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A Fund Firm Where Downside Is as Important as Upside

Osterweis knows steep losses can kill a fund and tries to avoid them.

Dan Culloton, 08/12/2010

Osterweis--a firm founded and run by a seasoned investor and backed by another pretty good investor.

John Osterweis was a professional analyst and money manager for more than a decade before opening his eponymous firm in 1983 with the financial backing of running buddy and private-equity investor Warren Hellman, founder of Hellman & Friedman. The firm focused on private accounts for about a decade before launching its first mutual fund, Osterweis OSTFX, in 1993. The firm has launched just one fund since, Osterweis Strategic Income OSTIX, a fixed-income fund, in 2002, though it recently filed papers with the Securities and Exchange Commission to launch a fund that combines its stock and bond strategies in one package. The firm also has a couple of hedge funds.

Brother-in-Law Funds
Investing, not asset gathering, seems to drive this firm. It originally started its first mutual fund for relatives of its wealthy clients who couldn't meet the minimum investments for separate accounts (sometimes referred to as a brother-in-law fund in money-management parlance). It waited about a decade before hiring someone to market the fund to fee-only financial advisors. The firm also has shunned the No Transaction Fee marketplaces of brokers, such as Charles Schwab (though the fund is available at many of them for a fee), and claims to have turned down acquisition offers from larger firms partly out of fear of compromising strategy and performance by growing too fast.

The firm has grown steadily on its own since its early days, but it's still small by money-management standards, with about $4 billion in assets across all its funds and accounts. Asset bloat is not a major concern here yet, though Osterweis has been willing to control assets by closing other accounts at times and by imposing 2% redemption fees on shares sold within 30 days on its funds.

Perhaps because of its long experience dealing with affluent investors, who tend to be more high maintenance than retail investors, the firm is client-focused. This is exemplified in regulatory disclosures and shareholder communications that are concise and informative, and supplemented with quarterly conference calls for advisors, analysts, and consultants. The managers typically discuss portfolio positioning, individual securities, their market outlook, and other issues.PAGEBREAK

The source of Osterweis' culture, though, is Osterweis himself. He's a confident investor and businessman. When he was a young sell-side broker and analyst, Osterweis said he secured the confidence and ear of legendary investor Roy Neuberger by telling him that he was wrong about a stock and should sell it. Osterweis built his firm by doing a few things well--focusing on fundamental research and stock-picking, investing with conviction, avoiding unnecessary trading, and not losing money for clients. Both the equity and fixed-income fund lost less than market and their respective category peers in 2008. The funds will lag peers in some up markets, but Osterweis is OK with that as long as the end result is solid absolute long-term returns. So far, that is what it has done. Osterweis' nearly 11% 15-year annualized gain through Aug. 3, 2010, beats the returns of the market and typical category peer by wide margins. Strategic Income's more than 7% five-year gain is very competitive as well. 

The key to the firm's continued success will be Osterweis' ability to attract and retain people who share his approach. So far, Osterweis has been able to find people with sound credentials. The five other members of the stock fund's team, for example, include a former sell-side analyst from Morgan Stanley and former buy-side analysts and managers from American Funds advisor Capital Group and Franklin Templeton Investments. Osterweis and Hellman are still the biggest shareholders of the firm, but all of the managers also have ownership stakes in the firm, and their interests should grow as Osterweis and Hellman step back.

The Next Generation
The firm's biggest challenge will be maintaining its culture as it grows. Osterweis is fit and shows no sign of slowing down, but he's conscious of the need to prepare for the next generation. So far, he has been able to attract a mix of experienced and new people who either share or can be inculcated with his investment approach and hasn't been afraid to make changes when employees don't seem to fit. He often holds up firms like San Francisco neighbor Dodge & Cox as his ideal of multigenerational cultural consistency. Time will tell if Osterweis the firm can achieve that kind of longevity and success. In many important ways, however, the firm has shown it is focused on the long-term interest of its fund owners. In recent years, for example, it has put breakpoints into its management fee schedules that will lower the expense ratios of its funds as assets grow. Such actions bode well for the future.

Dan Culloton is an associate director of fund analysis for Morningstar.

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