Quarterly Webinar Replay

Chris Zand: Hello and thank you for joining us today for the Osterweis quarterly call, where we will discuss recent market activity and trends, implications of Trump's new tariff policies, our portfolio positioning, and our outlook for the remainder of 2025. Joining me for today's discussion are Chief Investment Officers John Osterweis, Carl Kaufman, Nael Fakhry, and Greg Hermanski.

Please feel free to enter any questions into the Q&A at any time during the webinar. And with that, let's go ahead and begin. And today, John, I'd like to start with you and get your thoughts on what's happened over the last two weeks. On April 2nd, the Trump administration announced details surrounding long-awaited reciprocal tariffs on all of our trading partners, which precipitated a market selloff that has continued since then.

Despite a brief but strong rally when a 90-day pause on tariffs was announced, since then, we've really seen continued market volatility, as one of the most volatile stretches in equity markets has unfolded. So John, why do you think markets reacted so poorly to the tariff announcement? Trump talked extensively about tariffs on the campaign trail, but no one had expected them to trigger this kind of selloff.

John Osterweis: Well, thank you, Chris, and good morning, everybody, or good afternoon wherever you are. I think the most significant trigger was the fact that these tariffs were so much larger than anybody anticipated, and the implication of that was multifaceted. Number one, tariffs, of course, are a tax on the American consumer, and they are inflationary.

That's not a political statement, that is an economic statement. Tariffs of this magnitude clearly would disrupt trade and lead to a great deal of confusion. And I think people began to think that they would inhibit growth and possibly tip us into some kind of recession. Coupled with that, equities have been trading at somewhat, not somewhat, significantly above-average multiples.

And there's been a bit of a revaluation going on. And so if you take all of that together, there's the shock of these tariffs being much larger than anticipated; two, fear of inflation; three, fear of very slow growth or recession, which taken together means stagflation, and the need for equities to revalue. I think that is pure and simple what caused the big drop.

Chris Zand: Thanks, John. Now, the Trump administration has argued that the tariffs will create more jobs in the U.S. by motivating businesses to build new factories domestically in order to avoid the additional expense of the tariffs.

They also argue that collecting the tariff revenue would allow the federal government to lower income taxes. Both of these outcomes would be stimulative, but the market appears skeptical. What's your thought?

John Osterweis: My thoughts are quite complex. Of course, let's start with a simple economics. Revenue is volume times price. So if you significantly raise tariffs, there would be lower imports than there otherwise would be. So it's not clear how much revenue the tariffs could generate in and of themselves.

The second thing is obviously some industries will shift production back to the U.S. and that, of course, will create some jobs. But given all the uncertainties, I think there are other businesses that will delay building new factories, because they don't know where the economy's heading at this point.

Thirdly, there are a lot of small businesses that import most or all of their product from China and other countries, and they will be severely affected, if not bankrupted. And so there will certainly be some job losses from that sector, and there may be some job losses at companies that export a lot because our exports are going to be hurt.

So when you take it all together, yes, there will be more revenue, more tax revenue from tariffs, but there will also be lost tax revenue from other sources. So I don't know exactly where all this ends up, and in any case, these changes take a long time. They're not instantaneous, so I would say stay tuned on this one.

Chris Zand: Thanks, John, very helpful. Now, less than a week after the reciprocal tariffs were announced, the president declared a 90-day pause on the majority of the tariffs.

Though he also announced a 10% baseline tariff on all goods, while also increasing tariffs on China to 145%. Why do you think he ordered the 90-day pause?

John Osterweis: Probably because the stock market cratered and a number of his advisors said, "Slow down. This isn't necessarily as good as you think it is." So I think he just got a reality check.

Chris Zand: That makes sense. Thanks, John. Carl, can you add some perspective on how the bond market has responded to all of this?

Carl Kaufman: Sure, and thank you all for being here. The bond market reaction was a bit schizophrenic, to be honest. The initial response was exactly what you'd expect during an equity selloff. It was a typical flight to quality, and it was probably a global flight to quality, which is U.S. Treasuries. Investors clearly rotated out of the stocks initially and into the safest asset they could find.

But that trade fell apart a couple of days later when the reality of inflation bubbled to the surface. Our Fed Chair, Jerome Powell, said that he would not rush to save the markets with lower rates, because he was worried about the inflationary effects of tariffs. Additionally, there were rumors that countries like China were selling their Treasury positions due to concerns about the trade war.

I don't personally believe that. Also, they have a greatly diminished store of Treasury. They used to have $3 trillion, but I think they've gotten it down to less than a trillion now because they've been supporting their own weak economy, which has been dogged with real estate excess. So all of this resulted in a selloff and higher rates at the long end.

Chris Zand: Very helpful, Carl. Let me ask you both another question. Do you think the market's reaction has been rational thus far, or has it been more of an overreaction?

