ByeBye ZEOIX and ZSRIX

Dave

This just in:

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Important Update on the Osterweis Short Duration Credit and Sustainable Credit Funds
Date: Mon, 02 Oct 2023 18:32:58 -0600

We are writing to let you know we have made the difficult decision to liquidate the Osterweis Short Duration Credit Fund (ZEOIX) and Osterweis Sustainable Credit Fund (ZSRIX). You can read the prospectus sticker that was filed here https://info.osterweis.com/e/504651/-Osterweis-Prospectus-2023-pdf/3l9fmq

Here is an overview of important dates:
-9/29/23: The funds were closed to new investments.
-12/15/23: The funds will liquidate, and any remaining shareholders will receive a cash distribution.

You can redeem at any time and all such sales will be settled T+3. If you are planning to sell shares prior to 12/15/23, please email mailto:[email protected] or call us at (800) 700-3316.

If you have any questions, please let us know.

Best regards,

Carl Kaufman
Co-Chief Executive Officer, Chief Investment Officer - Strategic Income & Managing Director - Fixed Income
Cathy Halberstadt
Co-Chief Executive Officer

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Kind of sudden, but guess it's a good thing I liquidated most of my Osterweis (ZEOIX) holdings earlier...

/dave

ET91

I invested in ZEOIX $ that I inherited after my dad passed away. I was attracted by the absolute return mandate. I ended up losing $. I guess I should have done my homework. I am confused how someone investing in high yield bonds (and some low rated junk bonds) can tout absolute returns. I also owned Third Avenue credit fund. I am even more confused since bonds are higher up than stocks in terms of principal protection but that didn't help Third Avenue credit fund. I seem to find gems in the high yield bond fund universe. Although I didn't invest in Third Avenue until after it started to suffer (both withdrawals and returns). I was attracted by Third Avenue fund returns prior to the beginning of their slump which eventually led to them closing the fund to withdrawals. I tried to avg cost down both ZEOIX and Third Avenue credit fund; that was a huge mistake. I now know what catching a fallen knife means.

yogibearbull

Osterweis bought the ESG-oriented firm Zeo in October 2022 just when the tide was turning against the ESG. Closing is surprising as Osterweis could easily fold small AUMs them into its existing funds; but the people brought along with the acquisition may not have agreed to that. M* didn't help: ZEOIX AUM $73.5 million, M* 1*, Negative; ZSRIX AUM $3.8 million, M* 3*, Negative.
https://www.businesswire.com/news/home/20221011005063/en/Osterweis-to-Include-ESG-Integrated-Fixed-Income-Strategies-in-Product-Suite

msf

bonds are higher up than stocks in terms of principal protection

This sort of principal protection concerns bankruptcy. When a company goes bust, whatever assets it has go first toward paying off debt (bond holders). If the company has anything left over (i.e. if it's net value is positive), the remainder goes to stock holders.



There's also income protection - bond holders get paid interest (if possible); only if there is money left do stockholders get paid divs.

TFCVX (Focused Credit Fund) owners were hurt when it was forced into fire sales because people wanted to redeem shares and the mostly illiquid bond assets could not be sold except at huge discounts.

Liquidity Risk. Liquidity risk exists when particular investments are difficult to sell. The Fund may not be able to sell these investments at the best prices or at the value the Fund places on them. Investments in private debt instruments, restricted securities, and securities having substantial market and/or credit risk may involve greater liquidity risk.

Summary Prospectus, 2014

Nevertheless, it ultimately had an 85% recovery rate. This was helped by closing down redemptions to allow it to sell off assets gradually at better prices.
https://focusedcreditfund.com/
https://www.morningstar.com/funds/third-avenue-focused-credit-abruptly-shuttered

M* didn't help: ZEOIX AUM $73.5 million, M* 1*; Negative

M* groups RPHYX and ZEOIX, two short term HY funds, with "regular" (intermediate/long term) HY funds. That results in lower star ratings than they deserve and a negative medalist rating. But that doesn't seem to have hurt RPHYX.

ZEOIX always had risk. @dtconroe noted in Jan 2020 that "in the toughest downmarket for the 2 funds (2015/2016), RPHYX showed almost no dip, compared to a slight dip for ZEOIX". That was posted just before this greater risk was dramatically brought home. Between Feb 21, 2020 and March 24, 2020, ZEOIX lost 14.1% vs. a 2.8% loss by RPHYX. (JNK dropped 21.1%).

