Osterweis Strategic Investment (OSTVX)      

By David Snowball

Objective and strategy

The fund pursues the reassuring objective of long-term total returns and capital preservation. The plan is to shift allocation between equity and debt based on management’s judgment of the asset class which offers the best risk-return balance. Equity can range from 25 – 75% of the portfolio, likewise debt. Both equity and debt are largely unconstrained, that is, the managers can buy pretty much anything, anywhere. That means that the fixed-income portfolio might at one point contain a large exposure to high-yield securities and, at another, to Treasuries. The two notable restrictions are minor: no more than 50% of the total portfolio can be invested outside the U.S. and no more than 15% may be invested in Master Limited Partnerships, which are generally energy and natural resources investments.


Osterweis Capital Management. Osterweis Capital Management was founded in 1983 by John Osterweis to manage money for high net worth individuals, foundations and endowments. They’ve got $10 billion in assets under management (as of December 31, 2015), and run both individually managed portfolios and four mutual funds. Osterweis once managed hedge funds but concluded that such vehicles served their investors poorly and so wound them down in 2012. (Their argument is recapped in the “Better Mousetrap” article, linked below.) The firm is privately-held, mostly by its employees. Mr. Osterweis is in his early 70s and, as part of the firm’s transition plan, has been transferring his ownership stake to a cadre of key employees. At least six of the eight co-managers listed below own 5% of more of the adviser.


John Osterweis, Matt Berler and Carl Kaufman lead a team that includes the folks (John Osterweis, Matthew Berler, Alexander “Sasha” Kovriga, Gregory Hermanski, and Nael Fakhry) who manage Osterweis Fund (OSTFX) and those at the Osterweis Strategic Income Fund (Carl Kaufman, Simon Lee and Bradley Kane). The equity team manages over 300 separate accounts; the fixed-income team handles “a small number” of them. The team members have all held senior positions with distinguished firms (Robertson Stephens, Morgan Stanley, and Merrill Lynch).

Strategy capacity and closure

Mr. Kaufman was reluctant to estimate capacity since it’s more determined by market conditions (“in 2008 we could have put $50 billion to work with no problem”) than by limits on the asset classes or team. Conservatively estimated, the fixed-income team could handle at least an additional $4 billion given current conditions.

Active share

“Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio. High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index. An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. Typically active share is calculated only for equity funds, so we do not have a calculation for OSTVX. The equity sleeve of this fund is the same as the flagship Osterweis Fund (OSTFX), whose active share is 94 which reflects a very high level of independence from its benchmark.

Management’s stake in the fund

Four of the eight team members had investments in excess of $1 million in the fund, a substantial increase since our last profile of the fund. The four younger members of the team generally have substantial holdings. As of December 31, 2013, none of the fund’s independent trustees (who are very modestly compensated for their work) had an investment in the fund. Two of the five had no investment in any of the Osterweis funds they oversee.

Opening date

August 31, 2010

Minimum investment

$5000 for regular accounts, $1500 for IRAs and other tax-advantaged accounts.

Expense ratio

1.15% on assets of $304 million (as of December 31, 2014).


Explanations exist; they have existed for all time; there is always a well-known solution to every human problem — neat, plausible, and wrong. H.L. Mencken, “The Divine Afflatus,” New York Evening Mail, 16 Nov 1917.

If you had to invest in a portfolio that held a lot of fixed-income securities which of the following would you prefer, a fund that’s “more conservative than the portfolio’s credit profile suggests,” which “shines when volatility is considered” and its “lowest 10-year Morningstar Risk score” or one that suffers from “a lack of balance,” is “one-sided,” “doubles down on related risks” and “is vulnerable to contractions”?

Good news! You don’t have to choose since those excerpts, all from Morningstar analyst Kevin McDevitt’s latest analyses, describe the exact same portfolio: Osterweis Strategic Income (OSTIX), which serves as the fixed-income portion of the Osterweis Strategic Investment Fund’s portfolio.

How does the same collection of fixed-income securities end up being praised for their excellent low risk score and being pilloried for their riskiness? Start with the dogmatic belief that “investment grade” is always safe and good and that “high yield” is always dangerous and bad. Add in the assumption that the role of fixed-income in a stock/bond hybrid “is to provide ballast” and you’ve got a recipe for dismissing funds that don’t conform to the cookie-cutter.

Neither assumption is universally true which is to say, neither should be used as an assumption when you’re judging your investments.

Is high-yield always riskier than investment grade?


There are two sources of risk to consider: interest-rate risk and credit risk. Investment grade bond investors thrive when interest rates are falling; they suffer loss of principal when interest rates rise. The risk is systemic: all sorts of intermediate-term bonds are going to suffer about equally when the Feds raise rates. Fed funds rate futures are currently forecasting a 50% prospect of a 0.25% rate hike in April and an equal chance of a 0.50% hike by October. Credit risk, the prospect that a bond issuer won’t be able to repay his debt, is idiosyncratic. That is, it’s particular to individual issuers and it’s within the power of fund managers to dodge it. In a strengthening economy, interest rate risks rise and credit risk falls. Because ratings agencies under-react to changing conditions, companies and entire sectors of the economy might have substantially lower credit risk than their “non-investment grade” ratings imply. Mr. Kaufman, one of the managers, reports on the case of “one firm in the portfolio which cut its outstanding debt in half, has lots of free cash flow and was still belatedly downgraded.” Likewise, the debt of energy companies was rated as investment grade while the sector was imploding; now that it has likely bottomed, it’s being reclassified as junk.

