John Osterweis is president, chief investment officer, director, and portfolio manager at Osterweis Capital Management. As manager of Osterweis Fund , he answered our questions on where his highest-conviction ideas were clustering within the Morningstar style box. He also discussed where he stands on the "quality is cheap" mantra and provided an example of a high-quality firm that is being unduly ignored.
About the Author Liana Madura is an assistant site editor with Morningstar.com Contact Author | Meet other investing specialistsFurthermore, he addressed how he achieves a profitable balance between stable mega-caps and more speculative plays, as well as some ways that management will cushion against risk while generating profit in an insipid recovery. Finally, he commented on the portfolio's inclusion of ultrashort corporate and convertible bonds as cash equivalents.
1. The majority of the portfolio is held in mid-cap stocks, but the fund also has a stake in almost every area of the Morningstar style box. Are you finding that your highest-conviction ideas are clustering in any size/style of company?The fund's portfolio is definitely hard to fit into one or two boxes. We invest across the market-cap and value/growth spectrums. Right now one of our highest-conviction, long-term holdings is Valeant Pharmaceuticals displayPTip('VRX', 'VRX','YTD', '', '', '', '', '', '','msg','P');. We originally bought the company as a value stock in 2007. Since then it has evolved into a company capable of continually delivering impressive growth. Holding companies through the transition from value to growth is typical for us. We are happy to buy companies, such as Valeant, in their value stage and then hold them through the growth phase until we feel the fundamentals change or valuations are too rich.
Looking at the portfolio from capitalization and sector perspectives, lately, we have uncovered a number of very compelling investments in large-cap tech companies and a few opportunities in the financial sector where we were significantly underweight during the financial crisis. Opportunities in these sectors have been identified through the bottom-up fundamental research of our investment team. We also continue to find interesting ideas in the mid-cap sector, where underappreciated fundamental changes in a company can have a significant impact on earnings and cash flow.
2. Do you buy the "quality is cheap" mantra that we're hearing from so many fund managers? Why or why not? And if you do, what is the best example of a high-quality name that is being unduly ignored right now? What's the rest of Wall Street missing?Yes, we definitely believe that many high-quality, larger-cap companies with strong balance sheets and cash flow have been somewhat ignored during the early stages of this recovery. It seems many investors have been focused on beaten-down, highly cyclical companies that may have just escaped near-death experiences in 2008 and 2009. Johnson & Johnson displayPTip('JNJ', 'JNJ','YTD', '', '', '', '', '', '','msg','P'); is an excellent example of a high-quality name with what we feel is a very attractive valuation. It is trading at an approximately 12 times P/E which is low compared with historical standards. Johnson & Johnson has an excellent track record of allocating capital to high-growth/high-return businesses over time and has significant free cash flow. The company is also shareholder-friendly, paying healthy dividends and using share-buyback programs.
Wall Street could be missing a number of things in terms of Johnson & Johnson. For one, the Street may be too focused on short-term operational issues. Also, the Street's current lack of interest in large blue-chip companies could be related to the potential for short-term quick returns in smaller companies. Typical of any cycle, lower-quality issues decline more and can rise faster in an economic recovery. Higher-quality companies generally fall less in the downturn and bounce back less in the recovery. Over the long term, we prefer to hold higher-quality names with good long-term growth prospects. We believe Johnson & Johnson currently offers great risk-adjusted return potential during the coming years.
Another way to look at the value of Johnson & Johnson is in terms of holding the stock versus a Treasury. Investors currently have a choice of owning a 10-year Treasury bond yielding 3.3% or shares in AAA rated Johnson & Johnson offering a dividend yield of 3.4% and a history of long-term growth. From this perspective we also think Johnson & Johnson offers a very compelling value for investors.
3. As a value-oriented but loss-averse fund, how do you determine what is a healthy balance between owning undervalued, out-of-favor stocks and the more stable larger-cap stalwarts and cash?As we manage the portfolio, we look at cash as a way to help mitigate future loss potential. Our stock ideas often tell us how best to put capital to work. When we have lots of good ideas fighting for a position in the portfolio it makes sense to de-emphasize cash and to have a low allocation to it. On the other hand, if we are having trouble finding new ideas, it is likely an indication that the market is overvalued and that a higher cash allocation would be prudent.
