OBERWEIS INTERNATIONAL OPPORTUNITIES
INSTITUTIONAL FUND (OBIIX)
July 19, 2017
SECOND QUARTER AND FIRST HALF OF 2017 IN REVIEW
International small-cap markets delivered strong returns in the second quarter and first half of 2017, with the MSCI World ex-US Small Cap Growth Index (the “benchmark”) returning 8.16% and 17.31%, respectively. The Oberweis International Opportunities Institutional Fund outperformed in both periods, returning 8.64% in the second quarter and 20.27% in the first half of 2017. On a global basis, equities performed well in the second quarter as economic growth and corporate earnings remained at high levels, more than offsetting political uncertainties in some areas. Equity returns were led by emerging markets such as China and India and some developed markets including France and Germany. International stock returns, in U.S. dollar terms, were also enhanced by a weaker U.S. dollar.
While many investors already appreciate the American economy’s improvement, cyclical growth outside the U.S. seems to be catching up. Manufacturing PMI’s remained solidly above 50 in Canada, the Eurozone, Australia, Japan, and most emerging markets, signaling continued economic expansion. Additionally, year-over-year headline inflation has gently accelerated, dampening any lingering fears of deflation that dogged many global economies – particularly those in Europe – after the Global Financial Crisis. European firms reported the highest percentage of quarterly revenue surprises over analyst expectations since 2003 (Source:Morgan Stanley).
On the other hand some political risks, while still close in mind, are marginally abating. For example, the victory of Emmanuel Macron in the French presidential election has taken some steam out of the populist push. Ironically, European equities sold off in June, as investor focus shifted from fear of an EU breakup to concern that the European Central Bank may soon curtail the “easy money” quantitative easing spigot. Japanese small-cap stocks slightly under-performed the benchmark again this quarter despite all-time high annual earnings and more substantial returns of capital to shareholders through higher dividends and share buybacks (in a market that has historically been reticent to do so).
You may recall our balanced outlook for international small-cap equities in recent quarters. While we were encouraged by improving economic data amid attractive stock valuations, our enthusiasm was tempered by rising political uncertainties after surprising populist election wins in both the U.S. and U.K. With the recent overwhelming victory by Macron in France and a hung parliament in the U.K., populism appears to be losing momentum. Macron and German Chancellor Angela Merkel may have a window of opportunity to stabilize the EU. While Merkel still faces an upcoming election in Germany, her healthy approval rating of 64% suggests a lower risk of upset than was present in the U.K. or U.S. elections. Over time, we believe that a stable environment in the EU should lead to greater business investment and higher consumer confidence, both of which are leading indicators of future economic growth. Some indicators hint this may already be happening, as seen in a six-year high in June’s Eurozone PMI.
In Japan, after Prime Minister Shinzo Abe’s ruling party lost a recent Tokyo election, the pressure on him to increase economic growth will be high. In response, we expect that Abe will attempt to accelerate reforms and increase government spending. In short, we believe the opportunity in Japan could finally be ripe: many global fund managers are underweight, valuations remain below long-term averages, and we see marginally improving corporate governance as Japanese firms are increasingly electing to return capital to shareholders via dividend increases and share buybacks. Although intrigued, we remain underweight pending more evidence of change impacting growth.
While we are generally positive on opportunities in the EU, we are slightly concerned that increasingly hawkish commentary by global central bankers may create higher volatility going forward. Recently, the Federal Reserve, ECB and BOE have all talked about the unwinding of favourable money supply policies, and the potential impact of such a reversal on equity markets is uncertain.
From a sector standpoint, we see the 2016 outperformance from certain commodities unwinding as supply continues to be an issue. After finding more energy ideas in the second half of 2016, we trimmed our exposure during the first half, reflecting our stance that the oil market likely needs more time to balance supply and demand. We fear energy companies that relied on cost cuts to generate better-than-expected results may soon run out of options in the face of lower oil prices. We also trimmed materials for similar reasons and trimmed consumer staples as they appear expensive. On the flip side we added more consumer discretionary and health care ideas during the first half.
We are still broadly positive on technology given the current robust growth in the sector and strong future growth opportunities. However, we note some sub-sectors like software seem priced for perfection, and combined with high investor exposure, the sector may be ripe for some profit-taking. We reduced our exposure during the second quarter and enter the third quarter roughly neutral with the benchmark.
At the end of the first half, the portfolio was invested in 99 stocks in 17 countries. Our top five country weightings (portfolio weighting versus the MSCI World ex-US Small Cap Growth Index) at the end of the first half were the United Kingdom (26.3% vs. 16.2%), Japan (21.0% vs. 27.3%), Switzerland (6.8% vs. 4.4%), Canada (6.2% vs. 8.8%), and Australia (6.1% vs. 5.7%). On a sector basis, the portfolio is overweight consumer discretionary (21.7% vs. 17.4%) and underweight consumer staples (5.0% vs. 9.1%).
Some of the top performers for the first half included: Logitech International S.A. (LOGN SW), which returned +47.3% and contributed 101 bps; Aristocrat Leisure Ltd. (ALL AU), which returned +55.2% and contributed 84 bps to the portfolio’s return; Shopify Inc. (SHOP US), which returned +61.5% and contributed 73 bps. Some of the leading detractors for the first half included: Takeuchi Manufacturing Co. Ltd. (6432 JP), which returned -24.5% and detracted 32 bps; Japan Lifeline Co. Ltd. (7575 JP), which returned -11.2% and detracted 24 bps; and Outokumpu Oyj. (OUT1V FH), which returned -19.1% and detracted 19 bps.
In terms of valuation, the portfolio’s weighted average P/E and forward growth rates are roughly the same as the first quarter. With valuation dispersions across our developed world markets remaining relatively narrow, we continue to expect that company specific factors will remain more important in determining equity winners.
We appreciate your investment in The Oberweis International Opportunities Institutional Fund and are grateful for the trust you have shown us. If you have any questions, please contact Brian Lee (institutional clients) or John Collins (advisory accounts) at (800) 323-6166. Thank you for investing with us in The Oberweis Funds.
James W. Oberweis, CFA Ralf Scherschmidt
President Portfolio Manager
*Life of Fund returns are from commencement of operations on 03/10/14 for the 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 1.18% for OBIIX. Effective May 1, 2017 through April 30, 2018, Oberweis Asset Management, Inc., (OAM), 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.