Objective and Strategy
The fund pursues long-term capital appreciation by investing in international stocks, which might include companies headquartered in the US but having more than half of their business outside of the US. The vast bulk of the portfolio – 85% or so – are in small- to mid-cap stocks and about 5% is in cash. They will generally invest fewer than 25% of their assets in emerging markets.
Oberweis Asset Management Inc. Established in 1989, OAM is headquartered in suburban Chicago. Oberweis is an independent investment management firm that invests in growth companies around the world. It specializes in small and mid-cap growth strategies globally for institutional investors and its six mutual funds. They have about $700 million in assets under management.
Ralf A. Scherschmidt, who has managed the fund since its inception. He joined Oberweis in late 2006. Before that, he served as an equities analyst at Jetstream Capital, LLC, a global hedge fund, Aragon Global Management LLC, Bricoleur Capital Management LLC and NM Rothschild & Sons Limited. His MBA is from Harvard, while his undergrad work (Finance, Accounting and Chinese) was completed at Georgetown. Ralf grew up and has work experience in Europe and the UK, and has also lived in South Africa, China and Taiwan. Mr. Scherschmidt oversees nearly $200 million in five other accounts. He’s supported by three analysts who have been with Oberweis for an average of six years.
Strategy capacity and closure
Oberweis manages between $300-400 million dollars using this strategy, about 25% of which is in the fund. The remainder is in institutional separate accounts. The total strategy capacity might be $3 billion, but the advisor is contractually obligated to soft-close at $2.5 billion. They have the option of soft closing earlier, depending on their asset growth rate. Oberweis does have a track record for closing their funds early.
Management’s Stake in the Fund
As of December 31, 2012, Mr. Scherschmidt had between $100,000-500,000 invested in the fund. Three of the fund’s four trustees have some investment in the fund, with two of them being over $10,000. As of March 31, 2013, the officers and Trustees as a group owned 5.07% of the fund’s shares.
February 1, 2007.
$1000, reduced to $500 for IRAs and $100 for accounts established with an automatic investing plan. The fund is available through all major supermarkets (E Trade, Fidelity, Price, Schwab, Scottrade, TD Ameritrade and Vanguard, among others).
1.6% on assets of $78 million (as of September 2013)
This is not what you imagine an Oberweis fund to be. And that’s good.
Investors familiar with the Oberweis brand see the name and immediately think: tiny companies, high growth, high valuations, high volatility, high beta … pure run-and-gun offense. The 76% drawdown suffered by flagship Oberweis Emerging Opportunities (OBEGX) and 74% drop at Oberweis Microcap (OBMCX) during the 2007-2009 meltdown is emblematic of that style.
OBIOX isn’t them. Indeed, OBIOX in 2013 isn’t even the OBIOX of 2009. During the 2007-09 market trauma, OBIOX suffered a 69.7% drop, well worse than their peers’ 57.7% decline. The manager was deeply dissatisfied with that performance and took concrete steps to strengthen his risk management disciplines. OBIOX is a distinctive fund and seems to have grown stronger.
The basic portfolio construction discipline is driven by the behavioral finance research. That research demonstrates that people, across a range of settings, make very consistent, predictable errors. The management team is particularly taken by the research synthesized by Dan Ariely, in Predictably Irrational (2010):
We are not only irrational, but predictably irrational … our irrationality happens the same way, again and again … In conventional economics, the assumption that we are all rational implies that, in everyday life, we compute the value of all the options we face and then follow the best possible path of action … But we are really far less rational than standard economic theory assumes. Moreover, these irrational behaviors of ours are neither random nor senseless. They are systematic and, since we repeat them again and again, predictable.
This fund seeks to identify and exploit just a few of them.
The phenomenon that most interests the manager is “post-earnings announcement drift.” At base, investors are slow to incorporate new information which contradicts what they already “know” to be true. If they “know” that company X is on a downward spiral, the mere fact that the company reports rising sales and rising profits won’t quickly change their beliefs. Academic research indicates, it often takes investors between three and nine months to incorporate the new information into their conclusions. That presents an opportunity for a more agile investor, one more adept at adapting to new facts, to engage in a sort of arbitrage: establish a position ahead of the crowd and hold until their revised estimations close the gap between the stock’s historic and current value.
This exercise is obviously fraught with danger. The bet works only if four things are all true:
- The stock is substantially mispriced
- You can establish a position in it
- Other investors revise their estimations and bid the stock up
- You can get out before anything bad happens.
The process of portfolio construction begins when a firm reports unexpected financial results. At that point, the manager and his team try to determine whether the stock is a value trap (that is, a stock that actually deserves its ridiculously low price) or if it’s fundamentally mispriced. Because most investors react so slowly, they actually have months to make that determination and establish a position in the stock. They work through 18 investment criteria and sixteen analytic steps in the process. From a 4500 stock universe, the fund holds 50-90 funds. They have clear limits on country, sector and individual security exposure in the portfolio. As the stock approaches 90% of Oberweis’s estimate of fair value, they sell. That automatic sell discipline forces them to lock in gains (rather than making the all-too-human mistake of falling in love with a stock and holding it too long) but also explains the fund’s occasionally very high turnover ratio: if lots of ideas are working, then they end up selling lots of appreciated stock.
There are some risk factors that the fund’s original discipline did not account for. While it was good on individual stock risks, it was weak on accounting for the possibility that there might be exposure to unrecognized risks that affects many portfolio positions at once. Oberweis’s John Collins offered this illustration:
If we own a Canadian chemical company, a German tech company and a Japanese consumer electronics firm, it sounds very diversified. However, if the Canadian company gets 60% of their revenue from an additive for rubber used in tires, the German firm makes a lot of sensors for engines and the Japanese firm makes a lot of car audio and navigation systems, there may be a “blind bet” in the auto sector we were unaware of.
As a result, a sudden change in the value of the euro or of a barrel of crude oil might send a shockwave rippling through the portfolio.
In January 2009, after encountering unexpectedly large losses in the meltdown, the fund added a risk optimizer program from Empirical Research Partners that performs “a monthly MRI of the portfolio” to be sure the manager understands and mitigates the sources of risk. Since that time, the fund’s downside capture performance improved dramatically. It used to be in the worst 25% of its peer group in down markets; it’s now in the best 25%.
This remains, by all standard measures, a volatile fund even by the standards of a volatile corner of the investment universe. While its returns are enviable – since revising its risk management in January 2009, a $10,000 investment here would have grown to $35,000 while its average peer would have grown to $24,000 – the right question isn’t “have they done well?” The right questions are (1) do they have a sustainable advantage over their peers and (2) is the volatility too high for you to comfortably hold it? The answer to the first question is likely, yes. The answer to the second might be, only if you understand the strategy and overcome your own behavioral biases. It warrants further investigation for risk-tolerant investors.