We don't want to buy blue-chip names just as a place to hide. We like to buy them when they are underpriced and out of favor. Good, well-known large-cap companies often fall out of favor because of near-term problems that are perceived to be worse than they actually are. Johnson & Johnson, discussed above, would be a good example.
Today, the equity markets appear to have a tailwind as a result of the liquidity injected into the system and the slow but sustained economic recovery. This environment is presenting us with some interesting new potential investments with attractive two- to three-year return potential. These undervalued companies include both well-known, large-cap names, as well as some mid-caps. Our stream of investment ideas indicates that higher allocations to equities make sense at this point in the cycle.
4. In the fund's most recent shareholder letter, management foresees sluggish economic growth. Yet, the team also expresses confidence that the stocks in the portfolio should be able to deliver attractive returns even in an insipid economic environment. What are some practical, concrete ways that management will strive to not only cushion against risk, but continue to generate strong performance through an anemic economic recovery?First, it is important to note that while we believe growth will be subpar in this recovery compared with the norm, it is nonetheless positive. This modest growth coupled with the liquidity that the Federal Reserve has injected into the system suggests a positive environment for corporations and their stocks.
Second, in terms of balancing risk and return within the portfolio, we are always looking for companies that have the ability to increase earnings regardless of the market environment. As new positions are evaluated, we focus our efforts on trying to understand and assess the catalysts for earnings improvements. Many times these catalysts are not directly related to the economy and would include such things as management changes, reorganization to improve efficiency, a new product cycle, and so on. We hope that by identifying companies in stages of meaningful transition, our investors can benefit from lower downside risk as well as the potential for upside return.
5. The fund will sometimes invest in corporate bonds with maturities of less than a year as cash equivalents. What is the reasoning behind the inclusion of these in the portfolio?We believe that it is critical to take a disciplined, yet flexible approach to managing our clients' assets. In the Osterweis Fund, we have the ability to lower our equity exposure when we believe there is excess risk in the market. Said another way, if we see a freight train coming down the tracks, we want to be able to get off the tracks.
While the fund is primarily an equity fund, we believe in using cash and bonds in an attempt to protect capital in adverse market environments. Many times short-term bonds are used to provide potentially higher returns than those available through a traditional cash equivalent such as a money market fund. At other times, high-yield and convertible bonds may be used opportunistically in the portfolio when major market dislocations present buying opportunities.
Late 2008 is an excellent example of using fixed income both opportunistically and as a substitute for cash. During that time, there was uncertainty about the equity markets and the economy in general, and clearly the trajectory for the equity markets was not up. With that in mind, we stress tested all of our equity holdings and increased our cash exposure to more comfortable levels. At the same time, the credit markets were presenting some very attractive yields on short-term bonds from strong companies with the cash on the balance sheet to pay off that debt. It was an easy decision to invest in the fixed-income securities with a relatively secure payout rather than invest solely in low-yielding money market funds.
At times during 2001-02, we also held significant portions of the fund in cash and bonds when we found significant value in convertible bonds. In that time frame, some convertibles issued by companies with considerable cash on the balance sheet were trading with attractive yields. It was a slam dunk. The convertible bonds offered income streams and had some upside potential if the underlying stocks took off.
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 securities which involve political, economic & currency risks, greater volatility, and differences in accounting methods. The Fund may invest in Master Limited Partnerships which involve risk related to energy prices and demand. The Fund may invest in debt securities that are un-rated or rated below investment grade. Such 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 Fund is available by prospectus only. The Fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The summary and statutory prospectuses contain this and other important information about the Fund. You may obtain a prospectus by calling toll free at (866) 236-0050, or visiting www.osterweis.com. Please read the prospectus carefully before investing to ensure the Fund is appropriate for your goals and risk tolerance.
As of 12/31/2010, The Osterweis Fund held 3.53% and 2.59% in Valeant Pharmaceuticals International and Johnson & Johnson, respectively. Fund holdings and sector allocations are subject to change and are not recommendations to buy or sell any security.
