Funds that are way up: Osterweis
Value manager John Osterweis sees weak profits ahead, so he's buying high-yielding stocks and betting on selected turnarounds.
NEW YORK (Fortune) -- Even great fund managers have bad years.
The five funds we highlighted as wise bets for the coming year in our 2009 Investor's Guide were led by managers with stellar long-term records who shared an affinity for value stocks -- an unfortunate preference in 2008, when value favorites like financials and cyclicals were crushed.
Since then, however, value funds have snapped back sharply, and Fortune's selections were no exception: They returned an average of 52% from Dec. 1, 2008 through Sept. 22 of this year, vs. 34% for the S&P 500 Index.
Over the course of this week, we'll look at each fund -- Osterweis, Fairholme, Vanguard Primecap Core, Third Avenue Value, and Longleaf Partners -- and show you why they're thriving.
Osterweis Fund (OSTFX)
Manager: John Osterweis
Return since 12/01/08: 30%
A true bottom-up investor, John Osterweis doesn't make big sector bets -- so it's not surprising that his winning stocks this year were a varied bunch, including garbage collector Republic Services (RSG), security software maker Websense (WBSN), and publisher McGraw-Hill (MHP, Fortune 500).
The San Francisco-based manager's fund, which has about $700 million in assets, has returned about 10% annually since its 1993 inception, four points better than the S&P 500 (SPX).
Osterweis hunkered down in the third quarter of 2008, shifting his assets to cash and avoiding financial stocks. As a result, his fund dropped 29% last year, which was still eight points better than the index. So far this year, he's up 21%, four points better than the S&P.
Like many value managers these days, Osterweis currently has a large chunk of his portfolio -- about 23% -- in health-care stocks. But while he likes drugmaker Valeant Pharmaceuticals (VRX) and hospital chain Healthsouth (HLS), he says those are individual bets, not a sector play.
Nevertheless, the manager does look for some themes. One of his favorite types of investments is a turnaround story, or a company whose low operating margins belie its growth potential. That's why he bought shares of American Water Works (AWK), an underperforming utility that has undergone management changes. "With the shift, this company should start growing and get back on track," Osterweis says.
Another turnaround bet is consumer foods giant Unilever (UL), whose 12% profit margin is four points lower than rival Nestle's. "They're a company with strong brands and a national presence," says Osterweis. "They brought in a new CEO last year to get the company's margins on par with its competitors'."
While Osterweis has picked up some deep values this year, he has also boosted his cash position to 23% of his portfolio from 10%. He is skeptical about the strength of the economic recovery, which he thinks will be "anemic" by historical standards. He expects profit growth to be slow, and he's wary of banking stocks, having written in July to shareholders that bank balance sheets "remain suspect."
Osterweis says the continued deleveraging of the consumer and financial sectors will slow a rebound. "In an environment like that, stock market returns will be less robust than what we've seen in prior cycles," he says.
He does see one area of opportunity. "Getting total returns from dividends makes a lot of sense," says Osterweis. He prefers high-yielding stocks not only because they have stable returns, but also because they tend to belong to companies with better balance sheets.
In pursuit of dividends, Osterweis has bought shares of pipelines like Energy Transfer Equity (ETE, Fortune 500), a master limited partnership that has a 7.7% yield. He also added spirits maker Diageo (DEO), which has a 4.6% yield.