Still, it wasn't until 4Q 2022 that assets left in droves (from M*'s ZEOIX performance page). Not because the fund underperformed its category (top quartile for the year, per M*). Perhaps because that's when the fund was sold to Osterweis.

TheShadow

Here is the link to the most recent shareholder letter:

https://www.osterweis.com/files/Osterweis_Prospectus_2023.pdf

https://www.sec.gov/Archives/edgar/data/811030/000089418923007341/osterweis497eliquidation9-.htm

Shostakovich

Uh...I don't get it. I thought Osterweis was a solid, even conservative, research-oriented shop. This seems like a pretty major mess-up & inability to properly evaluate a business.

sma3

I read about ZEOIX here, of course. I thought it might be close to a cash equivalent because at the time RHPIX was closed

However there were several drawdowns where the NAV dropped 2 or 3% in a couple of days so I was concerned enough to call them. They said it was all because the bonds in the portfolio traded so infrequently they had to estimate their value, at at times this value dropped, but because they were such short term bonds, it would soon be made whole. This sorta made sense until you realize with large withdrawals they have to sell regardless of the price. I decided to bail.

The Same issues should be true of RHPIX unless they focus only on bonds that are very close to maturity

msf

focus only on bonds that are very close to maturity

That seems a bit excessive. Even MMFs can have debt that doesn't mature for 397 days. One only needs enough liquidity to meet redemptions. The SEC is increasing liquidity requirements for MMFs from 10% to 25% for daily liquidity and from 30% to 50% for weekly liquidity. MMFs are not entirely liquid; they don't have to be.
https://www.federalregister.gov/d/2023-15124/p-453

Average effective maturity of RPHYX is around 5 months. This is significantly longer than MMFs. I'm not suggesting otherwise, just that the portfolio has adequate assets close enough to maturity to address concerns. Probably

FWIW, ZEOIX has an "average life" of 2.34 years. Quite a difference.
https://riverparkfunds.com/assets/pdfs/rpsthyf/RiverPark_Short_Term_High_Yield_Fund_Fact_Sheet.pdf
https://www.osterweis.com/mutual_funds/short_duration_credit/portfolio

RPHIX has an additional out - it can reopen the fund. Currently it is soft closed - a new investor can open an account only directly with the fund.

David_Snowball

We can hope that Charles will weigh in here, since he knew the folks at Zeo better than most. My observation is that Zeo had a promising start and that Venk was a passionate advocate for it. Things turned south when his co-manager (Brad, I think) left the shop and returned to Canada. Suffering ensued. I suspect that Venk approached Osterweis, hopeful that dumping the back office part of the job would allow performance and assets to rebound. They took a chance. It did not work out. They're cutting their losses.

All of which is speculative. Folks never want to talk about failed partnerships, so I'm trying for an educated guess.

ET91

Thank you msf for your explanations. So if I understand it correctly, a company can default on its high yield bond and not file for bankruptcy. Sorry for being a novice. Venk mentioned in his latest (I think) report that he is exploring options to recover some lost $. I guess with covenant light bonds, shareholders aren't protected. Thanks again.

msf

A debtor files for bankruptcy voluntarily. The idea behind voluntary bankruptcy is to protect the debtor, to provide breathing space for the debtor to restructure or start over.
https://www.law.cornell.edu/wex/voluntary_bankruptcy

OTOH, creditors can under some circumstances force a debtor into involuntary bankruptcy.
https://www.justia.com/bankruptcy/involuntary-bankruptcy/

Hypothetically, a debtor might be solvent but simply choose to stiff his lawyers, his contractors, his employees, etc. Regardless of solvency, his creditors might try to force him into bankruptcy. But the debtor is likely to argue that the amounts owed are in dispute, which is a defense against involuntary bankruptcy.

So more often, the creditors just sue. Or they might try to work some arrangement out with the debtor. From what you wrote, it sounds like ZEOIX is working those angles.

Covenants are basically conditions that a lender imposes on a borrower before lending money. A simple example: before a bank will issue you a mortgage, it will require you to have homeowners insurance. In this way it protects its security interest (the real estate) but that does little to ensure timely mortgage payments.

Conversely, breaching covenants doesn't necessarily mean that payments are missed.