Price/Earnings Ratio (P/E): The price of a single share of a security, divided by the amount of earnings per share.
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.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice
The Osterweis Fund is distributed by Quasar Distributors, LLC. [1/11]
See More Manager Q&As
Return to DiscussBe Seen. Be Heard. Become a Morningstar Contributor.Reach a readership of advisors, professionals, and active investors. Submit your commentaries for publication on Morningstar.com.
Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Liana Madura does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports Jacobson's Bond Fund Picks for... More Videos... Most Popular Related News Also in Fund Manager Q&A TCW's Sri-Kumar: Beware of Economic AccidentsInvesco Van Kampen's Thick-Skinned Investing StrategyWhere Are the Best Opportunities in Mid-Caps?Managing Risk Through Volatility Sponsored Links Buy a Link Now Sponsor Center Please Wait... MUTUALFUNDS USA_OSTFX,USA_JNJ,USA_VRX FO_USA_OSTFX E0_USA_JNJ E0_USA_VRX &primaryKeyword=MUTUALFUNDS 2 {CommentWebService} OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} var _gaq = _gaq || []; _gaq.push(['_setAccount', 'UA-16669347-1']); _gaq.push(['_setDomainName', '.morningstar.com']); _gaq.push(['_trackPageview']); (function() { var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true; ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js'; var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s); })(); var Name = $('meta[name=DC.Creator]').attr("content").split(','); var Title = $('meta[name=DC.Title]').attr("content"); var URL = window.location.href; var Author = Name[1] + " " + Name[0]; var PubDate = $('meta[name=DC.Date]').attr("content"); _gaq.push(['_trackEvent', 'Article Title From Morningstar', Title, URL]); _gaq.push(['_trackEvent', 'Author Name From Morningstar', Author, URL]); _gaq.push(['_trackEvent', 'Article URL From Morningstar', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date From Morningstar', PubDate, URL]); _gaq.push(['_trackEvent', 'Article Title', Title, URL]); _gaq.push(['_trackEvent', 'Author Name', Author, URL]); _gaq.push(['_trackEvent', 'Article URL', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date', PubDate, URL]);Furthermore, he addressed how he achieves a profitable balance between stable mega-caps and more speculative plays, as well as some ways that management will cushion against risk while generating profit in an insipid recovery. Finally, he commented on the portfolio's inclusion of ultrashort corporate and convertible bonds as cash equivalents.
1. The majority of the portfolio is held in mid-cap stocks, but the fund also has a stake in almost every area of the Morningstar style box. Are you finding that your highest-conviction ideas are clustering in any size/style of company?The fund's portfolio is definitely hard to fit into one or two boxes. We invest across the market-cap and value/growth spectrums. Right now one of our highest-conviction, long-term holdings is Valeant Pharmaceuticals . We originally bought the company as a value stock in 2007. Since then it has evolved into a company capable of continually delivering impressive growth. Holding companies through the transition from value to growth is typical for us. We are happy to buy companies, such as Valeant, in their value stage and then hold them through the growth phase until we feel the fundamentals change or valuations are too rich.
Looking at the portfolio from capitalization and sector perspectives, lately, we have uncovered a number of very compelling investments in large-cap tech companies and a few opportunities in the financial sector where we were significantly underweight during the financial crisis. Opportunities in these sectors have been identified through the bottom-up fundamental research of our investment team. We also continue to find interesting ideas in the mid-cap sector, where underappreciated fundamental changes in a company can have a significant impact on earnings and cash flow.
2. Do you buy the "quality is cheap" mantra that we're hearing from so many fund managers? Why or why not? And if you do, what is the best example of a high-quality name that is being unduly ignored right now? What's the rest of Wall Street missing?Yes, we definitely believe that many high-quality, larger-cap companies with strong balance sheets and cash flow have been somewhat ignored during the early stages of this recovery. It seems many investors have been focused on beaten-down, highly cyclical companies that may have just escaped near-death experiences in 2008 and 2009. Johnson & Johnson displayPTip('JNJ', 'JNJ','YTD', '', '', '', '', '', '','msg','P'); is an excellent example of a high-quality name with what we feel is a very attractive valuation. It is trading at an approximately 12 times P/E which is low compared with historical standards. Johnson & Johnson has an excellent track record of allocating capital to high-growth/high-return businesses over time and has significant free cash flow. The company is also shareholder-friendly, paying healthy dividends and using share-buyback programs.
