Published on April 27, 2022

If you were unable to join our quarterly webinar, watch the replay to hear updates on the Osterweis Fund and Osterweis Growth & Income Fund (formerly named Strategic Investment Fund).


Shawn Eubanks: Good morning, everyone. I'm Shawn Eubanks and we would like to welcome you to our quarterly webinar for the Osterweis Fund and the Osterweis Growth & Income Fund. This webinar is being recorded. During the webinar, John Osterweis and Larry Cordisco will review the funds and our economic outlook. And after that, Greg Hermanski will review the top and bottom contributors. Then Larry will cover new and exited positions. Then we'll have a Q & A session. So please feel free to submit your questions in the Q & A at any time during the webinar. John, if you don't mind, maybe we can start off with your thoughts on the market and outlook going forward.

John Osterweis: Okay. Thanks, Shawn. Good morning, everybody. As you all know, the first quarter was a very choppy period for the market. It was beset with supply chain disruption issues, the Russian invasion of Ukraine, both of which were inflationary and drove inflation up to a 40-year high. That triggered a movement on the Fed to start raising interest rates. And so this combination sent the market lower. And it was particularly tough on high growth, high multiple stocks which respond more vigorously to changes in interest rates. We think that the extreme movement in inflation was, to some extent, a blip caused by what we think are temporary issues. That is the supply chain disruption, which will ultimately be ameliorated and the Russian invasion of Ukraine, which obviously is not going to go on forever, but could go on for a while.

Looking a little bit longer term, we are quite concerned that globalization is in retreat and that the massive supply shock in the labor markets is reversing. And by that, I mean, when China came into the global trading system, they brought with them millions upon millions of very cheap labor. That is reversing. And on a longer term secular basis, we think there will be something of a labor shortage and higher labor costs. And that will lead to a secular increase in inflation. So near term, we expect this very high inflation rate to drop, but I don't think it's going to drop down below 2%, kind of 2% inflation we were used to for many years. Technology is still a deflationary force, but globalization is abating and I think one needs to take that into account.

So with that view, we think it's important to focus on high quality companies that enjoy strong secular tailwinds, clean balance sheets, significant competitive advantage, and accelerating earnings and cash flow. We also obviously think that it's important to focus on companies that either benefit from inflation directly or help to fight inflation. So these would be companies that provide labor saving equipment, companies that offer consumers less expensive options. So for instance off-price retailers. Companies that would benefit from reshoring because we think reshoring is going to be a major factor. And obviously companies that provide new, innovative productivity enhancing technology. So with that, let's turn to... Go ahead.

Shawn Eubanks: I was going to ask you... Could you cover the performance of the Osterweis Fund?

John Osterweis: Yeah. So performance in the first quarter was a bit worse than the market. We were down about 7.6% versus 4.6% for the S&P 500. That reflects the fact that we owned a fair number of high growth, high multiple stocks. These are companies that we think have exceptional long term prospects and stocks that we do want to own over the long term, but obviously they were hit short term. We reduced our exposure there somewhat, but obviously not enough in the quarter in particular. Despite the underperformance in the first quarter, if you look over a very long period of time, the fund has done extremely well with leads and lags to the S&P. And it depends obviously where we are in that process. But long term, the fund has done quite well. So with that, I'll turn it back to you, Shawn.

Shawn Eubanks: Thanks, John. Greg, can we maybe have you review the top and bottom contributors in the first quarter and the past 12 months?

Greg Hermanski: Thanks, Shawn. Good morning, everyone. As you can see on the slide, the top and bottom contributors for the first quarter and the last 12 months, maybe the best way to summarize the recent performance is to say that there's been significant volatility. Some of our best over the last 12 months would include Microsoft, Danaher, Old Dominion, AMD. Those were detractors to our performance in the first quarter. These are wonderful share-gaining secular growth companies. And while at one level this can be frustrating, we've looked at the volatility in market leaders as an opportunity to potentially upgrade the portfolio. One example, aerospace has been a sector that has had significant volatility this year. And we came into the year owning Safran.

It's been a detractor to the performance over the last 12 months, but we own it because it's been positioned to benefit from its installed base of aircraft engines as air travel recovers. Now, during the quarter, the market volatility gave us an opportunity to upgrade by replacing Safran with Spirit Aerosystems. Recent evidence is showing that not only is there a strong post-pandemic recovery in global travel, but there is also significant demand for new narrow body aircraft. Recent increases in oil prices is only increasing demand for fuel efficient planes and now the backlog for narrow body planes is four to seven years out. Spirit, as a tier one supplier to the narrow body OEMs, is one of the best positioned companies to benefit from the increase in new plane demand.

And as a result, it has an opportunity to generate significant increase in free cash flow over the next few years as the production of narrow body air crafts ramps up. In addition, the company has been able to use the downturn to increase its share in its defense business and its aftermarket businesses. Those are more consistent businesses and less cyclical, and we believe the transformation of Spirit may also lead to multiple expansion over time. So in short, we think Spirit has significant upside over the next few years, and we view it as an upgrade to the portfolio. Now I'll turn the call over to Larry to discuss other upgrades to our portfolio with the new and exited positions during the quarter.

