For the calendar year 2021, U.S. equity markets performed extremely well. During the latter part of the fourth quarter, however, investors anticipating a correction of recent equity gains in combination with the emergence of the coronavirus omicron variant unsettled markets, triggering sharp selloffs and periods of intense volatility. At the start of the new year, fears regarding the highly transmissible variant, combined with continued supply-chain constraints, rising inflation and a hawkish shift regarding U.S. monetary policy have, once again, made many investors nervous about the prospect of slower economic growth restraining future equity returns. We expect investor nervousness and questions about the strength and pace of economic recovery are likely to continue causing periods of increased market volatility. Despite these challenges, as the somewhat uneven economic recovery continues, we believe the market should continue focusing primarily on company fundamentals, favoring high-quality companies with unique business models, competitive advantages, dependable cash flow, above average returns and sound balance sheets selling at prices which are not correctly valuing the company’s future ability to generate excess free cash flow. These valuation inefficiencies are often caused by temporary problems which investors feel will never end, negative market psychology or just plain misperceptions. The market leadership for the last three years has emphasized fundamentals and valuation. The recent market correction has resulted in many more free cash flow companies falling into the fundamentally undervalued category. For example, the All Cap Value Fund had an approximately 18% cash position at the top of the recent pandemic rally is now down to approximately 5%, as we have restocked the portfolio with what we believe are high quality free cash flow fundamental value plays that moved into our price range during the recent correction.
Our Strategies
Since the inception of the All Cap Value Fund (year end 1995), we have remained focused on analyzing individual companies, their operations and more importantly their prospects for generating and or growing free cash flow. Our stock selection process is an accounting driven approach that emphasizes looking behind the numbers of financial statements, footnotes, management disclosures, and S.E.C filings to identify companies selling below intrinsic value. We focus on the generation and growth of future free cash flow to determine intrinsic value. The word “future” is the key word. We are market neutral and long-term value investors. We read financial statements for heat looking for clues that a company’s ability to generate future free cash flow may be over or undervalued by the investing public when compared to the company’s current market price. Market prices and values can be drastically different, and we will continue to utilize fundamental analysis to alert us to potential discounts. We fundamentally value high growth companies according to the same metrics and inferential financial statement analysis that we apply to low growth and cyclical companies looking for undervaluation. Our selection process is limited to whether or not the market prices of the high growth companies are undervaluing the high P/E companies’ future free cash flow not P/E ratios. It is significant to note, for example, that companies such as Apple, Google, etc., have been key contributors to the All Cap Value Fund’s long-term appreciation. We search for value and believe growth is a component of value, not a separate asset class. We are market neutral whereas many investors utilize market timing in their investment process and are heavily influenced by short-term market calls, temporary problems, or just plain misinformation. Our Funds’ portfolios consist of companies that we believe are priced at a material discount to their future ability to generate and or grow long-term future free cash flow.
In addition, we believe these companies have discernable balance sheet strength and competitive advantages. As long-term value investors, since our inception we have been market neutral and will continue to focus on the analysis of individual companies with our own staff of seven professionals having cumulative experience of over 100 years. We believe since the bottom of the pandemic the market is paying more attention to company fundamentals when valuing companies. We believe our expertise in accounting and looking behind the numbers of financial statements (a lost art) should give our Funds an advantage in finding value opportunities. To repeat, we define value opportunities as companies with material differences between a company’s market price and a company’s intrinsic value (defined by a company’s ability to generate and or grow future free cash flow). As long-term value investors, we have the patience to wait for the catalyst that we identified via a forensic analysis of financial statements that should eventually close the discount between private market value and public market prices. We have a strict sell discipline when our predictions are incorrect. We believe the number and severity of our losses are key determinants of our long-term performance and spend a lot of time discussing the probability of permanent loss. We do not define volatility as risk. Volatility provides the opportunities to find undervaluation and sell overvaluation.
The ability to predict the overall market consisting of thousands of stocks all with different fundamentals, balance sheets, management philosophies, and industry issues with enough precision and regularity to profit therefrom, in our opinion, would be the only thing you would need to know to be the most successful and wealthiest money manager in the world. We believe attempts to accomplish this feat is similar to Ponce De Leon’s attempt to discover the Fountain of Youth, yet every day the media, market strategists, and hedge funds present their short and long-term predictions. The professional who has made the latest correct market call is anointed as an expert capable of moving markets until they are given money to manage utilizing their newfound powers. Although we are market neutral investors, our strategy reacts to the volatility created by these calls, looking for material price movements that have little to do with long-term fundamental intrinsic values. The next bad call by the recently anointed market geniuses’ usually results in a new guru soon thereafter.