Wall Street could be missing a number of things in terms of Johnson & Johnson. For one, the Street may be too focused on short-term operational issues. Also, the Street's current lack of interest in large blue-chip companies could be related to the potential for short-term quick returns in smaller companies. Typical of any cycle, lower-quality issues decline more and can rise faster in an economic recovery. Higher-quality companies generally fall less in the downturn and bounce back less in the recovery. Over the long term, we prefer to hold higher-quality names with good long-term growth prospects. We believe Johnson & Johnson currently offers great risk-adjusted return potential during the coming years.
Another way to look at the value of Johnson & Johnson is in terms of holding the stock versus a Treasury. Investors currently have a choice of owning a 10-year Treasury bond yielding 3.3% or shares in AAA rated Johnson & Johnson offering a dividend yield of 3.4% and a history of long-term growth. From this perspective we also think Johnson & Johnson offers a very compelling value for investors.
3. As a value-oriented but loss-averse fund, how do you determine what is a healthy balance between owning undervalued, out-of-favor stocks and the more stable larger-cap stalwarts and cash?As we manage the portfolio, we look at cash as a way to help mitigate future loss potential. Our stock ideas often tell us how best to put capital to work. When we have lots of good ideas fighting for a position in the portfolio it makes sense to de-emphasize cash and to have a low allocation to it. On the other hand, if we are having trouble finding new ideas, it is likely an indication that the market is overvalued and that a higher cash allocation would be prudent.
We don't want to buy blue-chip names just as a place to hide. We like to buy them when they are underpriced and out of favor. Good, well-known large-cap companies often fall out of favor because of near-term problems that are perceived to be worse than they actually are. Johnson & Johnson, discussed above, would be a good example.
Today, the equity markets appear to have a tailwind as a result of the liquidity injected into the system and the slow but sustained economic recovery. This environment is presenting us with some interesting new potential investments with attractive two- to three-year return potential. These undervalued companies include both well-known, large-cap names, as well as some mid-caps. Our stream of investment ideas indicates that higher allocations to equities make sense at this point in the cycle.
4. In the fund's most recent shareholder letter, management foresees sluggish economic growth. Yet, the team also expresses confidence that the stocks in the portfolio should be able to deliver attractive returns even in an insipid economic environment. What are some practical, concrete ways that management will strive to not only cushion against risk, but continue to generate strong performance through an anemic economic recovery?First, it is important to note that while we believe growth will be subpar in this recovery compared with the norm, it is nonetheless positive. This modest growth coupled with the liquidity that the Federal Reserve has injected into the system suggests a positive environment for corporations and their stocks.
Second, in terms of balancing risk and return within the portfolio, we are always looking for companies that have the ability to increase earnings regardless of the market environment. As new positions are evaluated, we focus our efforts on trying to understand and assess the catalysts for earnings improvements. Many times these catalysts are not directly related to the economy and would include such things as management changes, reorganization to improve efficiency, a new product cycle, and so on. We hope that by identifying companies in stages of meaningful transition, our investors can benefit from lower downside risk as well as the potential for upside return.
5. The fund will sometimes invest in corporate bonds with maturities of less than a year as cash equivalents. What is the reasoning behind the inclusion of these in the portfolio?We believe that it is critical to take a disciplined, yet flexible approach to managing our clients' assets. In the Osterweis Fund, we have the ability to lower our equity exposure when we believe there is excess risk in the market. Said another way, if we see a freight train coming down the tracks, we want to be able to get off the tracks.
While the fund is primarily an equity fund, we believe in using cash and bonds in an attempt to protect capital in adverse market environments. Many times short-term bonds are used to provide potentially higher returns than those available through a traditional cash equivalent such as a money market fund. At other times, high-yield and convertible bonds may be used opportunistically in the portfolio when major market dislocations present buying opportunities.
