be normal typically doesn’t give much of a macro-overlay tilt to our portfolios. The view that we would get back to normal relatively quickly, in say, less than five years, gave us an outlier projection – the result of which was that our portfolios were heavily oriented toward business reopening.

What value trends are you focused on currently?

Nygren: We think there’s tremendous pent-up demand for vacation travel and believe business travel will also come surging back. For example, we think companies like Hilton have become stronger businesses during Covid and are continuing to grow market share because some of their weaker competitors haven’t been able to spend as much on their futures. Hilton’s stock has recovered nicely, but we think there’s more to come there. Our projection is that by sometime next year and certainly for the entire year in 2023, business travel will be back to normal.

We also think the new normal is going back to work. For most businesses, collaboration and collegiality is an important part of corporate culture, and it’s difficult to maintain those elements via video conferencing. We think industry leaders in commercial real estate like CBRE, and even something in consumer products like single-serving coffee distributor Keurig Dr Pepper, are well positioned.

We believe the ultimate beneficiaries are some quality financial sector companies. The move to online banking is going to allow them to have a permanently lower expense ratio than they had pre-Covid. Because some of these stocks are cheap at single-digit price-to-earnings, we think it’s the most attractive area in the stock market. We are very much looking for a modern-day version of the Roaring Twenties to match what happened in the 1920s after the Spanish Flu pandemic.

What are your thoughts on value outperforming?

Nygren: A couple of quarters ago, we hardly saw any outperformance by value. But on those few days when value outperformed the S&P 500®, the Oakmark Funds were consistently performing stronger than the Russell Value Index, even when the Russell Value was doing better than the S&P 500®.

We think value’s underperformance has been historic, and that we’ll be in a good position to benefit from any reversion in that growth outperformance. We believe that the fundamentals should dictate a continuation of value outperformance. Valuation extremes are very similar to what we were facing back in 2000, and if I’m right on that, then this value run has a good distance left to go.

Are you concerned about inflation? Could it impact your portfolios?

Nygren: A return of inflation and a positive real interest rate would hurt growth stocks a lot more than it would hurt value stocks. Within our portfolio, I think the two biggest areas are financials and oil. Financials is about a third of our portfolio and should benefit most from higher interest rates. Their price-to-earnings are barely double-digit, so it would take a much higher long bond to suggest that Ally Financial is overvalued at nine times next year’s estimate. But a return to inflation and a T-bill at two or three percent instead of zero would be very good for our banks – especially the traditional banks that have a business model where they pay you interest.

Our oil stocks have benefited already this year with the fear of inflation’s return. That’s because hard assets do pretty well against inflation and people will stop talking about $70 per barrel being an unsustainable price for oil.

How do you think about ESG considerations?

Nygren: Our view is that as your time horizon extends, ESG becomes more and more consistent with good long-term investing. When you own a stock for seven years like we do, you want to know how businesses are being governed. Is the CEO getting paid to achieve goals that benefit the outside shareholders? That matters a lot to your performance.

We don’t buy a company unless we think it’s managed by people that are highly talented and have goals consistent with outside shareholders. So governance has always been hugely important to us in terms of stock selection. But it’s important to keep the distinction between ESG investing and impact investing clear. We aren’t accepting lower returns on anybody’s capital because we think we know what the right thing to do for the world is.

Why does quality matter in your portfolio? What types of investments do you avoid?

Nygren: Our view is that the quality of the business is what determines what a fair multiple would be for that business. We would gladly pay higher multiples to get businesses that have higher expected growth, higher durability of their growth, higher predictability of the growth, higher cash generation, all those attributes we normally associate with high-quality businesses.

To us, it’s just as much value investing to buy a great business at an average multiple, as it is to buy an average business at a cheap multiple. Value investing is buying businesses that are worth more than you have to pay for them. So it’s part of our process, and we absolutely do not limit ourselves to below average businesses like some deep value investors do.

We avoid parts of the market where speculation runs rampant. I would say that’s in some of the cryptocurrencies and some of the SPAC names, especially the ones run by celebrities. I think the meme stocks – like GameStop – that appear to be selling at multiples of very low fundamental value are extremely risky and not sustainable.
This material is provided for informational purposes only and should not be construed as investment advice. All investing involves risk, including the risk of loss. The views and opinions expressed are as of June 15, 2021 and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted. Past performance is no guarantee of future results.

Oakmark Fund Risks:
  • Equity Securities Risk: Equity securities are volatile and can decline significantly in response to broad market and economic conditions.
  • Value Investing Risk: Value investing carries the risk that a security can continue to be undervalued by the market for long periods of time.
  • Concentration Risk: Concentrated investments in a particular industry may be more vulnerable to adverse changes in that industry or the market as a whole.
  • Foreign Securities Risk: Foreign securities may involve heightened risk due to currency fluctuations. Additionally, they may be subject to greater political, economic, environmental, credit, and information risks. Foreign securities may be subject to higher volatility than US securities, due to varying degrees of regulation and limited liquidity.
The securities mentioned above comprise the following preliminary percentages of the Oakmark Fund’s total net assets as of 9/30/2021: Ally Financial 3.8%, Hilton Worldwide 2.0%, Keurig Dr Pepper 1.6%, CBRE Group Cl A 1.1%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

Top Ten Holdings for the Oakmark Fund as of 9/30/2021:

Security Percent of Net Assets
Ally Financial 3.8%
Capital One Financial 3.7%
Alphabet CI A 3.7%
Citigroup 3/0%
EOG Resources 2.9%
Gartner 2.9%
Netflix 2.7%
Charles Schwab 2.7%
Bank of America 2.7%
Facebook CI A 2.7%
Portfolio holdings are not intended as recommendations of individual stocks and are subject to change. The Funds disclaim any obligation to advise shareholders of such changes. Information about portfolio holdings does not represent a recommendation or an endorsement to Fund shareholders or other members of the public to buy or sell any security contained in the Funds’ portfolios. Portfolio holdings are current to the date listed but are subject to change any time. There are no assurances that the securities will remain in the Funds’ portfolios.

Before investing in any Oakmark Fund, you should carefully consider the Fund's investment objectives, risks, management fees and other expenses. This and other important information is contained in a Fund's prospectus and summary prospectus. Please read the prospectus and summary prospectus carefully before investing. For more information, please visit oakmark.com or call 1-800-OAKMARK (1-800-625-6275).

Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.

The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.

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