OBERWEIS INTERNATIONAL OPPORTUNITIES
INSTITUTIONAL FUND (OBIIX)
January 25, 2018
Thank you for your investment in the Oberweis International Opportunities Institutional Fund (OBIIX). This fund, which is managed by Ralf Scherschmidt and team, seeks to invest in small and mid-cap companies primarily outside of the United States which are experiencing positive fundamental changes not yet fully reflected in market prices. We are pleased to report favorable results for the fourth quarter and full year 2017. For the year, the Oberweis International Opportunities Institutional Fund returned 40.99% versus 34.27% for the MSCI World ex-USA Small Cap Growth Index. In the fourth quarter, the Fund returned 7.48% versus 6.43% for the benchmark.
THE YEAR IN REVIEW
The year’s strong outperformance was primarily attributable to favorable stock selection (as opposed to overweights in specific countries or sectors). Specifically, our equity investments in Japan and the United Kingdom were the largest positive contributors. Interestingly, while Japan underperformed in the first quarter, it rebounded strongly and finished the year as a top contributor. Our stock picks in Australia, Switzerland, and Canada performed exceptionally well – generating even more excess return than Japan or the United Kingdom, although these countries comprise smaller weights and therefore had a smaller impact on the overall portfolio return. Our investments in Germany underperformed in 2017, but in the aggregate 2017 was an excellent year.
At the sector level, our Information Technology investments were the most important contributor to the portfolio’s return in 2017. Smartphone component manufacturers such as Sunny Optical (2382 HK) and AMS AG (AMS SW) were two of our best performing holdings. Both benefitted from smartphone makers adding higher-quality camera lenses and 3D sensing capabilities to increase product differentiation.
Interestingly, global volatility remained low in 2017. Using the CBOE’s VIX Index as a proxy, 2017 ranked as the “quietest” year for market volatility since 1990. Complacency prevailed over what might otherwise be construed as above-average geopolitical uncertainty, given inflated North Korean tensions, continued Eurozone unity worries, and the uncertain direction of U.S. trade policy under the Trump administration. Three interest rate hikes from the U.S. Federal Reserve and a hint of more to come were also easily digested by equity markets. Accelerating global earnings growth (Europe posted double digit year-on-year earnings growth in each of the first three reported quarters of 2017) and a U.S. tax cut that could further stoke growth appear to have “Trumped” geopolitical concerns – at least for now. This macro backdrop was positive for our bottoms-up philosophy, which focuses exclusively on companies generating better than expected earnings due to underappreciated business fundamentals.
Consistent with the last few quarters, our outlook for international equities is somewhat mixed. On the positive side, growth in the Eurozone remains strong, with the Markit Eurozone Manufacturing Index posting its highest reading of the year in December. The outlook for Eurozone earnings growth seems promising, particularly if GDP growth continues. Eurozone earnings remain nearly 20% lower than the peak earnings level achieved in 2008, while earnings in the US have far eclipsed their pre-financial crisis peaks. If Europe’s economy is simply lagging the U.S., one might expect more efficient asset utilization to drive profit margin expansion. For example, consider the margin expansion that occurs as manufacturing firms continue to soak up excess factory capacity. The rebound in the Euro, however, represents a potential headwind for European earnings in 2018 and European expectations feel higher post a year of net inflows into the region. As a result, we enter the year underweight the Eurozone. In the U.K, ongoing Brexit uncertainty likely keeps future growth expectations muted but also means the bar is set relatively low for UK companies. We are slightly overweight the U.K but the exposure is largely related to companies geared toward global economic activity. We believe the U.K. consumer is challenged by lackluster wage growth in the face of higher overall inflation.
In Japan, we continue to like the combination of attractive valuations, an increasing willingness by Japanese corporations to return excess cash to shareholders, and a tight labor market which could spur some much-needed wage inflation. We found more Japanese investment ideas in the second half of 2017 and enter 2018 with a slight overweight.
When we think about international growth generally, we believe tax reform in the U.S. is likely to provide a boost to U.S. earnings in 2018, although the long-term implications are less clear. If U.S. corporations use the excess cash to re-invest, there are likely positive implications and benefits for international companies, potentially increasing the marginal probability of surprise.
