Morningstar - Q4 2020 - 81

Looking ahead, Callinan sees solar as a "monster
category." He expects states to continue to
subsidize the technology and younger consumers
to increasingly demand it-and he believes
Enphase is the best way to play it because of its
superior storage system.
Biotech is another area Callinan is enthusiastic
about; he says that while the Russell 2000
Growth Index is rife with tiny, unprofitable biotech
names, it is an area worth sifting through.
He singles out Iovance Biotherapeutics IOVA,
which develops cancer immunotherapy
products. "We think we will get paid. Either the
company will grow and get great license
deals, or they'll sell to companies like Merck MRK
and Pfizer PFE."
Wrangling Risk

The fund is up 42.8% for the year to date through
September, more than 30 percentage points
ahead of the category average. It's worth noting
that its average market cap has been in
line with the category norm-in other words,
returns weren't juiced with the large-cap growth
names that have dominated the market.
Morningstar Direct's performance attribution
analysis credits the strong showing to strong stock
picks in most sectors.
Busts often follow booms, of course, as with
Callinan's dramatic early success at RS
Investments, which was followed by precipitous
losses in the dot-com crash. Prospective
investors should note that Osterweis Emerging
Growth's 5-star rating reflects high returns
relative to the small-growth category over the past
three years but also high risk.
"It's a concentrated fund, so it will be
occasionally out of sync," Platt says. "But
over time, that style has led to outperformance."
Success with a strategy like this is a
question of being aware of the risk and able
to ride it out.
As McFadden puts it, "This outperformance is
tremendous-but we understand how aggressive
Callinan is." He also cautions that the fund
is best used in tax-deferred accounts because of
its high turnover.

The Osterweis Small Cap Growth Composite
separate account (which has a nearly
identical portfolio) reflects the performance
of Callinan's concentrated approach back
to its beginnings in 2006. This record isn't a perfect
proxy for how the mutual fund would have
performed before its inception-there are key
differences such as expenses and research
resources. That said, it is worth noting that while
volatility has been a constant for the composite
over time, so have strong returns. Over
the past decade, the composite's three-year
rolling returns beat both the Russell 1000
Growth Index and the small-growth category about
95% of the time.
The approach is not designed to manage volatility
per se, but there are some checks built into
the system. The maximum position size is generally
5%; that and the valuation overlay lead Callinan
to trim names heading for the stratosphere,
and the cash stake that sometimes results can
provide a bit of cushion. Sector stakes won't
exceed 1.5 times the Russell 2000 Growth weights;
while that leaves plenty of leeway to load
up on technology and healthcare, the fund's
stakes aren't outsize relative to its category peers.
Callinan aims for a different kind of diversification,
offsetting higher-risk growth prospects with
more stable names. Only about one third of the
portfolio is invested in "undiscovered or
misunderstood" companies that promise greater
than 30% revenue growth annually. One such
firm is Kornit Digital KRNT, which manufactures
textile printers; it's listed in the U.S. but
headquartered in Israel. "It's a great little story,
but it's unknown," Callinan says.
Aggressive picks such as that are offset by similar
allocations to two other categories. "Breakthrough"
companies are ramping up profitability and
establishing themselves as leaders, while growing
revenue 2% to 40% annually-such as Alteryx AYX,
which provides popular data analysis software.
The third category provides more ballast-
stable "proven" companies with 15%
to 25% revenue growth. Etsy ETSY is a good
example. The pandemic has sparked a
great run for the stock, fueled by sales of reusable

masks, but the stalwart has been in the portfolio
since 2017. Callinan says its business model
gives Etsy its edge: "It's a two-sided marketplace,
with really passionate sellers and a customer
base that's extremely loyal."
Sticking With It

The fund's strong performance so far has not
attracted an onslaught of attention. "I am
somewhat surprised that the fund has not taken
in more assets," McFadden says. "Of course,
if it grows too big, that may have an effect
on performance, but at this size the fund still has
plenty of room to grow."
Callinan is well aware of the danger posed
by asset growth. He's set the strategy's capacity
at around $1.5 billion because he does not
want to broaden the portfolio or expand too far
into mid-cap territory. With less than $300
million today between the fund and the separately
managed accounts, capacity is not a concern.
Despite its small size, the fund has a 1.16%
expense ratio-not a bargain but in line with the
norm for its category.
"Our advantage is that we've always looked
at undiscovered, new-to-the-market companies
that are mysterious to most investors,"
Callinan says, and he wants to guard that edge.
He notes, for example, that IPOs are on the
rise again, which promises a pool of opportunities
after the initial excitement wears off. "The
stocks will correct, and then we'll have a huge
pool of undervalued small-growth stocks."
Callinan is settled in, doing what he loves,
at a firm that respects his process. When pressed
for information on hobbies and other outside
interests, he mentions reading, working out, and
skiing with his family-but the conversation
always comes back to stock-picking.
"I don't really have that exciting a life outside
of investing," he insists. This emerging-growth
portfolio is perhaps excitement enough. K
Laura Lallos is managing editor of Morningstar magazine.
Photography by David Lees.

morningstar.com/lp/magazine

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Morningstar - Q4 2020 - CT2
Morningstar - Q4 2020 - Cover1
Morningstar - Q4 2020 - Cover2
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Morningstar - Q4 2020 - Contents
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