January 13, 2023
Dear Fellow Oberweis Funds Shareholder,
2022 was an unusually rough year for investors. The Fed’s fight against inflation and Russia’s war in Ukraine were mostly to blame. Both stocks and bonds felt the scourge of rising interest rates. The US Fed, in an attempt to fight inflation, increased its target rate for Fed Funds by 400 bps from March to December, going from a target range of 0.25-0.5% to 4.25-4.50%. Except for China, major central banks around the world followed suit. The magnitude of this year’s increase in rates materially exceeded investor expectations.
Unanticipated large increases in interest rates are a double whammy for growth stock investors. Higher interest rates tend to slow economic growth and depress future earnings. Additionally, they also tend to compress valuation multiples for growth stocks, as a higher discount factor reduces the present value of future earnings. When viewed in that light, it’s not terribly surprising to see a sharp decline in stock prices, particularly for growth stocks.
The Fed’s quest to quell inflation was complicated by supply-side disruptions and an incredibly tight labor market. The war in Ukraine and China’s COVID-related production problems increased commodity prices and pressured global supply chains, which fueled price increases and exacerbated inflation. Further, a labor shortage put upward pressure on wages, further complicating the Fed’s anti-inflation campaign.
In terms of economic growth, the US economy fared better than Europe. Europe suffered through a period of sky-high natural gas prices, largely from its dependence on Russian supply. Non-US small caps lagged their US counterparts for the second year in a row. Japanese equities fared relatively well in local currency terms, but not in USD terms, which include the effect of the Yen’s decline versus the US dollar.
China was the most challenging geography. Between President Xi Jinping’s “Covid zero” and “shared prosperity” policies, the investment climate could only be described as decidedly unfriendly and highly unpredictable. This occurred amid a strengthening US dollar and weakening Chinese property market, typically not great signs for Chinese asset prices. Chinese markets crashed into the October National Congress of the Communist Party, when Xi doubled down on the same adverse policy rhetoric.
However, in recent months and into 2023, Chinese equities have rallied strongly. After his successful consolidation of power, Xi dramatically changed policy direction, essentially abandoning “Covid Zero” entirely. While a massive wave of Covid promptly ensued, cases in urban areas may already have peaked and we expect a return to more open times soon. Xi also showed signs of softening his stance on property market regulation and anti-monopoly investigations against Internet firms. This drove a 30% rally in China over the two months that followed the National Congress, but it was not enough to recover from the heavy losses earlier in the year.
2022 PERFORMANCE IN REVIEW
While nobody is happy with a negative return, the domestic funds fared exceptionally well relative to their benchmark indices and peers. The Micro-Cap Fund and Small-Cap Opportunities Fund returned -10.60% and -11.17%, respectively (compared to -29.76% and -26.36% for the Russell Micro-Cap Growth and Russell 2000 Growth indices). Among the international funds, the International Opportunities Fund returned -37.06% (versus -27.02% for the MSCI World ex-US SCG Index). The China Opportunities Fund returned -37.23% (compared to -21.93% for the MSCI China Index). The Global Opportunities Fund returned -26.80% (compared to -18.67% for the MSCI ACWI Small-Cap Index).
It is entirely normal to have individual years deviate positively and negatively from the benchmark. Over the trailing ten years, the average annual returns of the Micro-Cap, Small-Cap, Global, International, and China Funds have all handily beaten their benchmarks. Similarly, although the Emerging Markets Fund underperformed this year, returning -24.31% (versus -18.02% for the MSCI EM Small Cap Index), the fund has markedly outperformed since its inception. In fact, the Emerging Markets Fund has generated 1,800 basis points of excess cumulative return, net of fees, since its inception on May 1, 2018.
When you measure our skill, we find the long-term track record to be far more indicative than any individual year. In fact, our experience has shown that some of the most attractive entry points often occur following periods of short-term underperformance.
THE YEAR AHEAD
A reader of the first page of this seemingly dreary commentary might conclude our outlook to be bearish. It is, in reality, quite the opposite. We believe that at current prices, the return potential for our funds is significantly above-average, particularly relative to the risks. Our research shows that valuations for global small-caps rival the incredible bargains last seen in the depths of the global financial crisis. That might seem surprising, as stock prices have not declined as much as they did in 2008-2009. However, price/earnings ratios for small-caps were not as expensive at the beginning of 2021 as they were in 2007 and earnings have not similarly declined.
