OBERWEIS INTERNATIONAL OPPORTUNITIES INSTITUTIONAL FUND (OBIIX)
February 2, 2021
Dear Fellow Shareholder:
We are pleased to report excellent results for the fund in 2020. The Oberweis International Opportunities Institutional Fund returned 63.65% versus 22.93% for its benchmark, the MSCI World Ex USA Small Cap Growth Index.
Experienced investors know well that virtually all funds, including those with the very best long-term track records, inevitably encounter shorter-term periods of good and bad performance. Style factors, sector constitution, and individual stock selection all play a role. We do not believe a single year says much at all about the stock selection skill of a portfolio manager. 2020 was a fantastic year, with 4072 basis points of excess return. On the other hand, in 2018-2019 our strategy faced headwinds. Despite the statistical irrelevance of short-term metrics, we have found that investors often act on them, with enthusiasm following periods of strong performance and with dismay following challenging ones. That’s normal, it’s human. But it also tends to be wrong.
For example, consider the 2018-2019 period. During this period, investors preferred companies with highly predictable near-term earnings over those with more favorable long-term earnings opportunities. As a result, the types of companies we seek underperformed, leading to what we viewed as a material mispricing. We noted in the 2019 annual report letter: “Over the long term, there is a tradeoff between near-term earnings visibility and long-term earnings potential, but we believe the past two years have rendered the price for favorable long-term earnings growth much less than normal (at least in relation to companies with more certain near-term earnings). Similar to other periods of underperformance in the past, we believe that 2018-2019 is likely to set the stage for a mean reversion to a more normal balance.” This proved spot on, and 2020 turned out to be one of our best years ever in terms of relative and absolute performance. This pattern will inevitably occur again at some point. No one can predict the future, but our experience has been that some of the very best times to buy our strategy often follow periods of challenging performance, with 2020’s exceptional gains following 2018-2019 being a good example.
Fortunately, over the longer term, our portfolio returns are not determined by market sentiment or style biases, but rather by the ability of our holdings to generate healthy cash flows. While many factors influence short-term returns, stock selection skill is the primary determinant of alpha generation over the long term. Good news on that front: Since we began this fund on 3/10/14, we are pleased to report that the fund has cumulatively returned +113.22% vs. 76.88% for the benchmark, resulting in an average annual outperformance of 302 basis points.
THE YEAR IN REVIEW
COVID-19 has caused short-term and potentially long-term challenges for the global economy. Early on and before many other investors, we recognized that after an initial shock from the global lockdown, many businesses would adapt. Consumer preferences evolved and many companies found themselves favorably positioned for the new environment. In other words, change happened at a rate far faster than some of the most sophisticated investors ever imagined. At the same time, investors’ expectations for future growth remained at depressed levels, enabling us to find a plentitude of highly mispriced businesses. In many instances, companies reported that COVID was positively accelerating key business metrics by years.
In short, our actively-managed portfolio is not the same as the broader economy. Even if the overall economy is facing issues, as it was in 2020, that does not mean that every company in the world is doomed. There will always be idiosyncratic winners. It is simply a matter of separating the wheat from the chaff. This bifurcation was later described as a “K-shaped” recovery.
In this environment we continue to find many opportunities that we believe to be undervalued, probably because of the continuing degree of significant economic change. The objection to investing in any equities just because the overall market might seem fairly valued misses the whole point of active management, which seeks out the undervalued tail-end. Interestingly, we continue to see many people who try hard to engineer reasons not to buy equities despite their favorable long-term return profile.
Internationally, in developed markets, equities may appear to be fully valued based on a superficial P/E analysis. However, based on other metrics such as Free Cash Flow Yield, which we have found to be more predictive, we believe that equities in our universe remain reasonable priced. This is different than in the US, where valuations are more elevated. On a relative basis, JP Morgan found that the US forward twelve-month P/E valuations to be the highest relative to the rest of the world in nearly 20 years.
Some investors are focused on finding value in companies that have been most affected by the COVID-19 pandemic, as share prices for many such companies have cratered. Our approach has been to focus on companies that have thrived in spite of it. Many of our top holdings have continued with unabated growth, often in higher-growth industries and nascent markets with niche offerings in the early stages of adoption. As one might expect, the portfolio is overweight in information technology and consumer discretionary, where such companies are concentrated. The COVID disruption caused rapid changes in business and consumer preferences, and accordingly has led to an abundance of ideas within these sectors. On the other hand, we also own a number of companies that operate in industries that were adversely affected by COVID, but have management teams that discovered ways to rapidly adapt to the new world reality. With expectations depressed, it was easier than normal for such companies to beat earnings estimates.