Larry Cordisco: Thanks, Greg. Now we were very active during the quarter, both trimming names where we saw less upside or more risk than we wanted to take on. And then we were also able to pick up a number of new names where we saw attractive valuations, very stable business models and long term secular growth. Along those lines, we purchased Target, a leading retailer with a burgeoning eCommerce business that trades at a mid-teens earnings multiple. Adobe and Nvidia are both leading technology companies with long term sector tailwinds who have seen significant stock price corrections, even though they're long term prospects are still quite bright. Energy supply was tight before the Ukraine war and has become tighter since, as John mentioned. Halliburton is a leading oil services company and we expect industry pricing discipline to result in a really strong upcycle for those companies.

Through a recent acquisition, PNC Financial is in the process of transforming to a super-regional bank. And it also has a very strong exposure to commercial lending, which we are pretty optimistic about as we expect the economy to transition from a more consumer-driven spending profile to more capital spending. And as Greg touched on already, we purchased Spirit Aerosystems, a company we think has tremendous earnings leverage to a commercial aerospace upcycle. Our exited positions all exhibit some combination of fundamental deceleration, relatively high valuations or more attractive alternatives. I won't go into them specifically because I think you get a sense from what we bought, where we see the opportunities. And as John touched on in general, what we're looking for are companies that have very favorable long-term growth prospects.

We like to buy these companies when they're experiencing temporary headwinds or market displacement and valuation compression. It's difficult to get the inflections in the stock prices correctly, so we'll leg into these positions. The timing's always difficult, but I think over the long term, we're very well positioned with this portfolio. We're particularly focused these days on companies that possess the ability to offset higher labor costs with productivity gains. And these tend to be the market leading companies that have higher profits to reinvest in their businesses. They have scale advantages, they have pricing power. Basically they're well positioned to do well in this environment and they gain market share in downturns. And with that, I'll hand it back to you, Shawn.

Shawn Eubanks: Thanks, Larry. Maybe we can transition to the Growth & Income Fund. And John, can you talk a little bit about the performance of that fund, both short and long term?

John Osterweis: Absolutely. So Growth & Income Fund, as you know, is a fund designed to do exactly what the title says, which is to generate growing income over time and also growth in the principal value. The fund outperformed its benchmark for the quarter. Was about 70% equities, 71% equities, 29% fixed income. The fixed income portion was short duration, high yield for the most part, which did quite well relative to the Barclays Agg in the quarter. The kinds of stocks were we own in Growth & Income are very similar for the most part with what's owned in the Osterweis Fund, but with greater emphasis on companies that pay dividends and obviously companies that are growing their dividends. So with that, why don't we open it up to Q & A.

Shawn Eubanks: Okay. And while we're waiting for questions to come in, Larry, I know we had a question before the webinar and I know you've been looking at some technology plays that are not in the technology sector. Can you talk a little bit about your thinking there and give us an example of one of those holdings?

Larry Cordisco: Yeah, Shawn. Absolutely. We all know technology adoption is pervasive. Some companies are better at it than others. And what we're starting to see is really innovative technology in areas that you wouldn't expect. And a really great example of that is Lincoln Electric. Big picture, Lincoln is a global leader in welding and metal bending, and cutting. It has a terrific history of high margins, free cash flow, and return on invested capital. From a macro perspective after years of below-trend capital spending, we think this company is particularly well positioned for a rebound as economies invest in infrastructure, manufacturing, and reshoring. Specific to your question though, Shawn, Lincoln is also the leader in robotic welding. So if you've ever seen pictures of assembly lines for cars with all those large robotic welding arms that work on the cars as they pass through, that's Lincoln's work right there.

And that robotic welding technology is now being adopted by large machinery companies, general manufacturing for household appliances. And all these companies want to increase productivity. They want to invest in the U.S. They want to expand their capacity, but they want to do so in the face of a labor shortage. So if you think about robotic welding and Lincoln Solutions which allow them to do so in a way that works 24/7 and never gets sick, this is a big tailwind for Lincoln's robotic solutions. And this is just one example where technology is making old industry companies more efficient. There are a number in our portfolio and not all of them are the providers of the technology. Some are very cutting edge in adopting technologies. And I'll just call out UPS, which is adopting RFID solutions to automate their sorting facilities. We expect that to help margins over time. So that's just one other example. I'll stop there, Shawn. That was a very good question.

Shawn Eubanks: And that's very interesting, especially given the pent up demand for autos and new autos at this point. Thank you, Larry. I don't see any questions currently in the queue. So do any of you gentlemen have any final comments?

John Osterweis: No, nothing we haven't already said. So if you do have questions, let us know. We'll be here. Otherwise we'll see you all in three months.

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 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 view Fund performance.

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.

The Fund’s top 10 holdings may be viewed by clicking here.

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An original equipment manufacturer (OEM) traditionally is defined as a company whose goods are used as components in the products of another company, which then sells the finished item to users.

Cash flow measures the cash generating capability of a company by adding non-cash charges (e.g. depreciation) and interest expense to pretax income.

Free cash flow represents the cash that a company is able to generate after laying out the money required to maintain and expand the company’s asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value.

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

One cannot invest directly in an index.

Earnings growth is the annual rate of growth of earnings from investments.

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 Growth & Income 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-20220421-0498]