Of course, earnings for our portfolios could be curtailed in 2023, but we don’t see that as the most likely outcome. First, while we expect recession as a base case in 2023, we believe a modest GDP contraction is unlikely to lead to an unhealthy level of unemployment. That is, with less leverage on both corporate and individual balance sheets and a tight labor market, we believe that the coming economic slowdown is likely to be less severe than that of 2008.
Second, and more importantly, our funds are less correlated to the broader economy than you might think. We tend to own “disruptive” niche-oriented companies growing much faster than the broader economy. Long-term growth for these companies tends to be much more correlated with product acceptance and market share gains than oscillations in GDP. While broad economic growth or contraction will influence many holdings to some degree, the real driver, especially over the long-term, tends to be company-specific product growth.
That said, during periods of rising risk-aversion, investors seek current cash flow versus the potential for future earnings growth. That’s why multiples compressed last year. But that has already happened, and buyers today are paying much lower multiples than historical averages. Multiple compression could continue in 2023 but multiples for small-cap growth stocks have already dropped to among the cheapest levels of the past two decades. It could get worse, but we doubt any further contraction will be persistent or material.
At some point, the recession will pass and valuation multiples are likely to revert back to more normal levels. We cannot predict when this will occur, but post-recessionary multiple expansion (which typically happens well before the economy reaches the end of a recession) have been the single best periods for the performance of our funds. Don’t miss it.
VALUATION RECAP
As of December 31, 2022, the price/earnings (P/E) ratio was 14.9 times for the Global Opportunities Fund (versus 13.0 last quarter), 13.0 times for the Small-Cap Opportunities Fund (versus 11.5 last quarter), 11.6 times for the Micro-Cap Fund (versus 10.5 last quarter), 15.2 times for the International Opportunities Fund (versus 12.9 last quarter), 18.9 times for the China Opportunities Fund (versus 18.6 last quarter), 18.2 times for the Emerging Markets Fund (versus 17.4 times last quarter). Each of these funds invests in companies with expected earnings growth rates that are higher than that of the broader market, and in companies expected to grow faster than current market expectations. As of December 31, 2022, the weighted-average market capitalization was $4.3 billion for the Global Opportunities Fund, $3.8 billion for the Small-Cap Opportunities Fund, $1.3 billion for the Micro-Cap Fund, $4.3 billion for the International Opportunities Fund, $3.9 billion for the Emerging Markets Fund, and $33.1 billion for the China Opportunities Fund.
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.
Sincerely,
James W. Oberweis, CFA
President & Portfolio Manager
MANAGEMENT DISCUSSION ON FUND PERFORMANCE
MARKET ENVIRONMENT
Global equities returned -17.74% in 2022, as measured by the MSCI World Index. Global small-caps, as measured by the MSCI World Small-Cap Index, returned -18.41%, slightly underperforming large-capitalization stocks. International small-caps underperformed U.S. small-caps for the second year, as evidenced by the -20.59% return on the MSCI World ex-USA Small-Cap Index. Within the United States, small-cap growth stocks outperformed large-cap growth stocks by 278 basis points, as measured by the respective returns of the Russell 2000 Growth (-26.36%) and Russell 1000 Growth (-29.14%) indices. Value stocks sharply outperformed growth stocks in 2022. Within domestic small-cap, the Russell 2000 Value Index (-14.50%) outperforming the Russell 2000 Growth Index (-26.36%) by 1186 basis points for the year.