Late 2008 is an excellent example of using fixed income both opportunistically and as a substitute for cash. During that time, there was uncertainty about the equity markets and the economy in general, and clearly the trajectory for the equity markets was not up. With that in mind, we stress tested all of our equity holdings and increased our cash exposure to more comfortable levels. At the same time, the credit markets were presenting some very attractive yields on short-term bonds from strong companies with the cash on the balance sheet to pay off that debt. It was an easy decision to invest in the fixed-income securities with a relatively secure payout rather than invest solely in low-yielding money market funds.
At times during 2001-02, we also held significant portions of the fund in cash and bonds when we found significant value in convertible bonds. In that time frame, some convertibles issued by companies with considerable cash on the balance sheet were trading with attractive yields. It was a slam dunk. The convertible bonds offered income streams and had some upside potential if the underlying stocks took off.
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 securities which involve political, economic & currency risks, greater volatility, and differences in accounting methods. The Fund may invest in Master Limited Partnerships which involve risk related to energy prices and demand. The Fund may invest in debt securities that are un-rated or rated below investment grade. Such 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 Fund is available by prospectus only. The Fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The summary and statutory prospectuses contain this and other important information about the Fund. You may obtain a prospectus by calling toll free at (866) 236-0050, or visiting www.osterweis.com. Please read the prospectus carefully before investing to ensure the Fund is appropriate for your goals and risk tolerance.
As of 12/31/2010, The Osterweis Fund held 3.53% and 2.59% in Valeant Pharmaceuticals International and Johnson & Johnson, respectively. Fund holdings and sector allocations are subject to change and are not recommendations to buy or sell any security.
Price/Earnings Ratio (P/E): The price of a single share of a security, divided by the amount of earnings per share.
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.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice
The Osterweis Fund is distributed by Quasar Distributors, LLC. [1/11]
See More Manager Q&As
Return to DiscussBe Seen. Be Heard. Become a Morningstar Contributor.Reach a readership of advisors, professionals, and active investors. Submit your commentaries for publication on Morningstar.com.
Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Liana Madura does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports Jacobson's Bond Fund Picks for... More Videos... Most Popular Related News Also in Fund Manager Q&A TCW's Sri-Kumar: Beware of Economic AccidentsInvesco Van Kampen's Thick-Skinned Investing StrategyWhere Are the Best Opportunities in Mid-Caps?Managing Risk Through Volatility Sponsored Links Buy a Link Now Sponsor Center Please Wait... MUTUALFUNDS USA_OSTFX,USA_JNJ,USA_VRX FO_USA_OSTFX E0_USA_JNJ E0_USA_VRX &primaryKeyword=MUTUALFUNDS 2 {CommentWebService} OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} var _gaq = _gaq || []; _gaq.push(['_setAccount', 'UA-16669347-1']); _gaq.push(['_setDomainName', '.morningstar.com']); _gaq.push(['_trackPageview']); (function() { var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true; ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js'; var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s); })(); var Name = $('meta[name=DC.Creator]').attr("content").split(','); var Title = $('meta[name=DC.Title]').attr("content"); var URL = window.location.href; var Author = Name[1] + " " + Name[0]; var PubDate = $('meta[name=DC.Date]').attr("content"); _gaq.push(['_trackEvent', 'Article Title From Morningstar', Title, URL]); _gaq.push(['_trackEvent', 'Author Name From Morningstar', Author, URL]); _gaq.push(['_trackEvent', 'Article URL From Morningstar', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date From Morningstar', PubDate, URL]); _gaq.push(['_trackEvent', 'Article Title', Title, URL]); _gaq.push(['_trackEvent', 'Author Name', Author, URL]); _gaq.push(['_trackEvent', 'Article URL', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date', PubDate, URL]);Looking at the portfolio from capitalization and sector perspectives, lately, we have uncovered a number of very compelling investments in large-cap tech companies and a few opportunities in the financial sector where we were significantly underweight during the financial crisis. Opportunities in these sectors have been identified through the bottom-up fundamental research of our investment team. We also continue to find interesting ideas in the mid-cap sector, where underappreciated fundamental changes in a company can have a significant impact on earnings and cash flow.
