April 18, 2017
Dear Fellow Oberweis Funds Shareholder:
Global equity markets fared well in the first quarter, gaining 6.38% as measured by the MSCI World Index. Economic data were broadly positive, adding to evidence that worldwide growth is accelerating. Manufacturing indices in many parts of the world remain close to multi-year highs. In the United States, optimism over tax reform and a pro-business political climate boosted market sentiment. Meanwhile in Europe, equities quietly outperformed those of the U.S. The Euro Stoxx 600 Index returned 7.8% and its constituents, on average, reported year-on-year earnings growth of 12% compared to 5% for those in the S&P 500. An improving European economy helped Europe’s earnings growth outpace that of the U.S. amid higher operating leverage and improving asset utilization. In Japan, the Nikkei slightly underperformed with a 4.4% return during the quarter. However, U.S.-dollar denominated Japanese returns were much better, since the Yen strengthened 4.8% during the quarter. Despite calls for a border-adjustment tax as the center-piece for U.S. tax reform, investors shrugged off the potential risk to Chinese exporters and Chinese equites were the star performer of the quarter. The MSCI China Index returned 12.93%, driven by a more stable macro environment, better-than-expected earnings, and a surge in demand by mainland Chinese investors for Hong Kong stocks.
FIRST QUARTER PERFORMANCE
I’m pleased to report an exceptional quarter for The Oberweis Funds. Each of the funds reported gains in excess of their respective benchmarks. Among our international funds, the International Opportunities Fund gained 10.60% versus 8.46% for the MSCI Word ex-US SCG Net Index. The China Opportunities Fund returned 14.35% versus 6.09% for the MSCI Zhong Hua Small-Cap Growth Net Index. Our global fund, Emerging Growth, returned 9.78% versus 6.03% for the MSCI ACWI Small-Cap Index. Among our domestic funds, the Micro-Cap Fund returned 7.36% versus 2.63% for the Russell Micro-Cap Growth Index. Lastly, the Small-Cap Opportunities Fund gained 8.78% versus 5.35% for the Russell 2000 Growth Index.
It’s difficult to deny that the underlying currents of global growth are stronger. A leading indicator for manufacturing health, known as the Purchasing Managers Index (PMI), began accelerating last autumn in a number of geographies including the U.S., Canada, the Eurozone, Australia, and Japan. This trend continued in the first quarter of 2017. Additionally, the U.S. consumer is confident and healthy: U.S. consumer sentiment, as measured by the University of Michigan, reached its highest level since February 2007, and the household debt service ratio remains at historically low levels. U.S. housing, despite higher mortgage rates, also remains at historically affordable levels, and housing starts are still below average, suggesting strength in the U.S. housing market – a key economic driver – could be sustainable for some time. The result: analysts are expecting accelerating S&P 500 earnings in 2017, driven by strengthening global economies and a return to positive earnings in the U.S. energy sector.
While it sounds like good news, our concern is that expectations are too high. Large-cap stock valuations are already considerably above-average relative to history, so while we agree that the economy looks pretty good, stock prices already are discounting the positive data. So the real question isn’t if the economy is good, but is it better than people already think it is? Likewise, are market expectations for tax reform, fiscal stimulus and reduced regulations higher than the odds of material legislation? President Trump’s recent failure to repeal and replace the Affordable Care Act was a warning sign that the market may be overestimating the potential for change. We believe tax reform in particular will be incredibly complex and some suggested reforms, such as a border adjustment tax, will be politically polarizing, even more so than healthcare.
Our belief is that the market may be underestimating the degree that earnings could surprise on the upside, but might also be underestimating the probability of President Trump messing it up. We won’t hasten a prediction on what exactly might go wrong but we’ve got a full menu of options: global “hot-spots” like North Korea, Syria, Russia, and Afghanistan, and domestic “hot-buttons” like tax reform and healthcare reform. Unfortunately, high expectations increase the risk and consequences of disappointment when reality throws a curveball.
As always, rather than ruminate about politics or unpredictable macro factors, our strategy focuses on investing in individual businesses with idiosyncratic attributes that can lead to earnings growth in excess of consensus expectations. While the earnings multiple the market is willing to pay for such businesses can oscillate in the short-term, we believe the prudent selection of such companies in a diversified portfolio will lead to performance that exceeds the benchmark over long periods of time.
