Published on July 26, 2021

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).

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'd like to welcome you to our quarterly webinar for the Osterweis Fund and the Osterweis Growth & Income Fund, formerly Strategic Investment Fund.

During the webinar, John Osterweis will review the funds and our economic outlook. After that, Greg will review the top and bottom contributors as well as new and exited positions. Then Larry Cordisco will go into more detail into a couple of our holdings. We'll then have a question and answer session..

Before I hand it off to John Osterweis, I'd like to let everyone know about a few changes we made to the funds effective June 30th, and then Larry and John can elaborate a little bit more on the call. First, we lowered the management fee for these two funds to a flat 0.75%. Secondly, we renamed the Strategic Investment Fund to the Osterweis Growth & Income Fund. We believe this better conveys the fund's focus on delivering both growth and income. Larry will elaborate on this later in the webinar. I'll now turn it over to John Osterweis.

John Osterweis: Good morning, everybody. As you all know, the second quarter of this year the stock market moved higher propelled by a strong post-pandemic economic recovery, coupled with robust monetary and fiscal stimulus. While inflation did increase, the question is whether or not the Fed views this as a supply/demand imbalance, which is temporary, or whether the pickup in inflation is more durable.

We believe that economic growth will remain strong for the remainder of the year. First off, consumers have a lot of money and are spending it. Secondly, businesses are hiring, both in order to reopen and to expand. Wages, in many industries, are rising, which we view as a plus for economic growth. As a result, high single digit GDP growth I think it's in the cards for the next several quarters. As I mentioned, the surge in demand exceeds supply, which is at least temporarily pushing inflation higher. We expect that once businesses normalize and the supply chains normalize, inflation will start to tail off again.

What's interesting about the quarter is the volatility between small and large caps and the volatility between growth and value. This suggests that there's a lack of real consensus about the next trajectory for the economy. Is the economy headed towards a return to low growth and low inflation, or are we going to be stuck with a higher inflation and a long duration cyclical recovery?

The other question of course is whether the economy can recover or withstand another surge in Covid, which we're certainly seeing. One school of thought posits that we will actually start experiencing persistent labor shortages and therefore a long-term upward pressure on wages, reversing trends of the last 20 and 30 years. As you know, globalization and technology have combined to keep labor costs down.

We see no letup in the impact of technology, but there is some shift in globalization, in that China's demographics suggest that they're running out of cheap labor, and this could have significant long-term implications on labor availability, labor supply, over the next several decades. It's impossible to say which of these negative trends from demographics or the positive trends from technology will prove stronger.

I point out that while most economists worry about inflation, there are a few economists concerned about deflation, and they point to the drop in Treasury yields, the drop in prices for Bitcoin and precious metals, and the obvious decline in the velocity of money, even though the Fed has been very, very accommodative.

Our own view is that inflation will certainly decelerate meaningfully in the back half of 2021 and obviously the first half of 2022. Longer term, we do see some upward pressure on wages that may not be fully offset by technology and automation. Our best guess is that the reality will fall somewhere in between; that is the economy will ultimately settle back into a slower growth lower inflation pace where wages will keep pace with inflation, which would be a positive long-term change, I think.

We also believe that the yin-yang in the market between the love for great secular growth stories on the one hand, and on the other hand, desire to play cyclical recovery stories will persist for a while as investors vacillate between the desire to play near term recovery trends versus a desire to lock in positions that have persistent reliable long-term growth stories.

We have tilted somewhat more towards the long-term secular growth stories, because we think that once the recovery peaks and we get back to a slower growth economy, these will again be stand-out in terms of their ability to outgrow the economy. We focused very much on sectors of the economy that have real tailwinds, to give you an idea, the shift away from carbon based fuels to alternative energy, the shift towards electric vehicles, the shift from brick and mortar retail to e-commerce and the long term digitization of the economy to name a few.

We think these areas will support growth well in excess of overall GDP and, to the extent that we can identify companies that are likely to emerge as leaders in these areas, we think they make great long-term sense in building portfolios. Shifting for second to the returns during the quarter, the Osterweis Fund was up a little over 7%, slightly lagging the S&P 500, which was up about eight and a half percent. This obviously reflects what happened in the cyclical recovery plays, which in many cases were quite strong during the quarter. Long term, we think our approach has delivered real value, and I'm going to turn it over to Greg and Larry to cover a lot of the specifics, so Greg.

Greg Hermanski: Thanks, John. Good morning, everyone. You can see on the slide, the top and bottom contributors for the second quarter and year-to-date. In the second quarter, our best performing stocks included some of our longest tenured holdings. These include Alphabet, Microsoft, Danaher, and Charter. These stocks continue to benefit from strong business execution, as well as strong market positions in secular growth markets. For example, Danaher has had very strong operating results, and these have been driven by their investments that they've made in life sciences, and they're benefiting from the secular growth of cell, gene and biotechnology.

In addition, during the quarter, the company announced the acquisition of Aldevron, which leverages further their core life science capabilities and adds depth to their cell and gene therapy portfolio. This should help accelerate the growth rate going forward. AMD continues to benefit not only from the secular growth markets they're in, including AI and cloud computing, but also from their innovative solutions, which have leapfrogged the competition and it's enabling them to take significant market share and drive strong earnings growth.

