October 11, 2019
Dear Fellow Oberweis Funds Shareholder:
YEAR-TO-DATE PERFORMANCE THROUGH SEPTEMBER 30, 2019
Global equity markets fared well in the first nine months of this year. The China Opportunities Fund has delivered strong performance, returning 21.82% compared to 7.62% for the MSCI China Index. Compared to its benchmark, the Emerging Markets Fund also performed very well, returning 12.82% versus 1.82% for the MSCI EM Small-Cap Index. The International Opportunities Fund returned 13.80% versus 14.74% for the MSCI World ex-US Small-Cap Growth Index. For our U.S. funds, the Micro-Cap Fund and Small-Cap Opportunities Fund returned 12.08% and 14.62% compared to 4.79% for the Russell Micro-Cap Growth Index and 15.34% for the Russell 2000 Growth Index, respectively. The Small-Cap Value Fund returned 10.42% versus 12.82% for the Russell 2000 Value Index. Our global fund, the Global Opportunities Fund, returned 12.66% versus 13.58% for the MSCI ACWI Small-Cap Index.
In the third quarter, trade tensions with China remained front-and-center, with the market reacting wildly at times to the latest Tweet, rumor, or unnamed source. We believe the uncertainty surrounding trade policy and the magnitude of tariffs now faced by American companies is impacting corporate profits, the economy, and investor risk appetite for small-cap stocks. U.S. real GDP growth is projected to be a lackluster 1.8% in the third quarter, and the September ISM Manufacturing survey reading of 47.8 was the lowest since June of 2009, implying manufacturing contracted for the second consecutive month. Sub-50 readings were also posted in Japan, Korea, Mexico, Russia, and throughout much of Europe, headlined by a distressing 41.7 measure in Germany.
Under the cover of controlled inflation, the Federal Reserve responded with more accommodative monetary policy, cutting rates twice during the quarter for the first time since 2008 and suspending its balance sheet reduction strategy. Fed funds futures project additional rate cuts as we conclude 2019 and move into 2020. U.S. 10-year yields declined from 2.00% to 1.68% during the quarter, and are now 100 basis points lower than where they finished 2018. Similar duration government bonds in Germany and Japan have negative yields.
Rising risk aversion has been a headwind for our growth strategies in 2019, but it has also set the stage for more attractive valuations today. Our growth funds seek to invest in companies with substantially misunderstood long-term earnings growth potential. We focus on disrupters – companies that we believe have the potential to take significant market share from competitors or to create new markets where none previously existed. That means we focus much more on long-term earnings potential versus short-term cash flow. During most periods, the market strikes a reasonable balance between companies with more predictable near-term earnings and companies with the opportunity to invest for outsized long-term earnings growth. During times of uncertainty, however, investors often flock to the relative confidence of near-term earnings and shun companies with stronger long-term earnings prospects. We’ve seen this play out in the third quarter. Value-oriented sectors like real estate, utilities, and communication services performed very well. Technology and innovative healthcare companies faced headwinds. Note that over long periods of time, both growth and value approaches have worked well, but there are clearly cycles that seem to favor one over the other.
Additionally, returns in the short run can be highly influenced by political and macroeconomic events as well as by perceived investor risk, even though such variables may be transitory and have only limited effects on the long-term cash flows of our portfolio holdings. During this past quarter, day-to-day volatility in global equity markets was closely correlated with positive and negative developments in U.S. trade negotiations with China. Indeed, these variables should affect stock prices in some way as a prolonged trade war with China is likely to slow economic growth around the world and create uncertainty that defers marginal business investment. These are real risks that should, all else equal, marginally reduce valuations of businesses closely tied to GDP.
The reality, however, is that our growth funds are populated with niche businesses whose long-term success or failure is not particularly tied to the cycles of global GDP, but rather to the ability of the individual company to unsettle incumbents or create new markets. For these companies, an economic slowdown and/or recession would likely affect near-term earnings on the margin but is unlikely to derail long-term growth. In our experience, the best time to purchase companies with robust long-term growth opportunities is typically when they are not popular with other investors, as the premium required to pay for such long-term potential growth tends to be compressed when fear is elevated.