We do not believe in conventional timing of markets or stocks. Our timing comes from paying the right price and is also our attempt to control downside risk. We believe playing against the volatility of extreme market moves creates the most and best opportunities to find discounted high-quality securities for the portfolio and to liquidate fully valued securities. In our opinion, volatility is a value investor’s best friend. We never know exactly when discounts will begin to close.. We believe attempts to time purchases and sales of our Fund based on conventional market timing techniques increases the chances of underperforming the Funds’ results. Our Funds have often underperformed as we were accumulating bargains during periods of negative market psychology, temporary problems affecting an industry or company, or just plain misperception.
We believe our unique inferential analysis of financial statements and investment discipline to identify undervalued companies in combination with assessing risk gives our Funds an advantage in the volatile environment we foresee going forward. Volatility is not a definition of risk and cannot be controlled. Paying the right price is not only our attempt to increase the probability of achieving our capital gains objectives but to limit risk and often involves buying the downside volatility and selling the upside volatility.
In 2022, we will continue to focus on those companies that demonstrate a commitment to maintaining a strong financial position and have the potential to deliver long-term free cash flow that is not being properly valued by the market. We will seek to capitalize on periods of market volatility to buy such companies at advantageous prices and sell companies that become fully valued or overvalued. Our cash position has generally gone down in down markets and up in good markets. The direction of our cash balances goes against common sense. Free cash flow companies tend to compete profitability during both favorable and challenging economic environments. Our cash levels are determined by the size of the discounts on companies we own or are interested in buying and not by market timing. In fact, our cash balances have generally gone in the opposite direction of market timers
Many investors are heavily influenced and react to stock market prognostications via the media and Wall Street strategists making definitive stock market calls. Understandably, the negative market psychology creates the pressure to liquidate during periods of market weakness and/or underperformance (precisely at the time we often found bargains). We believe super imposing market timing on the Funds’ long-term value-based investment discipline increases the odds of a shareholder not achieving the Fund’s long-term capital gains results. Of course, patience is required by the Funds to wait for the market psychology to change in order to achieve the gains that resulted from the eventual elimination of these undervaluation discounts. For example, see the chart on page 12 that reflects how a patient investor who invested in the All Cap Value Fund at its inception through December 31, 2021 faired.
THE OLSTEIN ALL CAP VALUE FUND
For the full calendar year ended December 31, 2021, Adviser Class shares of the Fund appreciated 26.32%; load-waived Class C shares appreciated 25.08% and load-waived Class A shares appreciated 26.00%.1 The Fund’s primary benchmark, the Russell 3000® Value Index, appreciated 25.37% during calendar year 2021, and its secondary benchmark, the Russell 3000® Index, appreciated 25.66%. For the six-month reporting period ended December 31, 2021, Adviser Class shares of the Olstein All Cap Value Fund appreciated 3.50%, load-waived Class C shares appreciated 2.98% and load-waived Class A shares appreciated 3.35%. During the same six-month period, the Russell 3000® Value Index appreciated 6.54% and the Russell 3000® Index appreciated 9.17%.
PORTFOLIO REVIEW
As of December 31, 2021, the Olstein All Cap Value Fund portfolio consisted of 83 holdings with an average weighted market capitalization of $163.91 billion. During the six-month reporting period, the Fund initiated a position in Hormel Foods Corporation (HRL, Financial) and eliminated its holdings in four companies. During the reporting period, the All Cap Value Fund sold its holdings in Accenture plc (ACN, Financial), Aon plc (AON, Financial), Keysight Technologies (KEYS, Financial) and Lowes Companies (LOW, Financial). The Fund eliminated these holdings from the portfolio as the price of each company’s stock reached its valuation level.
Our Leaders
The Olstein All Cap Value Fund’s leading performers for the six-month reporting period ended December 31, 2021, include: Dollar Tree, Inc. (DLTR, Financial), Jones Lang LaSalle Inc. (JLL, Financial), Aon plc, Quest Diagnostics (DGX, Financial) and Apple Inc. (AAPL, Financial). At the close of the calendar year the Fund continued to maintain positions in Dollar Tree, Inc., Jones Lang LaSalle Inc., Quest Diagnostics and Apple Inc. The Fund liquidated its position in Aon as the price of the company’s stock reached our valuation level.
Our Laggards
Laggards during the six-month reporting period include: ViacomCBS, Discovery Inc., Zimmer Biomet Holdings (ZBH, Financial), Southwest Airlines (LUV, Financial), and WestRock Company (WRK). At the close of the reporting period the All Cap Value Fund maintained positions in all five of these companies.
THE OLSTEIN STRATEGIC OPPORTUNITIES FUND
For the full calendar year ended December 31, 2021, Adviser Class shares of the Fund appreciated 21.99%, load-waived Class A shares appreciated 21.62% and load-waived Class C shares appreciated 20.73%.2 During the same twelve-month period, the Fund’s primary benchmark, the Russell 2500® Value Index appreciated 27.78%, and its secondary benchmark, the Russell 2500® Index appreciated 18.18%.