Then Google continues to benefit from the rebounding economy, as well as their extremely well-positioned digital ad business. This business is thriving from the digitization of the economy that John mentioned. Looking at our bottom contributors in the second quarter, the key takeaway that I have from this is that we have not seen a change in the long-term fundamentals of our companies. So as a result, our thesis hasn't changed on these companies and we expect them to performance to be transitory. I'll turn it over to Larry to discuss new and exited positions in the quarter.

Larry Cordisco: Thanks, Greg and good morning, everyone. I'll just briefly address some of the common elements of our buys and what we see as opportunities for the new positions as we look forward in the fund. All of our new positions have very strong, competitive advantages, secular tailwinds, and a long-duration outlook for growth. Specifically, we have three new positions in the quarter.

The first is Etsy. It's a leading sales platform for producers of craft and artesian goods. Etsy is established a dominant two-sided marketplace that connects large consumer markets with small producers. We think this market is large. It will grow significantly, especially as more small companies making unique products are attracted to selling through the Etsy platform, we think this will attract more consumers who go to Etsy looking for products that they can't find elsewhere.

The second name I'll highlight is Snap. It's one of the leading social media platforms globally. The platform has a following among Generation Z, which are people between about 15 and 30 years old. This is a group that likes to message through short video clips. We like Snap because we see no letup in its usage. It currently monetizes its users at a fraction of other leading social media platforms, but provides a lot of fuel for future revenue growth. There are a number of opportunities for Snap to increase engagement through venues like virtual reality and gaming.

Our third name that was new in the quarter is Xilinx. Xilinx is one of the two leading companies that make a type of semiconductor called an FPGA. This is a chip that can be custom programmed for very specific use cases. These chips are very common in communications applications and are growing very quickly in the data center. Xilinx is in the process of being acquired by AMD, another one of our holdings, and we think the combination of these two companies will be a real growth accelerant for a substantial period of time.

We did not exit any positions during the quarter. At this point I'd like to transition to a quick discussion of the Growth & Income Fund. We're very excited about the recent changes to the fund. First, as I think with Shawn highlighted, that the management fee has reduced the expense ratio by 20 basis points and is now at just 94 basis points as of June 30th. Second, as we mentioned, we renamed the fund to better communicate the fund's approach, which should deliver both growth and income over time.

Finally, given the fund's income component, we transitioned into a quarterly distribution schedule, which will begin in September. In this low yield environment, we believe the fund can fill a real need in the market. The emphasis is in income and growth opportunities and that's because it's more difficult to lose money when a company is growing and compounding dividends can drive very strong returns over time.

We think both these elements are very attractive, especially to pre-retirees and retirees who want both income and the ability to have an asset appreciating over time. The focus is on market leaders, and this is where unique business models are found and I'd also add very stable business models. From the fixed income perspective, we don't limit the fixed income to investment grade. In this low yield environment it's really important to strategically allocate fixed income exposure to areas where better yields can be found. Finally, we concentrate on our best ideas. Over diversified portfolios can limit the ability to perform over time. So we really do like to focus our best ideas. John, would you like to add anything and cover the fund's performance?

John Osterweis: I think Larry has done a good job of expressing how we view this fund. I would just say that the growing stream of income that this portfolio can produce should be very, very attractive over time and we're all quite excited about this approach. We ended the quarter with 71% equity, 28% fixed income, and 1% cash. With that I think we should open up for questions.

Shawn Eubanks: Thank you, John. Larry, while we're waiting can you talk a little bit about the differences in the equity holdings between the Osterweis Fund and the Osterweis Growth and Income Fund?

Larry Cordisco: Yeah, Shawn. I start with basically maybe a very quick overview of the investment process because it's very similar for both funds. In both cases, we start with the universe, the very high quality companies. We define high quality by metrics, such as leading market share, faster growth, higher margins. Then we look for a combination of attractive valuation and a change in the business that will accelerate earnings growth and will compound over a multi-year period.

So for companies that are more oriented toward income, they may pay a dividend or they would pay a dividend. Those stocks that come out of this process are more appropriate for the Growth & Income Fund. They tend to be more mature companies possibly than in the Osterweis Fund and certainly have a greater emphasis on dividends. A similar trait between these funds is a goal of capture opportunities where we can both get an acceleration in earnings and multiple expansion.

Again, we're looking for opportunities where maybe growth is underappreciated. Again, that's common to both funds. We view this as a recipe for very good returns where you can get both an acceleration in growth and multiple expansion. I'm going to just want to emphasize what we've talked about and John mentioned within the Growth & Income Fund, we put far more emphasis on a company's ability to grow dividends over time as opposed to the current yield.

We do this for the reasons we highlighted before. The first is that a company that's growing its earnings and dividends stream is more likely to have capital appreciation and we want the value of the fund to grow over time. The second, as we've mentioned again, is the investor's cost basis, compounding dividend growth over a number of years is as a really powerful income generator. So I'll stop there, Shawn. Thank you.

Shawn Eubanks: Thank you, Larry. So I'm not seeing any questions at this point, but we appreciate the update on both of the funds and let me know if you have any final comments.

John Osterweis: I think we covered it.

Shawn Eubanks: Thank you all and thanks for everyone for participating today.


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 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.

Click here to read the prospectus.

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.

Yield is the income return on an investment, such as the interest or dividends received from holding a particular security.

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.

Investment grade includes bonds with high and medium credit quality assigned by a rating agency.

Fed is short for Federal Reserve.

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

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-20210721-0296]