Average valuations for the funds at quarter end were similar to last quarter. The average forward P/E on March 31, 2017 was 20.0 times for the Micro-Cap Fund (versus 19.5 last quarter), 20.6 times for the Emerging Growth Fund (versus 23.1), 19.5 times for the Small-Cap Opportunities Fund (versus 19.7), 15.4 times for the International Opportunities Fund (versus 16.1), and 17.8 times for the China Opportunities Fund (versus 17.5). Remember, each of the Funds invests in companies with expected earnings growth rates substantially higher than that of the broader market. Sector mix will also affect each Fund’s average P/E. As of 3/31/17, the weighted-average market capitalization was $788 million for Micro-Cap, $2.87 billion for Emerging Growth, $2.58 billion for Small-Cap Opportunities, $3.94 billion for International Opportunities, and $19.10 billion for China Opportunities.
We appreciate your investment in The Oberweis Funds and are grateful for the trust you have shown us with your valuable investments. If you have any questions about your account, please contact shareholder services at (800) 245-7311. Thank you for investing with us in The Oberweis Funds.
*Life of Fund returns are from commencement of operations on 01/07/87 for the Emerging Growth Fund, 01/01/96 for the Micro-Cap Fund, 09/15/96 for the Small-Cap Opportunities Fund, 10/01/05 for the China Opportunities Fund and 02/01/07 for the International Opportunities Fund.
** Expense ratio is the total net annualized fund operating expense ratio as of 12/31/16. The expense ratio gross of expense offset arrangements and expense reimbursement was 1.59%, 1.65%, 2.40%, 1.99% and 1.82% for the OBEGX, OBSOX, OBMCX, OBCHX and OBIOX, respectively. Effective May 1, 2017 through April 30, 2018, Oberweis Asset Management, Inc., the Fund’s investment advisor, is contractually obligated to reduce its management fees or reimburse OBEGX and OBMCX to the extent that total ordinary operating expenses, as defined, exceed in any one year the following amounts expressed as a percentage of each Fund’s average daily net assets: 1.8% of the first $50 million; plus 1.6% of average daily net assets in excess of $50 million. OAM is also contractually obligated through April 30, 2018 to reduce its investment and management fees or reimburse OBSOX, OBCHX and OBIOX to the extent that total ordinary operating expenses exceed in any one year 1.55%, 2.24% and 1.60% expressed as a percentage of the Fund’s average daily net assets, respectively. The annual expense ratio will reflect a blend of both the old and new expense reimbursement arrangements in effect for 2017.
Performance data shown represents past performance and is no guarantee of future results. Investment return and principal value will fluctuate, so that you may have gain or loss when shares are sold. Current performance may be higher or lower than quoted. Visit us online at oberweisfunds.com for most recent month-end performance. The Oberweis Funds invest in rapidly growing smaller and medium sized companies which may offer greater return potential. However, these investments often involve greater risks and volatility. Foreign investments involve greater risks than U.S investments, including political and economic risks and the risk of currency fluctuations. There is no guarantee that the funds can achieve their objectives. Holdings in the Funds are subject to change. Before investing, consider the fund’s investment objectives, risks, charges, and expenses. To obtain a copy of the prospectus or summary prospectus containing this and other information please visit our website at oberweisfunds.com or call 800-323-6166. Read it carefully before investing. The Oberweis Funds are distributed by Oberweis Securities, Inc. Member: FINRA & SIPC.
The MSCI Zhong Hua Small Cap Growth Index (Net) is a free float-adjusted, market capitalization weighted index that is designed to measure the performance of small cap stocks in the developed markets and emerging markets of China and Hong Kong excluding A share classes, with minimum dividends reinvested net of withholding tax. The MSCI AC Asia Pacific Ex-Japan Small-Cap Growth Index (Net) is a free float adjusted market capitalization index that is designed to measure the equity market performance of small cap growth developed and emerging markets in the Pacific region excluding Japan, with minimum dividends reinvested net of withholding tax. The MSCI World ex-US Small Cap Growth Index (Net) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of small cap growth developed markets excluding the US, with minimum dividends reinvested net of withholding tax. The MSCI ACWI Small Cap Index (Net) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of small cap developed and emerging markets with dividends reinvested net of withholding tax. The MSCI World Index (Net) is a free float‐adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.
The Russell 2000 Index measures the performance of approximately 2,000 companies with small-market capitalizations. The Russell 2000 Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted earnings growth rates. The Russell Microcap Growth Index measures the performance of those Russell Micro Cap companies with higher price-to-book ratios and higher forecasted growth values. The performance data includes reinvested dividends. The Russell Microcap Index is represented by the smallest 1,000 securities in the small cap Russell 2000 Index plus the next 1,000 securities. Each index is an unmanaged group of stocks, whose performance does not reflect the deduction of fees, expenses or taxes. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.