For the six-month reporting period ended December 31, 2021, Adviser Class shares of the Strategic Opportunities Fund depreciated 1.63%, load-waived Class A shares depreciated 1.80% and load-waived Class C shares depreciated 2.17%. The Fund’s primary benchmark, the Russell 2500® Value Index, appreciated 4.16% and the Fund’s secondary benchmark, Russell 2500® Index appreciated 1.04%, during the same time period.
PORTFOLIO REVIEW
As of December 31, 2021, the Olstein Strategic Opportunities Fund portfolio consisted of 40 holdings with an average weighted market capitalization of $6.40 billion. During the reporting period the Fund eliminated its holdings in Keysight Technologies, Korn Ferry (KFY) and UFP Technologies (UFPT) as the price of each company’s stock reach our valuation level. During the reporting period, the Fund initiated and eliminated its position in multi-brand fitness company, Nautilus Inc. (NLS). The Fund sold its position in Nautilus as supply chain constraints and inflationary pressures in a highly competitive environment changed our near- and medium-term cash flow projections for the company, undercutting our original investment thesis and valuation.
Our Leaders
Leading performers for the six-month reporting period include: Jones Lang LaSalle, The Shyft Group (SHYF), WESCO International (WCC), CoreCard Corporation (CCRD), and Wabash National Corporation (WNC). At the close of the calendar year the Fund continued to maintain positions in all five of these companies.
Our Laggards
Laggards during the six-month reporting period include: Blue Bird Corp (BLBD), Nautilus Inc., Big Lots, Inc. (BIG), Johnson Outdoors Inc (JOUT), and Discovery Inc. (DISCK). At the close of the year the Strategic Opportunities Fund maintained positions in Blue Bird Corp, Big Lots, Inc., Johnson Outdoors Inc, and Discovery Inc. As previously discussed, the Fund liquidated its holding in Nautilus Inc.
DEALING WITH UNCERTAINTY
With the highly transmissible COVID omicron variant, continued supply-chain constraints, rising inflation and a hawkish shift regarding U.S. monetary policy, fueling fears of slower economic growth and an equity market correction, we believe it is important to weather such negative news and events by focusing on the equities of financially strong companies with stable or growing free cash flow.
In the face of increased volatility, how should equity investors respond? Messages such as “stick to your long-term investment plan” or “stay in the market for the long haul” may sound like worn clichés and fall on deaf ears, especially when markets stagnate or decline. This is especially true for investors in the types of companies that we favor – undervalued companies that are either overlooked, misunderstood, face unique strategic challenges and choices, or whose stock prices suffer disproportionately from an overreaction to short-term results or overall negative market sentiment. Such companies tend to get hit hard in the face of market uncertainty as investors seek what they believe are safer options or better or more exciting opportunities.
Dealing with Uncertainty by Focusing on Fundamentals
Our method of dealing with the uncertainty of equity markets is to remain focused on company fundamentals, the quality of a company’s earnings and its ability to generate free cash flow as market volatility increases and doomsayers predict the next downturn. Since we value companies based on their ability to generate free cash flow, our approach focuses on company fundamentals and operations in all market and economic environments. We not only develop a thorough understanding of how each company’s operations generate sustainable free cash flow under good or bad economic conditions; we also seek to answer a series of questions about the company’s business model, its strategy, its future prospects and its management when faced with uncertain economic conditions.
We develop a thorough understanding of each company through two important analytical approaches: a bottoms-up fundamental analysis of a company’s financial statements (balance sheet, income statement and cash flow statement), and an ongoing forensic analysis of regulatory filings and other disclosures (10K, 10Q, proxy filings, annual reports, public announcements, and other regulatory filings). The objective of our fundamental analysis is to understand the company’s business model and how the company’s operations generate free cash flow under all economic scenarios. We also want to understand the level of ongoing investment that is required to maintain or grow the company’s free cash flow and ultimately how much of the cash generated by a company’s operations likely will be returned to us as investors. The objective of our forensic analysis is to determine if a company’s accounting policies and practices reflect economic reality, to identify and make accounting adjustments that eliminate management’s reporting bias, and to identify positive or negative factors that may affect future free cash flow.
We believe our ongoing forensic analysis of a company’s public filings and communications serves us well during periods of increased market volatility or economic trouble and is, in our opinion, more useful than short-term economic or market forecasts. When markets become more irrational and volatile, we believe our forensic analysis provides us with the necessary knowledge to judge the likely success of a company’s strategy and the sustainability of its performance. We also believe that such ongoing analysis is vital when evaluating and monitoring investments in companies facing unique strategic choices for two reasons: (1) it allows us to assess the nature and likely duration of strategic challenges and/or problems; and (2) it allows us to judge the quality, effectiveness and skill set of the management team in the face of adverse circumstances and provides us with the patience to stay the course. In our opinion, patience is a value investor’s best attribute and is encouraged by the balance created from knowing what you own.