Lastly, it is worth nothing that growth outperformed value stocks in 2017, and while the magnitude was large, it didn’t fully recover the outperformance of value stocks in 2016. Recently, many market pundits have questioned if technology – the sector most synonymous with growth and the best-performing sector in our universe in 2017 – can provide an encore performance this year. While there is always a temptation to assume mean reversion, we continue to find a quality and quantity of technology investments that lead us to maintain our overweight position from 2017. While we are cognizant of the potential risk of a style transition from growth to value, the data to support such a change is unclear. Our friends at Empirical Research Partners found that there is only ‘weak’ statistical evidence to suggest that a prior year’s winning sector will not repeat the following year.
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.
James W. Oberweis, CFA Ralf Scherschmidt
President Portfolio Manager
MANAGEMENT DISCUSSION ON FUND PERFORMANCE
Global equities returned 22.40% in 2017, as measured by the MSCI World Index. Global small-caps, as measured by the MSCI World Small-Cap Index, returned 22.66%. International small-caps outperformed U.S. small-caps, as evidenced by the 31.04% return on the MSCI World ex-USA Small-Cap Index. Non-US small cap growth companies outperformed Non-US small-cap value companies. The MSCI World ex-USA Small-Cap Growth Index return 34.27% versus 27.93% for the MSCI World ex-USA Small-Cap Value Index.
DISCUSSION OF THE INTERNATIONAL OPPORTUNITIES INSTITUTIONAL FUND
The International Opportunities Institutional Fund returned 40.99% versus 34.27% for the MSCI World ex-US Small Cap Growth Index. The portfolio benefitted from stock selection in Japan, the United Kingdom, and Australia offset by adverse stock selection and an underweight allocation in Germany. An underweight allocation in Finland also detracted from performance. On a sector level, the portfolio benefitted from stock selection in Technology, Consumer Discretionary, and Industrials. At the stock level, Sunny Optical Technology (2382 HK), Open House (3288 JP), and AMS (AMS SW) were among the top contributors to performance; Takeuchi Manufacturing (6432 JP), Outokumpu (OUT1V FH), and Japan Lifeline (7575 JP) were among the top detractors.
At year-end, the portfolio was invested in 73 stocks in 14 countries. Our top five country weightings (portfolio weighting versus the MSCI World ex-US Small Cap Growth Index) at the end of the quarter were Japan (31.8% vs. 28.2%), the United Kingdom (15.8% vs. 15.7%), Canada (6.6% vs. 9.1%), Switzerland (6.0% vs. 4.9%), and Sweden (5.8% vs. 5.6%). On a sector basis, as of year-end, the portfolio was overweight information technology (24.6% vs. 17.6%) and underweight consumer staples (2.2% vs. 8.9%). In addition, we ended the quarter with a slightly above-average cash levels to provide flexibility entering 2018. OBIIX Holdings
For current performance information, please visit www.oberweisfunds.com.
*Life of Fund returns are from commencement of operations on 03/10/14 for the Fund.
** December 31, 2017 unaudited data. Expense ratio is the total net annualized fund operating expense ratio. The expense ratio gross of expense offset arrangements and expense reimbursements were 1.12%. 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 OBIIX to the extent that total ordinary operating expenses exceed in any one year 1.10% 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 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. MSCI World Index (Net) is a free float-adjusted market capitalization index that is designed to measure developed-market equity performance throughout the world. The MSCI World ex USA Small Cap Value Index is based on a traditional market cap weighted parent index, the MSCI World ex USA Small Cap Index, which includes small cap stocks across 22 Developed Markets (DM) countries (excluding the US). The MSCI World ex USA Large Cap Growth Index captures large-cap securities exhibiting overall growth style characteristics across 22 Developed Markets (DM) countries and 23 Emerging Markets (EM) countries. The MSCI World ex USA Small Cap Value Index reweights each security of the parent index to emphasize stocks with lower valuations. Index weights are determined using fundamental accounting data—sales, book value, earnings and cash earnings—rather than market prices. The S&P 500® Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general.