After continued strong performance for the fund, one might again ask: what is next? Looking forward, we are actually more positive on our long-term opportunity set. We believe changes in business and consumption are still being underestimated by the rest of the market. Most economists and market participants fail to fully understand the degree that the pandemic was met by mankind’s ingenuity. Many companies will benefit from significant long-term productivity improvements due to an acceleration in innovation.
Rapid change has brought along even more opportunities at the individual stock level and we expect that to continue. We have conviction that the positive trends we are seeing at the individual company level will continue to offer considerable returns for long-term investors. Indeed, we will not be surprised when we all look back in 20 years and come to understand that COVID was merely an accelerant in the multi-decade shift for the economy through innovation in digitalization, AI, eCommerce, robotics, data analytics, cloud usage and so forth. Covid has led to a bifurcation in the economy – many companies are doing much worse than before and many companies are doing much better than before. Essentially, looking at a normal distribution, the tails have gotten wider. At the right side of the tail, we are finding more companies that are doing even better than before and whose long-term prospects are even more misunderstood and therefore even more undervalued than before.
At year end, the fund was invested in 64 stocks in 14 countries. Our top five country weightings (portfolio weighting versus the MSCI World Ex USA Small Cap Growth Index) were Japan (35.1% vs. 26.6%), Sweden (12.9% vs. 10.2%), the United Kingdom (12.8% vs. 15.2%), the Netherlands (6.9% vs. 2.0%), and Canada (5.8% vs. 8.2%). On a sector basis, the portfolio was overweight consumer discretionary (22.8% vs. 14.2%) and underweight consumer staples (1.8% vs. 7.4%).
Top contributors for the year include Sinch AB (SINCH SS), which returned 433.1% and contributed 883 bps; Baycurrent Consulting (6532 JT), which returned 245.9% and contributed 534 bps; and Evolution Gaming Group AB (EVO SS) which returned 141.1% and contributed 423 bps. The largest detractors in 2020 include Air Canada (AC CN), which returned -66.5% and detracted 186 bps. Redrow PLC (RDW LN) which returned -54.3% and detracted 185 bps; and Capita PLC (CPI LN) which returned -69.1% and 167 detracted bps.
On behalf of the entire team at Oberweis, thank you for investing in the Oberweis International Opportunities Institutional Fund. If you have any questions about your account, please contact shareholder services at (800) 245-7311.
James W. Oberweis, CFA – President Ralf Scherschmidt – Portfolio Manager
MANAGEMENT DISCUSSION ON FUND PERFORMANCE
Global equities returned 15.90% in 2020, as measured by the MSCI World Index. Global small-caps, as measured by the MSCI World Small-Cap Index, performed similarly, returning 15.96%. Foreign small-caps underperformed U.S. small-caps, as evidenced by the 12.78% return on the MSCI World ex-USA Small-Cap Index. Internationally, small-cap growth equities outperformed small-cap value by 2035 basis points, with the MSCI World ex-USA Small Growth Index returning 22.93% versus only 2.58% for the MSCI World ex-USA Small-Cap Value Index.
DISCUSSION OF THE INTERNATIONAL OPPORTUNITIES INSTITUTIONAL FUND
The International Opportunities Institutional Fund returned 63.65% versus 22.93% for the MSCI World ex-US Small-Cap Growth Index. The portfolio benefitted from stock selection in Japan and Sweden while stock selection in Canada and the U.K. detracted from performance. On a sector level, the portfolio benefitted from stock selection in information technology and consumer discretionary while performance was negatively impacted by stock selection in utilities and financials. At the stock level, Sinch AB (SINCH SS), Baycurrent Consulting (6532 JT), and Evolution Gaming Group AB (EVO SS) were among the top contributors to performance; Air Canada (AC CN), Redrow PLC (RDW LN) and Capita PLC (CPI LN) were among the top detractors. The fund’s portfolio turnover ratio was 134% and the fund’s expense ratio was 1.10%.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, 2020 data. Expense ratio is the total net annualized fund operating expense ratio. The expense ratio gross of expense offset arrangements and expense reimbursements were 1.13%. Oberweis Asset Management, Inc. (OAM), the Fund’s investment advisor is contractually obligated through April 30, 2021 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 each Fund’s average daily net assets.
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.