2. Do you buy the "quality is cheap" mantra that we're hearing from so many fund managers? Why or why not? And if you do, what is the best example of a high-quality name that is being unduly ignored right now? What's the rest of Wall Street missing?Yes, we definitely believe that many high-quality, larger-cap companies with strong balance sheets and cash flow have been somewhat ignored during the early stages of this recovery. It seems many investors have been focused on beaten-down, highly cyclical companies that may have just escaped near-death experiences in 2008 and 2009. Johnson & Johnson is an excellent example of a high-quality name with what we feel is a very attractive valuation. It is trading at an approximately 12 times P/E which is low compared with historical standards. Johnson & Johnson has an excellent track record of allocating capital to high-growth/high-return businesses over time and has significant free cash flow. The company is also shareholder-friendly, paying healthy dividends and using share-buyback programs.
Wall Street could be missing a number of things in terms of Johnson & Johnson. For one, the Street may be too focused on short-term operational issues. Also, the Street's current lack of interest in large blue-chip companies could be related to the potential for short-term quick returns in smaller companies. Typical of any cycle, lower-quality issues decline more and can rise faster in an economic recovery. Higher-quality companies generally fall less in the downturn and bounce back less in the recovery. Over the long term, we prefer to hold higher-quality names with good long-term growth prospects. We believe Johnson & Johnson currently offers great risk-adjusted return potential during the coming years.
Another way to look at the value of Johnson & Johnson is in terms of holding the stock versus a Treasury. Investors currently have a choice of owning a 10-year Treasury bond yielding 3.3% or shares in AAA rated Johnson & Johnson offering a dividend yield of 3.4% and a history of long-term growth. From this perspective we also think Johnson & Johnson offers a very compelling value for investors.
3. As a value-oriented but loss-averse fund, how do you determine what is a healthy balance between owning undervalued, out-of-favor stocks and the more stable larger-cap stalwarts and cash?As we manage the portfolio, we look at cash as a way to help mitigate future loss potential. Our stock ideas often tell us how best to put capital to work. When we have lots of good ideas fighting for a position in the portfolio it makes sense to de-emphasize cash and to have a low allocation to it. On the other hand, if we are having trouble finding new ideas, it is likely an indication that the market is overvalued and that a higher cash allocation would be prudent.
We don't want to buy blue-chip names just as a place to hide. We like to buy them when they are underpriced and out of favor. Good, well-known large-cap companies often fall out of favor because of near-term problems that are perceived to be worse than they actually are. Johnson & Johnson, discussed above, would be a good example.
Today, the equity markets appear to have a tailwind as a result of the liquidity injected into the system and the slow but sustained economic recovery. This environment is presenting us with some interesting new potential investments with attractive two- to three-year return potential. These undervalued companies include both well-known, large-cap names, as well as some mid-caps. Our stream of investment ideas indicates that higher allocations to equities make sense at this point in the cycle.
4. In the fund's most recent shareholder letter, management foresees sluggish economic growth. Yet, the team also expresses confidence that the stocks in the portfolio should be able to deliver attractive returns even in an insipid economic environment. What are some practical, concrete ways that management will strive to not only cushion against risk, but continue to generate strong performance through an anemic economic recovery?First, it is important to note that while we believe growth will be subpar in this recovery compared with the norm, it is nonetheless positive. This modest growth coupled with the liquidity that the Federal Reserve has injected into the system suggests a positive environment for corporations and their stocks.
Second, in terms of balancing risk and return within the portfolio, we are always looking for companies that have the ability to increase earnings regardless of the market environment. As new positions are evaluated, we focus our efforts on trying to understand and assess the catalysts for earnings improvements. Many times these catalysts are not directly related to the economy and would include such things as management changes, reorganization to improve efficiency, a new product cycle, and so on. We hope that by identifying companies in stages of meaningful transition, our investors can benefit from lower downside risk as well as the potential for upside return.