Dealing with Uncertainty by Taking Advantage of Market Volatility
Another way we deal with market uncertainty is to focus on the compelling investment opportunities that rocky market conditions create. Short-term market volatility usually presents significant buying opportunities that enables us to strategically position our portfolios for potentially greater long-term gain. As emotion and negative sentiment contribute to falling stock prices, we are in a better position to identify quality companies trading at a significant discount to their intrinsic value by focusing on company fundamentals — particularly the quality of earnings and a company’s ability to generate sustainable future free cash flow.
From our perspective, Wall Street’s obsessive focus on short-term concerns has increased deviations between a company’s stock price and our estimate of its intrinsic value. Investors reacting to the daily noise and news create favorable opportunities for the Olstein Funds to buy companies with solid balance sheets and business models that generate excess cash flow at bargain prices. We believe that our investment approach, which attempts to avoid long-term impairment of capital while providing shareholders with the potential to realize long-term capital appreciation, is suited to all economic environments. Although unfavorable economic or market conditions may cause short-term downward price movements, we believe that by focusing on understanding a business, its potential to generate sustainable free cash flow and ultimately its value we can achieve our Funds’ investment objectives of long-term capital appreciation. After identifying companies that meet well-defined investment criteria, we seek to take advantage of market volatility and downward price movements to buy such companies at advantageous prices that we believe will increase the probability of a successful investment.
FINAL THOUGHTS
While we are concerned with the overall economic environment and outlook and recognize that macro-economic factors and other newsworthy events can exert extreme short-term influence over equity prices from time to time, we are more concerned with how individual companies operate under all types of economic conditions and cycles. We believe it is an important job of company management to adequately anticipate and plan for the impact of economic shifts on their business and their ability to generate sustainable free cash flow. From our focused analysis, we judge a company’s resiliency in the face of macro-economic shocks and shifts and incorporate that judgment into our normalized cash flow projections.
Over the past twenty-five years we have identified many companies that have successfully navigated turbulent economic times to adapt, invest, grow, and restructure for the future. As short-term economic news and events overwhelm equity markets from time to time, it is important to remain balanced and focused as we take advantage of the short-term noise affecting individual stock prices which we believe have little to do with long-term values. As value investors, we require patience to take on a balanced perspective of the equity markets. Both of our Funds utilized the extreme market volatility caused by the pandemic to take advantage of high-quality free cash flow companies being offered at what we believe were material discounts. Throughout our 27-year history we have experienced other investment panics which resulted in significant short-term declines, and we have weathered the storms by following our investment discipline and being patient. Despite some current bearish sentiment, we intend to stay the course since we are invested in companies that, in our opinion, have the financial strength to ride out current market jitters while offering favorable long-term business prospects and thus the potential for long-term capital gains.
We value your trust and remind you that our money is invested alongside yours as we work hard to accomplish the Funds’ objective of long-term capital appreciation.
Sincerely,
Robert A. Olstein, Chairman and Chief Executive Officer
Eric R. Heyman, Co-Portfolio Manager
1 The performance data quoted represents past performance and does not guarantee future results. The Olstein All Cap Value Fund’s Class C average annual return for the one-year, five-year, and ten-year periods ended 12/31/21, assuming reinvestment of dividends and capital gain distributions and deduction of the Olstein All Cap Value Fund’s maximum CDSC of 1% during the one-year period, was 24.08%, 12.22%, and 12.51%, respectively. Per the Fund’s prospectus dated 10/28/21, the expense ratio for the Olstein All Cap Value Fund Class C was 2.14%. Performance and expense ratios for other share classes will vary due to differences in sales charge structure and class expenses. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than performance quoted. To obtain performance data current to the most recent month end, please go to our website at olsteinfunds.com.
2 The performance data quoted represents past performance and does not guarantee future results. The Olstein Strategic Opportunities Fund Class C return as of 12/31/21 for the one-year, five-year, and ten-year periods, assuming deduction of the maximum Class C contingent deferred sales charge of 1% during the one-year period, was 19.73%, 9.69% and 11.92%, respectively. Per the Fund’s 10/28/21 prospectus, the gross expense ratio for the Class C share was 2.46% and the net expense ratio was 2.35%. The Adviser has contractually agreed to waive certain fees/expenses until at least October 28, 2022. Performance would have been lower without waivers in effect. Expense ratios for other share classes will vary. Performance for other share classes will vary due to differences in sales charge structure and class expenses. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than performance quoted. To obtain performance data current to the most recent month end, please visit our website at www.olsteinfunds.com.
