Published on January 27, 2021

If you were unable to join our quarterly webinar, watch the replay to hear updates on the Osterweis Fund and Osterweis Strategic Investment Fund.

Transcript

Shawn Eubanks: Good morning, everyone. This webinar is being recorded. My name is Shawn Eubanks, and I'm the Director of Business Development at Osterweis Capital Management. We would like to welcome you to our quarterly webinar for the Osterweis Fund and the Osterweis Strategic Investment Fund. During the webinar, John Osterweis will review the funds and our economic outlook. After that, Greg will review top and bottom contributors, as well as new and exited positions. And then Larry will go into more detail on a few of our holdings. We'll then have a Q and A session, so please feel free to submit your questions in the Q and A at any point during the webinar. I'll now turn over the webinar to John Osterweis.

John Osterweis: Well, good morning, everybody. Welcome. I think the economic outlook can be explained pretty simply. As we get increasing amounts of vaccination, people will feel more and more comfortable re-entering the economy and doing the things they always did, like going to restaurants or movies or whatever. You couple that with a massive monetary stimulus and an increasing amount of fiscal relief or stimulus, however you want to phrase it, and I think the background for having an expanding economy is pretty obvious. And what that means is that as we go through the year, more and more of the economy will open up, we will get back closer and closer to some kind of pre Covid normality. The risk in this, of course, is that as the economy starts to re-accelerate, there will be bottlenecks and demand maybe outstripping supply in certain areas. And so we could see a temporary blip in inflation. We do regard any blip in inflation as transitory, but that, of course, is a risk, that we're wrong and inflation really becomes much more virile than we think it will.

There are some very strong arguments as to why inflation is not likely to become systemic. We still have globalization. We still have the impact of technology, which is, you know we've said over and over again, is inherently deflationary. And there are demographics, aging populations in the developed world really does tend to retard inflation over time. So, assuming that we're right and inflation, if it does pick up, is at best transitory, that means that interest rates will stay low for longer. And you couple that with an acceleration in GDP and obviously corporate profits, that sets up a very good scenario for continued rise in equity prices and possibly even valuations. We've done a considerable amount of work on equity valuations, and I'll give you the simple conclusion, which is: In today's very low interest rate environment, equity valuations, we do not think, are particularly stretched and could actually be a bit low. We'll have a lot more to say about that over time. But our general conclusion is one should not freak out over the fact that price to earnings ratios or valuations are above where they have been historically.

So that's pretty much the economic and market outlook. Turning to the fund for a minute, during the quarter, the Osterweis Fund was up a bit over 13%, which outperformed the S&P, which was up around 12%. As you can see from the next slide, over time, our approach to investing has proven quite valuable and durable. So with that, I'll turn it over to Greg and Larry to get into specifics within the portfolio.

Greg Hermanski: Thank you, John. Good morning, everyone, and happy new year. You can see on this slide, the top and bottom contributors for the fourth quarter and the full year of 2020. During the quarter and the year, we had very strong results from our semiconductor stocks, which included Micron, Applied Materials, AMD, and Monolithic Power. As the economy has started to recover, there's been very strong demand for semiconductors. And as a result, as we entered 2021, there's more demand than supply for semiconductors, which positions these companies well for continued growth in revenue and earnings. While these companies are benefiting from a rebounding economy in the short run, all of these companies are also taking advantage of their strong competitive position to take market share from their competitors. Alphabet was also a very strong contributor for both the fourth quarter and the full year. Google's dominant search and digital advertising businesses continue to benefit from strong secular demand growth, as well as the rebound from the depths of the pandemic. Moreover, their Google Cloud and YouTube platforms have become meaningful growth drivers for the company.

During the fourth quarter, our financial positions, which include JP Morgan, did well due to the expectation of improving economic growth in 2021, as well as the steepening of the yield curve, which is helping to drive net interest income growth. Looking at our bottom contributors for the fourth quarter, it's worth noting that while these companies detracted from performance in the quarter, most of them had very strong performance for the full year of 2020.

Now, before I turn it over to Larry, I'd like to discuss briefly our exited positions. We sold three stocks in the quarter. The first was Concho Resources. We sold Concho after it agreed to be acquired by ConocoPhillips. Turning to Hologic, their strong sales of their PCR-based Covid test has driven the stock towards our target price. So during the quarter, we decided to exit the stock to reallocate capital to companies that will benefit more from an economic rebound that we expect in 2021. And for L3Harris, similarly, we decided to sell this defensively positioned company to add more economic exposure as you move towards the end of the year. We continue to like L3 and we would consider adding it back to the portfolio at another time in the future. So for now, I'll turn the call over to Larry to discuss the fund positioning and new stocks that we added during the quarter.

Larry Cordisco: Thanks, Greg. I'll start with the bigger picture view of the portfolio. And as always, we continue to focus on market leading and market disrupting companies that benefit from secular tailwinds. Within our holdings and companies that all fit that construct, on the margin we've increased our exposure to companies that will benefit from reopening, recovery and fiscal stimulus, as we expect these companies to be beneficiaries of an accelerating economy in 2021. During the quarter, we purchased two new positions. The first is Amazon. As you all know, Amazon is the dominant provider in two different businesses; e-commerce and cloud hosting. And even though these businesses have already become enormous, we expect both of them to continue to grow substantially over the next 10 years. For example, if you look at just the cloud hosting business, it's still only about 25% of the data center market. So you look at the underlying growth of data consumption and the ongoing mix shift towards cloud hosted solutions, and we think it's a possibility that Amazon could grow by 10 times over the next 10 years in the cloud business.