5. The fund will sometimes invest in corporate bonds with maturities of less than a year as cash equivalents. What is the reasoning behind the inclusion of these in the portfolio?We believe that it is critical to take a disciplined, yet flexible approach to managing our clients' assets. In the Osterweis Fund, we have the ability to lower our equity exposure when we believe there is excess risk in the market. Said another way, if we see a freight train coming down the tracks, we want to be able to get off the tracks.
While the fund is primarily an equity fund, we believe in using cash and bonds in an attempt to protect capital in adverse market environments. Many times short-term bonds are used to provide potentially higher returns than those available through a traditional cash equivalent such as a money market fund. At other times, high-yield and convertible bonds may be used opportunistically in the portfolio when major market dislocations present buying opportunities.
Late 2008 is an excellent example of using fixed income both opportunistically and as a substitute for cash. During that time, there was uncertainty about the equity markets and the economy in general, and clearly the trajectory for the equity markets was not up. With that in mind, we stress tested all of our equity holdings and increased our cash exposure to more comfortable levels. At the same time, the credit markets were presenting some very attractive yields on short-term bonds from strong companies with the cash on the balance sheet to pay off that debt. It was an easy decision to invest in the fixed-income securities with a relatively secure payout rather than invest solely in low-yielding money market funds.
At times during 2001-02, we also held significant portions of the fund in cash and bonds when we found significant value in convertible bonds. In that time frame, some convertibles issued by companies with considerable cash on the balance sheet were trading with attractive yields. It was a slam dunk. The convertible bonds offered income streams and had some upside potential if the underlying stocks took off.
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 securities which involve political, economic & currency risks, greater volatility, and differences in accounting methods. The Fund may invest in Master Limited Partnerships which involve risk related to energy prices and demand. The Fund may invest in debt securities that are un-rated or rated below investment grade. Such 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 Fund is available by prospectus only. The Fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The summary and statutory prospectuses contain this and other important information about the Fund. You may obtain a prospectus by calling toll free at (866) 236-0050, or visiting www.osterweis.com. Please read the prospectus carefully before investing to ensure the Fund is appropriate for your goals and risk tolerance.
As of 12/31/2010, The Osterweis Fund held 3.53% and 2.59% in Valeant Pharmaceuticals International and Johnson & Johnson, respectively. Fund holdings and sector allocations are subject to change and are not recommendations to buy or sell any security.
Price/Earnings Ratio (P/E): The price of a single share of a security, divided by the amount of earnings per share.
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.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice
The Osterweis Fund is distributed by Quasar Distributors, LLC. [1/11]
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Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Liana Madura does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports Jacobson's Bond Fund Picks for... More Videos... Most Popular Related News Also in Fund Manager Q&A TCW's Sri-Kumar: Beware of Economic AccidentsInvesco Van Kampen's Thick-Skinned Investing StrategyWhere Are the Best Opportunities in Mid-Caps?Managing Risk Through Volatility Sponsored Links Buy a Link Now Sponsor Center Please Wait... MUTUALFUNDS USA_OSTFX,USA_JNJ,USA_VRX FO_USA_OSTFX E0_USA_JNJ E0_USA_VRX &primaryKeyword=MUTUALFUNDS 2 {CommentWebService} OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} var _gaq = _gaq || []; _gaq.push(['_setAccount', 'UA-16669347-1']); _gaq.push(['_setDomainName', '.morningstar.com']); _gaq.push(['_trackPageview']); (function() { var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true; ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js'; var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s); })(); var Name = $('meta[name=DC.Creator]').attr("content").split(','); var Title = $('meta[name=DC.Title]').attr("content"); var URL = window.location.href; var Author = Name[1] + " " + Name[0]; var PubDate = $('meta[name=DC.Date]').attr("content"); _gaq.push(['_trackEvent', 'Article Title From Morningstar', Title, URL]); _gaq.push(['_trackEvent', 'Author Name From Morningstar', Author, URL]); _gaq.push(['_trackEvent', 'Article URL From Morningstar', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date From Morningstar', PubDate, URL]); _gaq.push(['_trackEvent', 'Article Title', Title, URL]); _gaq.push(['_trackEvent', 'Author Name', Author, URL]); _gaq.push(['_trackEvent', 'Article URL', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date', PubDate, URL]);Wall Street could be missing a number of things in terms of Johnson & Johnson. For one, the Street may be too focused on short-term operational issues. Also, the Street's current lack of interest in large blue-chip companies could be related to the potential for short-term quick returns in smaller companies. Typical of any cycle, lower-quality issues decline more and can rise faster in an economic recovery. Higher-quality companies generally fall less in the downturn and bounce back less in the recovery. Over the long term, we prefer to hold higher-quality names with good long-term growth prospects. We believe Johnson & Johnson currently offers great risk-adjusted return potential during the coming years.