The Osterweis team argues that it’s possible to find lots of opportunities in shorter term high yield debt, in particular of companies that are fundamentally stronger than outdated ratings reports recognize. Such firms, Mr. Kaufman argues, offer the best risk-return tradeoff of any fixed income option today:

We invest in fixed-income for absolute return. We’re playing chicken right now, betting that interest rates won’t rise just yet. When the music stops, people are going to get hurt. I don’t like to make bets. I want to control what I can control. Investment grade investors win only if interest rates go lower. Look at what’s going to happen if nothing happens. The yield on the 10-year Treasury is 1.673%. That’s what you would get for returns if nothing happens.

Is fixed-income always the portfolio’s ballast?


There are, broadly speaking, two sorts of funds which mix both stocks and bonds in their portfolios. One sort, often simply called a “balanced” fund, sticks with a mix that changes very little over time: 60% stocks (mostly domestic large caps) plus 40% bonds (mostly investment grade), and we’re done. They tend to be inexpensive, predictable and reassuringly dull. An excellent anchor for a portfolio, at least if interest rates don’t rise.

The second sort, sometimes called an “allocation” fund, allows its manager to shift assets between and within categories, sometimes dramatically. These funds are designed to allow the management team to back away from a badly overvalued asset class and redeploy into an undervalued one. Such funds tend to be far more troubled than simple balanced funds for two reasons. First, the manager has to be right twice rather than once. A balanced manager has to be right in his or her security selection. An allocation manager has to be right both on the weighting to give an asset class (and when to give it) and on the selection of stocks or bonds within that portion of the portfolio. Second, these funds can carry large visible and invisible expenses. The visible expenses are reflected in the sector’s high expense ratios, generally 1.5 – 2%. The funds’ trading, within and between sectors, invisibly adds another couple percent in drag though trading expenses are not included in the expense ratio and are frequently not disclosed.

Why consider these funds at all?

If you believe that the market, like the global climate, seems to be increasingly unstable and inhospitable, it might make sense to pay for an insurance policy against an implosion in one asset class or one sector. One is to seek a fund designed to dodge and weave through the hard times. If the manager is good (see, for example, Rob Arnott’s PIMCO All Asset PASDX, Steve Romick’s FPA Crescent FPACX or Leuthold Core LCORX) you’ll receive your money’s worth and more. Another option would be to use the services of a good fee-only financial planner who specializes in asset allocation. In either case, you’re going to pay for access to the additional “dynamic allocation” expertise.

Why consider Osterweis Strategic Investment?

There are two reasons. First, Osterweis makes sense in an uncertain world. Osterweis Strategic Investment is essentially the marriage of the flagship Osterweis Fund (OSTFX) and Osterweis Strategic Income (OSTIX). OSTFX is primarily a stock fund, but the managers have the freedom to move decisively into bonds and cash if need be. In the last 10 years, the fund’s lowest stock allocation was 60% and highest was 96%, but it tends to have a neutral position in the upper-80s. Management has used that flexibility to deliver solid long-term returns (7.3% over the past 15 years, as of 1/21/2015) with a third less volatility than the stock market’s. Osterweis Strategic Income (OSTIX) plays the same game within the bond universe, moving between bonds, convertibles and loans, investment grade and junk, domestic and foreign. This plays hob with its long-term rankings at Morningstar, which has placed it in three very different categories (convertibles, multi-sector income and high-yield bonds) over the past 10 years but now benchmarks all of its trailing returns as if it had been a high-yield bond fund all along.

For now, the fund is dialing back on its stock exposure. Mr. Kaufman reports:

We can invest 75%/25% in either direction. Our decision to lighten up on stocks now – we’ve dropped near 60% – determined by opportunity set. We’re adding fixed income now because we’re finding lots of great value in the short-term side of the market. Equities might return 6% this year and we think we can get equity-like returns, without equity-like risk, in fixed-income portfolio.

In his recent communication with shareholders, he writes:

We prefer to add risk only when we see a “fat pitch,” of which there are precious few at this time … at current yields there is no investment grade “fat pitch.” Our focus remains on keeping duration short and layering-in higher yielding paper, especially on sharp corrections in the market like we have seen recently. We believe that the appropriate time to take a swing at investment grade bonds will be when yields are much higher and the economy is teetering towards recession.

Second, Osterweis’s expenses, direct and indirect, are more reasonable than most. The 1.15% ratio (as of the most recent prospectus) has been dropping steadily and is at the lower end for an active allocation fund, strikingly so for a tiny one. And the other two Osterweis funds each started around 1.5% and then steadily lowered their expense ratios, year after year, as assets grew. In addition, both funds tend to have lower-than-normal portfolio turnover, which decreases the drag created by trading costs.

Bottom Line

It is easy to dismiss OSTVX because it refuses to play by other people’s rules; it rejects the formulaic 60/40 split, it refuses to maintain a blind commitment to investment grade bonds, its stock sector-, size- and country-weightings are all uncommon. Because rating systems value herd-like behavior and stolid consistency, these funds may often look bad. The question is, are such complaints “neat, plausible and wrong”? The fund’s fixed income portfolio have managed a negative down-market capture over the past 12 years; that is, it rises when the bond market falls, then rises some more when the bond market rises. Osterweis closed down their hedge fund business, concluding that many investors would derive much more benefit, more economically, from using a balanced fund as a significant part of their portfolio. Given reasonable expenses, outstanding management and a long, solid track record, Osterweis Strategic Investment warrants a place on any investor’s due-diligence short list.

Fund website

Osterweis Strategic Investment. There’s a link to a really nicely-reasoned, well-written piece on why, to be blunt, hedge funds are stupid investments. Osterweis used to run one and concluded that they could actually serve their investors better (better risk/return balance, less complexity, lower expenses) by moving them to a balanced fund. The story “A Better Mousetrap” ran in the Inside Information newsletter, September 2014. It gives good insight into how the Osterweis folks think.

© Mutual Fund Observer, 2015. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.
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About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.