David Herro Market Commentary | 4Q13 — Summary & Takeaways · Oakmark Funds

Theme and Background

This chapter discusses the investment performance and strategy of the Oakmark International Fund in 2013. The market environment was filled with negative "macro noise," including Europe's structural crisis, slowing growth in emerging markets, and uncertainty over Japan's reform prospects. The author's core stance is to ignore macro noise and focus on two variables—company valuation and business quality—to assess investment attractiveness.

Core Views

The author argues that at the beginning of 2013, European and Japanese stock markets offered extreme value, leading the fund to overweight these two regions while underweighting emerging markets (deemed lacking in value). Although the overweight position in the European financial sector was controversial at the time (with the market generally believing that the eurozone's fiscal issues were far from resolved), the slow economic recovery in Europe and Japan's efforts to tackle deflation drove a market rebound, benefiting the fund. By the end of 2013, as Japanese stock prices rose far faster than corporate value creation, the fund had shifted to an underweight position in the Japanese market.

Key Arguments and Data

Japanese Market: The Topix index rose approximately 80% from its 2012 low. As price gains outpaced corporate value creation, the fund had significantly underweighted Japanese equities by year-end.
Japanese Corporate Governance: The author notes a phenomenon of "lazy balance sheets" in Japan (cash surpluses depressing returns) and insular tendencies (boards lacking external and foreign directors). However, changes are underway; for example, Olympus has introduced a substantial number of independent external directors, with management explicitly setting key goals of improving operational returns and restoring shareholder cash returns.
Japan's Economic Reforms: The author believes the Japanese government needs to complete three structural reforms: eliminating protections for specific industries (e.g., agriculture), removing barriers to productivity and labor growth, and abolishing obstacles to corporate mergers and acquisitions. Government officials have acknowledged these issues, but the effects remain to be seen.

Companies/Assets Involved

Company/Asset	Role	Key Data	View
Olympus	Fund holding	Board has introduced numerous independent external directors; management aims to improve operational returns and restore shareholder cash returns	Bullish (positive case of governance improvement)
Japan Topix Index	Market benchmark	Rose approximately 80% from its 2012 low	Underweighted by year-end (price gains too rapid)
European Financial Sector	Fund overweight sector	Overweight position was "measurable"	Bullish (despite market controversy, supported by slow European economic recovery)

Investment Insights

Ignore Macro Noise, Focus on Company Fundamentals: The author emphasizes that price fluctuations caused by short-term macro issues offer long-term investors opportunities to buy high-quality companies. Investors should focus on company valuation and business quality, not market sentiment.
Caution on the Japanese Market: Although Japanese stocks have risen sharply, the author believes prices have outpaced value creation, leading to a reduction in holdings by year-end. Investors should be wary of overvaluation risks and monitor substantive progress in Japanese corporate governance improvements.
Value Remains in the European Financial Sector: Despite market doubts about eurozone fiscal issues, the author argues that a slow European economic recovery will support the sector. Investors can look for high-quality companies within European financial stocks.
Emerging Markets Not Yet Attractive: The author explicitly states that emerging markets lack value, and underweighting the region helped the fund avoid downside risk. Investors should wait for more reasonable valuations to emerge.