DISCUSSION OF THE OBERWEIS FUNDS
The International Opportunities Fund returned -37.06% versus -27.02% for the MSCI World ex-US Small Cap Growth Index. At the country level, the United Kingdom, Japan, and Canada detracted from portfolio return, partially offset by favorable performance in Denmark. At the sector level, the portfolio was negatively impacted by stock selection in consumer staples and consumer discretionary, partially offset by positive stock selection in industrials. At the stock level, Hexatronic (HTRO SS), D/S Norden (DNORD DC), and Aixtron (AIXA GY) were among the top contributors to performance; Future (FUTR LN), Nordic Semiconductor (NOD NO), and Food & Life Companies (3563 JP) were among the top detractors. OBIOX Holdings
The Global Opportunities Fund returned -26.80% versus -18.67% for the MSCI AWCI Small-Cap Index. At the country level, stock selection in the United States, Taiwan, and Germany added to portfolio return, while Japan, the U.K., and China detracted from portfolio return. At the sector level, healthcare added to return, while information technology, consumer discretionary and financials detracted. At the stock level, Halozyme Therapeutics (HALO US), Acadia Healthcare (ACHC US), and Super Micro Computer (SMCI US) were among the top contributors to performance; Synaptics (SYNA US), Intermediate Capital Group (ICP LN) and Ultra Clean Holdings (UCTT US) were among the top detractors. OBEGX Holdings
The China Opportunities Fund returned -37.23% versus -21.93% for the MSCI China Index. At the sector level, consumer discretionary added to return, while information technology, financials, and materials were top detractors. At the stock level, Pinduoduo (PDD US), Hygeia Healthcare (6078 HK), and Trip.com (9961 HK), were among the top contributors to performance; ACM Research (688082) and Longfor Group (960 HK) were among the top detractors. OBCHX Holdings
The Emerging Markets Fund returned -24.31% versus -18.02% for the MSCI EM Small-Cap Index. At the country level, China, Mexico, and Turkey were the primary detractors while Indonesia was the top contributor. At the sector level, the fund was positively impacted by stock selection in consumer staples, while performance was adversely impacted by stock selection in industrials and information technology. At the stock level, Mitra Adiperkasa (MAPI IJ), Xiabuxiabu Catering Management (520 HK), and PT Sumber Alfaria Trijaya (AMRT IJ) were among the top contributors to performance; Aspeed Technology (5274 TT), Weimob (2013 HK), and Pan Jit International (2481 TT) were among the top detractors. OBEMX Holdings
The Micro-Cap Fund returned -10.60% versus -29.76% for the Russell Micro-Cap Growth Index. The portfolio benefitted from favorable stock selection in technology, producer durables and healthcare. At the stock level, Lantheus (LNTH), Sierra Wireless (SWIR), and Bel Fuse (BELFB) were among the top contributors to performance. Alpha & Omega Semiconductor (AOSL), Boot Barn (BOOT), and Ultra Clean (UCTT) were among the top detractors. OBMCX Holdings
The Small-Cap Opportunities Fund returned -11.17% versus -26.36% for the Russell 2000 Growth Index. The portfolio benefitted from favorable stock selection in healthcare, technology, and producer durables. Lantheus (LNTH), Clearfield (CLFD), and Sierra Wireless (SWIR) were among the top contributors to performance. Synaptics (SYNA), Crocs (CROX), and Ultra Clean (UCTT) were among the top detractors. OBSOX Holdings
For current performance information, please visit www.oberweisfunds.com.
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. Unusually high returns may not be sustainable. 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.
1Institutional Class shares OBGIX, OMCIX, OBSIX and OCHIX performance information was calculated using the historical performance of Investor Class shares for periods prior to May 1, 2017.
2Life of Fund returns are from commencement of operations on 01/07/87 for the Global Opportunities 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, 02/01/07 for the International Opportunities Fund, 05/01/17 for the Institutional Share Classes and 05/01/18 for the Emerging Markets Fund Share Classes.
3December 31, 2022 data. Expense ratio is the total net annualized fund operating expense ratio. The expense ratio gross of expense offset arrangements and expense reimbursements was 1.52%, 1.28%, 1.53%, 1.27%, 1.45%, 1.20%, 2.05%, 1.80%, 1.87%, 2.90% and 2.65% for OBEGX, OBGIX, OBMCX, OMCIX, OBSOX, OBSIX, OBCHX, OCHIX, OBIOX, OBEMX and OIEMX respectively. Oberweis Asset Management, Inc. (OAM), the Fund’s investment advisor is contractually obligated through April 30, 2023 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 and for OBGIX and OMCIX 1.55% of the first $50 million; plus 1.35% of average daily net assets in excess of $50 million. OAM is also contractually obligated through April 30, 2023 to reduce its management fees or reimburse OBSOX, OBCHX, OBIOX and OBEMX to the extent that total ordinary operating expenses exceed in any one year 1.25%, 2.24%, 1.60% and 1.75% expressed as a percentage of each Fund’s average daily net assets, respectively, and for OBSIX, OCHIX and OIEMX 1.00%, 1.99%,1.50%, respectively.
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 Emerging Markets Small Cap Index is a free float-adjusted, market capitalization-weighted index that measures the performance of small-cap stocks in 24 emerging markets. The MSCI China Net Index is a free float-adjusted market capitalization-weighted Index of Chinese equities that include China-affiliated corporations and H shares listed on the Hong Kong Exchange, and B shares listed on the Shanghai and Shenzhen exchanges and P chips and foreign listings with minimum dividends reinvested net of withholding tax. The MSCI EAFE Index is an equity index that captures large and mid-cap representation across 21 developed markets countries around the world, excluding the U.S. and Canada. The index is comprehensive, covering approximately 85% of the free-float-adjusted market capitalization in each country.
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.
