Trust and effective communication provide investment teams with the ability to stick with a sound investment philosophy and process during periods when the approach is out of favor with the market. Oakmark’s focus on developing an intrinsic value for companies provides a foundation for portfolio management decisions. He believes that this foundation drives the long-term successful investment returns that the firm has earned for clients.
David Herro, CFA, partner, portfolio manager and chief investment officer of International Equity at Harris Associates, addressed 200 guests at the University Club on Tuesday, October 8th for the sold-out Distinguished Speaker Series luncheon. Herro emphasized the importance of our fiduciary duty, a sound investment philosophy, the difference between a business’s value and its stock price, the opportunities that macro events can create and the importance of managing emotions. These five themes have been central to his long-term success managing the Oakmark International Equity mutual fund.
Herro measures the attractiveness of a business based on the present value of expected free cash flow. Prices below this value create buying opportunities, and above a reason to sell or not buy. He uses a normalization process to determine the required discount rate, instead of using today’s very low rates. The discount rate also varies for countries and companies based on risk assessments. During his presentation, he illustrated times when one of his holdings, Glencore PLC’s stock price movied far from his computation of intrinsic value. He noted that price often responds to current information versus the long-term business value. This volatility provides opportunities for investors. He guides clients to think and act like investors, not traders.
Herro provided several examples of when macro events moved security prices far from intrinsic value. During the European sovereign-debt crisis investors could purchase Italian government bonds with yields near 8.0% that are less than 1% today. Additionally, yields on Greek government bonds moved above 30% in 2012 and are now lower than US Treasury yields. He notes that despite these movements in price, intrinsic values have not changed by these large magnitudes.
Managing emotions requires a strong foundation. The faith to maintain a set of beliefs during the great financials crisis eventually rewarded investors. In contract, a focus on stock price movement created severe anxiety that lead to many poor decisions.
Herro compared today’s difference between the performance of growth and value styles as comparable to the 1995 to 2000 timeframe. He acknowledges that identifying a change in this relative performance is extremely difficult due to a large number of variables with unstable coefficients. However, he believes that the magnitude of the differences strongly favors the value style currently.
Herro noted that we should never forget that our purpose is to earn returns for our clients. Key ingredients to success include a sound approach, acting like an investor vs. a trader, exploiting opportunities created by macro events and managing emotions. These thoughts have served him well and he believes that they will continue to serve our industry well.