Fortunately and despite a murkier macro picture, we continue to find a typical number of new investment ideas where positive earnings growth is supported by underlying company fundamentals that seem to be misunderstood or underestimated by other investors. As you can see in the next section, valuations have also broadly become more attractive over the last three months, when measuring on a P/E basis. While sentiment and equity prices may oscillate wildly in the short-run in response to the latest macro headline, our investment approach instead focuses on companies generating better-than-expected earnings power driven by transformational change. Thus, while the P/E multiple that investors are willing to pay for these companies may vary from quarter to quarter, we believe that a diversified portfolio of these investments is likely to yield reasonable returns over the long-term.
With respect to several of our growth-oriented funds, the average forward P/E ratio declined considerably from the prior quarter. As of September 30, 2019 it was 14.2 times for the Global Opportunities Fund (versus 16.9 last quarter), 14.8 times for the Small-Cap Opportunities Fund (versus 16.6 last quarter), 11.9 times for the Micro-Cap Fund (versus 14.8 last quarter), 13.8 times for the International Opportunities Fund (versus 18.5 last quarter), 20.1 times for the China Opportunities Fund (versus 17.8 last quarter), and 17.6 times for the Emerging Markets Fund (versus 17.9 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. For the Small-Cap Value Fund, the average P/E ratio was 12.8 times (versus 12.6 last quarter). Notably, small-cap value stocks appear to be trading at below-average valuations, with the Russell 2000 Value Index trading toward the lower end of its 10-year range. As of September 30, 2019, the weighted-average market capitalization was $3.8 billion for the Global Opportunities Fund, $2.7 billion for the Small-Cap Opportunities Fund, $1.0 billion for the Micro-Cap Fund, $2.9 billion for the Small-Cap Value Fund, $3.8 billion for the International Opportunities Fund, $2.1 billion for the Emerging Markets Fund, and $68.6 billion for the China Opportunities Fund. Note the China Opportunities Fund’s market cap is skewed upward due to two mega-cap holdings, even though the majority of holdings are in small/mid-cap firms (the median market cap for China Opportunities was $7.7 billion).
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.
For current performance information, please visit www.oberweisfunds.com.
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, 2018 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%, 1.57%, 1.33%, 2.13%, 1.88%, 1.57%, 1.29%, 1.91%, 1.65%,1.77%, 3.99% and 3.74% for OBEGX, OBGIX, OBMCX, OMCIX, OBSOX, OBSIX,OBIVX, OBVLX, OBCHX, OCHIX, OBIOX, OBEMX and OIEMX respectively. Oberweis Asset Management, Inc. (OAM), the Fund’s investment advisor is contractually obligated through April 30, 2020 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, 2020 to reduce its management fees or reimburse OBSOX, OBVLX, OBCHX, OBIOX and OBEMX to the extent that total ordinary operating expenses exceed in any one year 1.55%, 1.30%, 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 1.30%, 1.99% and 1.50%, respectively.
4On October 2, 2017, the Cozad Small Cap Value Fund was reorganized into OBVLX, and adopted the performance history of the Cozad Small Cap Value Fund’s Class I shares. Performance shown before October 2, 2017 is for the Cozad Small Cap Value Fund’s Class I shares. The Cozad Small Cap Value Fund acquired all of the assets and liabilities of the Cozad Small Cap Value Fund I, L.P., from its inception on September 30, 2010, in a tax free reorganization on July 1, 2014. Investor Class share OBIVX performance information was calculated using the historical performance of Institutional Class share for periods prior to May 1, 2018.
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. 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 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 2000 Value Index is an unmanaged market capitalization-weighted index of value-oriented stocks of U.S. domiciled companies that are included in the Russell 2000 Index. Value-oriented stocks tend to have lower price-to-book ratios and lower forecasted growth values.