David Herro, chief investment officer for international equities at Harris Associates, has been a manager of the $47 billion Oakmark International fund (OAKIX) since 1992. He won Morningstar's International Stock Fund Manager of the Year in 2006, International Stock Fund Manager of the Decade for 2000-09 and International Stock Fund Manager of the Year in 2016. InvestmentNews spoke with Mr. Herro about world markets, his fund and the global economic recovery.
John Waggoner: How difficult is it to find international bargains these days?
David Herro: It was a strong year in 2017 and aided by a weaker dollar, which helped the situation. Since then we've seen weakness. The Euro Stoxx 50 index is down a percent this year, against what is a very robust earnings and economic environment. So share prices are down, earnings are up, and the value gap is starting to open up again — so it's a bit easier to find stocks. The Euro Stoxx 50 is at 12.4 times earnings, and its dividend yield is 4%. Europe in particular offers decent value, although I can't say that about Japan or emerging markets. Europe is still the place where there are attractively priced stocks.
JW: You have a fairly Euro-centric portfolio: about 57% in Europe and another 21% in the United Kingdom. Let's start with the U.K., where you've got nearly twice your benchmark. Do you think U.K. stocks have been unfairly depressed because of Brexit?
DH: Brexit has been the No. 1 factor, and it will have some impact on U.K. companies, but it's case by case by case. What happens frequently is that these macro things move prices, although the fundamentals haven't changed very much for a value investor. So it's a long-term opportunity. As long-term investors, we can take advantage of this. If prices don't move with underlying intrinsic value, you have to be patient and disciplined, and wait for fundamental value to come out.
For example, we bought Lloyd's Bank at around 25 pence per share in 2011. Now it's at 67 pence, and it's paid a lot of dividends over time. The turnaround for Lloyds continues, and it's nine times earnings, one times book value, and yields 6%. It's got excess capital and has continued to grow in earnings power. The only thing that has prevented further earnings growth is that it has had some conduct charges that has cost them billions. But the core underlying profit keeps improving — they have low loan losses and have maintained a healthy interest-rate spread. It's a good, solid value.
JW: You have big positions in France and Germany, both of which are famous for high worker benefits and regulation. Do you think the tide there is moving in the other direction, or are the valuations simply compelling, or both?
DH: Some good things have happened in both countries. Germany has had a more flexible labor situation for some time. France is just passing labor market reforms. We're seeing that in other parts of Southern Europe — Italy is doing it, and Spain has completely done it.
One of the things helping this recovery, aside from the general feel-good factor in the past year, is that we're seeing increased policies that are more pro-growth, more pro-capitalist. And with increased consumer confidence comes more hiring and more spending.
When the Greek crisis was the big thing, everyone thought it would drag down the entire European banking system. None of that really happened. In the wake of Brexit and the uncertainty about the Italian election comes lackluster equity performance, even though earnings have become quite strong.
JW: Do you have an opinion on the U.S. market?
DH: I think the U.S. is ahead of Europe as far as its economic recovery goes. We're now entering an accelerator phase — seeing top-line growth and capital expenditures. Earlier, earnings were driven by stock buybacks and cost-cutting. Now we're seeing real economic growth, rather than manufactured earnings growth.
JW: Your fund is overweight in financials. Why is that?
DH: It's not just the banks — we also have some asset management, such as Allianz. With low and negative rates, there was the fear that financials would never be able to make money. But despite low rates, they have maintained profitability.
Now we're seeing growth as we see more credit expansion and more money coming off the sidelines from asset managers. For insurance, we're starting to see a more positive impact of higher rates for holders of bonds, as well as from lending spreads. Basically, financials have maintained earnings while doing the hard work in the recession. Now we're going to see some growth.
JW: Your fund isn't an emerging-markets fund, although you're allowed to have some emerging markets in your portfolio. Lately, the sector has been getting a lot of attention. Do you think the enthusiasm is overblown, or is it just an area where you tend to tread lightly?
DH: The enthusiasm is very, very naive. When emerging markets get trashed, we go overweight, we go where our value training takes us. You've got to be very selective in emerging markets. It's a rifle shot, not a shotgun.
We have a big stake in Groupo Televisa, a Mexcian company that's one of the cheapest media companies in the world. We have an Indian bank stock, Axis Bank. So we have some exposure to emerging markets. But it's not that easy. Now that the bull has been unleashed on emerging markets, you have to look carefully at what you're buying in terms of quality.
JW: You're underweight Japan. Will there ever be a good time to invest in Japan?
DH: We were overweight in Japan in 2011. The world, ex-Japan, was selling at two times book value, and Japan was selling at book — there were enough decent companies at the right price. The weight in the index was 19%, and we were 25% Japan. Now we're 4.5% in Japan. Corporate performance in Japan is weak: You have low returns and poor capital allocation. You can't be generous on how you value these businesses. It's a struggle for us to find names in Japan.
JW: It's not just you running the fund. Tell us about the team behind you.
DH: We have a really strong team — 12 investment pros, of which four are partners. For partners, aside from myself, we have Mike Manelli, my co-manager on Oakmark International; Jason Long, who co-manages Oakmark Global (OAKGX); Eric Liu, co-manager of Oakmark Global Select (OAKWX); and Justin Hance, co-manager of Oakmark International Small Cap (OAKEX).
We have a team of analysts and research associates who work together to do one thing: find value by pricing businesses as accurately as possible. It's a two-step process: Value businesses and act upon the information. If the price is rich, we do nothing. If it's selling at a discount, we invest in it. You have to have the courage to do that. A lot of investors don't like to buy stocks that have fallen. People in our business like stocks that go up and dislike stocks that go down. We see price as exogenous: If price gives us an opportunity, we're poised to take advantage of that.
JW: Oakmark reopened the fund in July, and has seen strong inflows since. Any thoughts about shutting the doors again?
DH: We did a soft close at the end of January, and that has helped — basically, it's cut the inflows down 60% to 80%. We don't want to go to outflows, but we were growing too fast. We've taken steps to slow that down, and, frankly, the lackluster start of the year has helped.
JW: Any last thoughts?
DH: When you're buying foreign stocks, you're exposing yourself to somewhat mildly undervalued foreign currencies, with the exception of the Swiss franc and the Norwegian krona. But in the euro, the yen and sterling, you're able to find cheap stocks at favorably priced currencies. That's a bit of a tail wind, in my view.