Another way to look at the value of Johnson & Johnson is in terms of holding the stock versus a Treasury. Investors currently have a choice of owning a 10-year Treasury bond yielding 3.3% or shares in AAA rated Johnson & Johnson offering a dividend yield of 3.4% and a history of long-term growth. From this perspective we also think Johnson & Johnson offers a very compelling value for investors.
3. As a value-oriented but loss-averse fund, how do you determine what is a healthy balance between owning undervalued, out-of-favor stocks and the more stable larger-cap stalwarts and cash?As we manage the portfolio, we look at cash as a way to help mitigate future loss potential. Our stock ideas often tell us how best to put capital to work. When we have lots of good ideas fighting for a position in the portfolio it makes sense to de-emphasize cash and to have a low allocation to it. On the other hand, if we are having trouble finding new ideas, it is likely an indication that the market is overvalued and that a higher cash allocation would be prudent.
We don't want to buy blue-chip names just as a place to hide. We like to buy them when they are underpriced and out of favor. Good, well-known large-cap companies often fall out of favor because of near-term problems that are perceived to be worse than they actually are. Johnson & Johnson, discussed above, would be a good example.
Today, the equity markets appear to have a tailwind as a result of the liquidity injected into the system and the slow but sustained economic recovery. This environment is presenting us with some interesting new potential investments with attractive two- to three-year return potential. These undervalued companies include both well-known, large-cap names, as well as some mid-caps. Our stream of investment ideas indicates that higher allocations to equities make sense at this point in the cycle.
4. In the fund's most recent shareholder letter, management foresees sluggish economic growth. Yet, the team also expresses confidence that the stocks in the portfolio should be able to deliver attractive returns even in an insipid economic environment. What are some practical, concrete ways that management will strive to not only cushion against risk, but continue to generate strong performance through an anemic economic recovery?First, it is important to note that while we believe growth will be subpar in this recovery compared with the norm, it is nonetheless positive. This modest growth coupled with the liquidity that the Federal Reserve has injected into the system suggests a positive environment for corporations and their stocks.
Second, in terms of balancing risk and return within the portfolio, we are always looking for companies that have the ability to increase earnings regardless of the market environment. As new positions are evaluated, we focus our efforts on trying to understand and assess the catalysts for earnings improvements. Many times these catalysts are not directly related to the economy and would include such things as management changes, reorganization to improve efficiency, a new product cycle, and so on. We hope that by identifying companies in stages of meaningful transition, our investors can benefit from lower downside risk as well as the potential for upside return.
5. The fund will sometimes invest in corporate bonds with maturities of less than a year as cash equivalents. What is the reasoning behind the inclusion of these in the portfolio?We believe that it is critical to take a disciplined, yet flexible approach to managing our clients' assets. In the Osterweis Fund, we have the ability to lower our equity exposure when we believe there is excess risk in the market. Said another way, if we see a freight train coming down the tracks, we want to be able to get off the tracks.
While the fund is primarily an equity fund, we believe in using cash and bonds in an attempt to protect capital in adverse market environments. Many times short-term bonds are used to provide potentially higher returns than those available through a traditional cash equivalent such as a money market fund. At other times, high-yield and convertible bonds may be used opportunistically in the portfolio when major market dislocations present buying opportunities.
Late 2008 is an excellent example of using fixed income both opportunistically and as a substitute for cash. During that time, there was uncertainty about the equity markets and the economy in general, and clearly the trajectory for the equity markets was not up. With that in mind, we stress tested all o Read Full Article »