The other stock that we purchased was Aptiv. Aptiv is a leading auto supplier with a particular focus on content that goes into electric vehicles and advanced auto safety systems. The company is both a technology leader and benefits from a first mover advantage, which is particularly important in the auto industry where suppliers are designed into car production plans for very long periods of time. So as we look at the way the auto market is evolving, the number of electric vehicles and cars with advanced safety systems is expected to grow by four times over the next five to 10 years. And Aptiv has two to three times the content on these kinds of cars versus traditional combustible engine vehicles. So when you look at these trends together, they provide a very powerful secular tailwind to support Aptiv's growth. At this point, I'll turn it back to John for concluding statements.

John Osterweis: Thank you, Larry. Just a reminder, please submit any questions to the Q and A box or select the raise your hand icon so we can address them at the end of the seminar. Let me talk for a minute about Strategic Investment Fund, which is a dynamically balanced fund using our fixed income strategy and equity strategy in combination. Given the current level of interest rates, we think this fund also provides a very interesting way of generating income in a low interest rate environment. Before I do that, let me just review performance for a second. During the quarter, the fund outperformed its blended benchmark of 60% S&P, 40% Bloomberg Barclay's Aggregate Bond Index. We ended the quarter with 70% equity, 28% fixed income, 2% cash.

Before we switch over to Q and A, let me just talk for a second about the whole concept of generating income in a low interest rate environment. As you know, the S&P yields something like 1.55% versus the U.S. 10 year, which yields roughly 1%. What's interesting about the S&P is that over time you would expect the dividends to basically grow, whereas a fixed income interest rate does not grow. So if you then further break down the S&P into companies that pay dividends and companies that don't, something like 75 to 80% pay dividends, which means 20 to 25% so not pay dividends.

So the income or the yield of companies that are paying dividends is probably in the area of 1.8 to 2%. We're doing work on that. We'll have more to say. So when you look at a fund like a Strategic Investment Fund, not only do we think we can get equity-like total returns, but we can get a better income than we can buying something like the 10-Year Treasury. So it becomes a very interesting vehicle, both for the generation of income and long-term gains.

Shawn Eubanks: Okay. Well, we would like to thank everyone for joining us today. If you do come up with questions after the call, feel free to reach out to me or anyone on our team, and we'll be happy to get you any more information on either of the two funds. We appreciate your interest. John, any final comments, Larry?

John Osterweis: No, I think that wraps it up. But as Shawn said, if you do have questions, we're all available. So, contact us offline if you want.

Shawn Eubanks: Thank you.

John Osterweis: Okay. Thanks everybody.


Opinions expressed are subject to change, are not intended to be a forecast of future events, a guarantee of future results, nor investment advice.

The S&P 500 Index is an unmanaged index that is widely regarded as the standard for measuring large-cap U.S. stock market performance. The index does not incur expenses, is not available for investment, and includes the reinvestment of dividends.

The 60/40 blend is composed of 60% Standard & Poor’s 500 Index (S&P) and 40% Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) and assumes monthly rebalancing. The S&P is an unmanaged index that is widely regarded as the standard for measuring large-cap U.S. stock market performance. The BC Agg is an unmanaged index that is widely regarded as a standard for measuring U.S. investment grade bond market performance.

These indices do not incur expenses and are not available for investment. These indices include reinvestment of dividends and/or interest income.

Performance data quoted represent past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Osterweis Fund may be higher or lower than the performance quoted.

Click here to read the prospectus.

Holdings and sector allocations may change at any time due to ongoing portfolio management. References to specific investments should not be construed as a recommendation to buy or sell the securities by the Osterweis Fund or Osterweis Capital Management.

A basis point is a unit that is equal to 1/100th of 1%.

Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period.

Price-to-Earnings (P/E) ratio is the ratio of the stock price to the trailing 12 months diluted EPS.

A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates.

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock.

Treasuries (including bonds, notes, and bills) are securities sold by the federal government to consumers and investors to fund its operations. They are all backed by “the full faith and credit of the United States government“ and thus are considered free of default risk.

Duration measures the sensitivity of a fixed income security’s price (or the aggregate market value of a portfolio of fixed income securities) to changes in interest rates. Fixed income securities with longer durations generally have more volatile prices than those of comparable quality with shorter durations.

One cannot invest directly in an index.

Earnings growth is not a measure of future performance.

Mutual fund investing involves risk. Principal loss is possible.

The Osterweis Fund may invest in medium and smaller sized companies, which involve additional risks such as limited liquidity and greater volatility. The Fund may invest in foreign and emerging market securities, which involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. The Fund may invest in Master Limited Partnerships, which involve risk related to energy prices, demand and changes in tax code. The Fund may invest in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities.

The Osterweis Strategic Investment Fund may invest in small- and mid-capitalization companies, which tend to have limited liquidity and greater price volatility than large-capitalization companies. The Fund may invest in foreign and emerging market securities, which involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. The Fund may invest in Master Limited Partnerships, which involve risk related to energy prices, demand and changes in tax code. The Fund may invest in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. From time to time, the Fund may have concentrated positions in one or more sectors subjecting the Fund to sector emphasis risk. The Fund may also make investments in derivatives that may involve certain costs and risks such as those related to liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Leverage may cause an increase or decrease in the value of the portfolio securities to be magnified and the Fund to be more volatile than if leverage was not used. Investments in preferred securities typically have an inverse relationship with changes in the prevailing interest rate. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments.

Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OSTE-20210121-0125]