DEFAULT – A failure to pay principal of or interest on a bond when due or a failure to comply with other covenant, promise or duty imposed by the bond contract. The most serious event of default, sometimes referred to as a “monetary” default, occurs when the issuer fails to pay principal, interest or other funds when due. Other defaults, sometimes referred to as technical or non-payment defaults, result when specifically defined events occur, such as failure to comply with bond contract covenants, failing to charge rates sufficient to meet rate covenants, failing to maintain insurance on the project or failing to fund various reserves. Generally, if a monetary default occurs or if a technical default is not cured within a specified period (usually after notice) such default becomes an event of default and the bondholders or trustee may exercise legally available rights and remedies for enforcement of the bond contract.

MSRB Glossary of Municipal Securities Terms

yogibearbull

Games people play with defaults/bankruptcy, Twitter LINK

"When a large player like Brookfield defaults on a $300M office loan they just hand the keys to the bank...

The bank then has two options:

1. Sell the property at a significant discount (let's say $200M)
2. Add value to the property themselves then sell it

Most banks choose option 1

But how many buyers do you think are out there for distressed $200M office buildings?

Not many. Enter Brookfield again...

Yes, companies like Brookfield will default on a loan (with no recourse), hand back the keys, then buy the same asset back for a huge discount.

Pretty crazy if you ask me."

msf

Not exactly.

The bank then has two options:
1. Sell the property at a significant discount (let's say $200M)
2. Add value to the property themselves then sell it

Assuming the lender perfected its security interest (i.e. did a UCC 9 filing to put the world on notice that it had a type of lien on the property), then in #1, the buyer would get the property subject to a $300M lien.

how many buyers do you think are out there for distressed $200M office buildings
None, and even fewer (if that were possible) who would buy a $200M office building with a $300M lien against it. Even for $1. That $200M sale ain't a-gonna happen.

As far as walking away from the loan (neither option 1 nor option 2) goes, it is premised on at best a somewhat incomplete understanding of non-recourse loans. Most loans aren't.

WHERE ARE NON-RECOURSE LOANS USED?
These loans are often used to finance commercial real estate projects and other projects that include an extended completion period. In the case of real estate, the land acts as collateral for the loan. A non-recourse loan is also used in financial industries, with securities placed as collateral.

HOW DO I QUALIFY FOR NON-RECOURSE LOANS?
Clearly, the majority of the risk and exposure with non-recourse loans rests with the lender. Therefore, a non-recourse loan may be more difficult to qualify for than a recourse loan. Commercial lenders will often only extend non-recourse loans to finance certain types of properties and only to worthy borrowers. Stable finances and an excellent credit score are two of the most important factors that a lender will look at. Generally, the loan requires the property to be a larger city, be in good condition, and have good historical financials, too.

https://fidelityca.com/non-recourse-loan-financing/

If a large player walks away from a debt, especially one that it could pay, its reputation will be mud for a long time. Most players won't risk their reputation. Though there are exceptions, and they might get lucky - they might find "a reckless institution willing to do business with clients nobody else would touch."

Historically, non-recourse mortgages arose out of the Great Depression. They made the news in the 1990s when several regional real estate markets collapsed and so many homeowners who were underwater simply walked away.

Non-recourse loans are a unique characteristic of the US mortgage market and first emerged in state legislation in the 1930s. A decrease in demand for real estate and the ensuing precipitous drop in prices during the Great Depression led to the realization of mortgages at minimal prices, significantly below their outstanding balances. As a result, not only did borrowers lose the roofs over their heads to lenders but also faced lawsuits by the same lenders for the significant remainder of their debt. This harsh reality caused many states to adopt borrower-friendly legislation. ... In effect it gave the borrower a put option

https://scholarship.law.nd.edu/jleg/vol42/iss2/2/

There are roughly a dozen non-recourse states, the largest of course being California. But it's not so simple there. A bank may execute a non-judicial foreclosure, bypassing the courts and getting a relatively quick sale. If it follows this path, it has no recourse for any deficiency (shortfall). This is the norm for small potato mortgages (I suppose that means $3M homes in California).

However, a bank is not likely to let a creditor with deep pockets like Brookfield simply walk away with a $100M deficiency. It will go through the courts. In California, judicial foreclosures are not non-recourse (pardon the double negative).

Commercial Mortgage Foreclosure (CA), Practice Note, Alston and Bird LLP (14 pages)

Yes, companies like Brookfield will default on a loan (with no recourse), hand back the keys, then buy the same asset back for a huge discount.

Pretty crazy if you ask me

Yes, the idea that they will, or even can, do this is pretty crazy.

Charles

Wow.

Charles

Brad Cook.