David Herro Market Commentary | 1Q23
Oakmark is the mutual fund family launched in 1991 by Harris Associates, the Chicago deep-value firm founded in 1976 (about $105bn AUM). Bill Nygren runs the flagship Oakmark Fund and David Herro the Oakmark International Fund, buying businesses at large discounts to intrinsic value and holding them like owners — publishing quarterly fund commentaries, market commentaries and insight articles.
In plain words
This is Oakmark fund manager David Herro's Q1 2023 commentary. His main point: the Silicon Valley Bank failure was an isolated event, not a systemic crisis like 2008. Banks today have much more capital and better assets, so the March sell-off was overblown. He's especially bullish on European banks (BNP Paribas, Intesa Sanpaolo, Lloyds) because they hold fewer securities and have more diverse deposits, which could actually benefit from a flight to safety. For regular investors, the lesson is not to confuse one bank's problems with the whole industry—panic can create buying opportunities in solid companies.
Oakmark International Fund delivered strong performance in the first quarter of 2023, with both absolute and relative returns outstanding. The fund achieved a return of 13.9%, continuing the robust momentum from the fourth quarter of 2022, when it posted gains of over 20%. This performance was prima
Theme and Background
This chapter primarily discusses the performance of the Oakmark International Fund in the first quarter of 2023, with a focus on the global bank stock sell-off triggered by the collapse of Silicon Valley Bank (SVB) and Signature Bank in March. The author argues that the market reaction was excessive and inconsistent with fundamentals, using this opportunity to elaborate on a bullish stance toward European bank stocks.
Core Thesis
The author's core investment argument is: The global banking system is not in crisis; the crises of individual banks stem from their own poor risk management, not systemic risk. Since the 2008 financial crisis, the current banking system has significantly improved capital adequacy ratios and asset quality. Therefore, the sell-off in bank stocks (especially European bank stocks) creates buying opportunities for value investors.
Contrarian Judgment:
- The market interprets the SVB crisis as a systemic banking crisis, but the author views it as an isolated event, with the global banking system being more resilient than in 2008.
- The market broadly sells off bank stocks, but the author believes European banks (such as BNP Paribas, Intesa Sanpaolo, and Lloyds), due to their smaller securities portfolios and diversified deposit bases, may actually benefit from capital flight to safety.
Key Arguments and Data
1. Fund Performance and Market Context:
- The Oakmark International Fund returned 13.9% in the first quarter of 2023, continuing the strong performance of over 20% in the fourth quarter of 2022.
- The rebound was primarily driven by holdings in Europe (especially Germany), but European stocks still trade at a significant discount compared to other global regions.
As of March 31, 2023, the fund's annualized return since inception (9/30/1992) is 8.69%, 10-year return 5.04%, 5-year return 1.46%, 1-year return 5.22%, 3-month return 13.91%, with an expense ratio of 1.04%
2. Banking System Comparison (2008 vs. Now):
- After the 2008 financial crisis, new regulatory requirements forced banks to significantly increase reserves and capital bases, limiting lending and shareholder returns but making the system more resilient.
- The chart below shows the ratio of tangible equity to adjusted assets rising from approximately 3% in 2008 to approximately 6% in 2022 (Source: Bernstein Autonomous LLP).
| Metric | 2008 (Pre-Financial Crisis) | 2022 (Current) |
|---|---|---|
| Tangible Equity / Adjusted Assets Ratio | ~3% | ~6% |
| Asset Quality | Poor (subprime, etc.) | Higher |
3. Causes of the SVB Crisis:
- Severe maturity mismatch: short-term deposits vs. long-term assets.
- High deposit concentration: a large portion of deposits exceeded FDIC insurance limits, and clients were concentrated in non-diversified industries such as venture capital and cryptocurrencies.
- These industries contracted post-pandemic, leading to deposit outflows, forcing the bank to sell long-term assets at a loss, triggering solvency concerns and a bank run.
4. Advantages of European Bank Holdings:
- Securities portfolios as a percentage of assets are significantly lower than those of U.S. peers, resulting in substantially lower unrealized loss risk.
- Mark-to-market adjustments have a negligible impact on European banks' net assets and regulatory capital.
- Strong and diversified deposit bases position them to benefit from capital flight to safety amid uncertainty.
European bank leverage ratios recovered from a low of approximately 2.5% in 2007 to approximately 5.2% in 2023, while Basel 3 CET1 capital ratios rose steadily from approximately 5% in 2009 to approximately 13.5% in 2023
5. Specific Holdings Data:
- BNP Paribas: Sold Bank of the West in January for $16 billion (1.75 times book value), with proceeds available to repurchase its own shares at approximately 0.5 times book value, a highly value-accretive move.
- Held European banks (Intesa Sanpaolo, Lloyds, BNP Paribas) trade at low price-to-book and low price-to-earnings ratios, with high dividend yields, 10%+ free cash flow yields, and excess capital.
Companies/Assets Involved
| Company | Role | Key Data | View |
|---|---|---|---|
| BNP Paribas | Core holding | Share price fell 25% at one point in March; sold Bank of the West for $16 billion (1.75x book value); own shares trade at ~0.5x book value | Bullish, believes buybacks are highly value-accretive |
| Intesa Sanpaolo | Core holding | Low P/B, low P/E, high dividend yield, 10%+ free cash flow yield | Bullish |
| Lloyds Banking Group | Core holding | Same as above | Bullish |
| Credit Suisse | Liquidated | Held for over 20 years; decided to exit in autumn 2022, completed liquidation in early March 2023 | Bearish, due to uncontrolled risk in investment banking, wealth management client outflows, and unquantifiable valuation |
Investment Implications
- For bank stock investors: Do not equate isolated bank crises (e.g., SVB) with systemic crises. The current global banking system has ample capital and high asset quality, especially European banks, which have low securities portfolio risk and stable deposit bases, potentially benefiting from widening interest rate spreads, economic resilience, and capital returns.
- For value investors: Market volatility (e.g., the March bank stock sell-off) widens the gap between stock prices and intrinsic value, creating opportunities to buy high-quality but unjustly punished stocks. Focus on bank stocks with low P/B, high dividend yields, and high free cash flow yields.
- For investors holding troubled banks (e.g., Credit Suisse): When a company's fundamentals undergo fundamental changes (e.g., lack of transparency in investment bank restructuring plans, core business client attrition), promptly reassess the investment thesis and decisively exit.