Carl Kaufman: I can go first on that one. I'd say it's been rationally irrational. The behavior I just described all seems like the type of buying and selling we'd expect given the available information the market has. I can add that our main weighting, which is in high yield market, has been holding up pretty well. It's been acting like the adult in the room.

It's down just a point or so this year. And the bonds that have been hit the hardest are the sectors that we do not typically invest in. Energy has struggled, so oil and gas, E&P companies' bonds have been weak. And highly leveraged, private equity sponsored leverage buyout loans have also done poorly. Everything else has held up pretty well.

John Osterweis: I would add I think the response was rational. As I said earlier, the tariffs are inflationary. They tend to lead to lower growth, and equities came into this at a higher than normal valuation.

So I think the selloff was quite rational. And there's so much uncertainty, that to expect anything other than a market reaction like this would be naive.

Chris Zand: That's great. Thank you both. Now, I mentioned earlier, Trump has changed his tariff policy repeatedly. First, with the 90-day pause on all countries but China, then a broad set of exemptions on certain electronic devices and semiconductors.

The market, of course, seesawed in response. And then over this past weekend, we learned of a second package of semiconductor-related tariffs that will be coming. Nael, my question for you is why do you think the volatility has been so pronounced?

Nael Fakhry: I think it's really the uncertainty. If you think about it, consumers and businesses, they like certainty so that they can plan out what their spending is going to be, understand what their cost structure is going to look like. And the constant change in tariff policy means that the rules of the road just keep changing.

So the pause certainly takes the worst-case scenario off the table, at least for the time being, but we still have now a 10% so-called baseline tariff in place. And then the 145% tariff on China, which if that holds, that'll represent a massive increase on tens, if not hundreds of billions of dollars' worth of Chinese imports.

So as John and Carl said earlier, tariffs are not helpful and they can be really harmful in our view. But you add in the uncertainty and the constant change in policy, and that makes the market a lot more volatile.

Chris Zand: Thanks, Nael, very helpful. Where do you think things might go from here?

Nael Fakhry: It's hard to know obviously, but we think that ultimately U.S. and China will work out some sort of a settlement. And perhaps that is why the markets have settled a bit more recently, in addition to some comments from the Fed. But the stakes are really high, if you think about it from the perspective of both the U.S. and China.

We're codependent economies. The Chinese economy obviously will suffer if they lose the U.S. as an export market. Meanwhile, the U.S. economy will suffer if everything we're importing increases significantly in cost. So like nuclear war and a burning nuclear war, you'd think that the cost would be so high that a settlement will ultimately be reached.

But again, if the 10% baseline tariffs are the ultimate outcome of all of this across the board, including China or maybe some slightly higher tariffs for China but 10% for everyone else, it's not ideal. But as a global economy, that should be a much more manageable situation that'll thwart the worst-case scenario.

Chris Zand: Thanks, Nael, very helpful. Now, given all the challenges that we've discussed, can you talk a bit about how we're navigating the volatility and how we've positioned portfolios?

Nael Fakhry: Sure. Yeah, I would say we've done some tactical stuff, and then we've also made some strategic decisions. In terms of the tactical in the near term, we sold higher valuation positions and that goes back months we started trimming or exiting those. We've raised cash and opportunistically, we've tried harvesting losses and upgrading the portfolio where it made sense. So that's the more tactical.

In terms of the strategic, I think the single most important thing that we've done, is we've rooted our portfolio and companies that we refer to as quality growth businesses. So we're a broken record on this point. But we think times like this really illustrate and highlight how important it is to own very high-quality businesses and to avoid the speculative ones, which I think can get lost in a straight vertical market.

This is not a last-minute change. We built this portfolio over several years. We often say you can't build the ship during the storm. It has to be watertight and ready for rough seas well ahead of time. So that's what we've tried doing well before all of this. And just as a reminder, the way we define quality growth companies is as businesses with really three characteristics.

One, they have to have a durable competitive advantage that protects the business from competitive encroachment, and ultimately enables growing free cash flow. Two, the business has to be able to reinvest to grow at or above GDP. And three, it has to be a business with good governance practices and that's well-run.

So if you look at each of those three legs of the stool, the first one is the durable competitive advantage. We look for financial metrics to substantiate that and one we've talked a lot about is pricing power, and that's going to be super important. If the tariffs stick around, costs are going to go up for businesses across the board.

And the ability to pass through price, which many of our companies have, will be really important to both protect free cash flow and even grow it during periods like this. We also look at the financial metric of leverage. And so well-capitalized businesses, all of which our businesses are, will do much better in the current environment.

And they can actually take share because their competitors and their peers are going to be in some cases on their heels. In terms of the second leg of the stool, the ability to grow through reinvestment. What that really reflects is that our businesses tend to be very relevant and they are providing really critical goods and services.

So think about waste management, think about water utilities, think about personal auto insurance just to name a few. These are things that you need or businesses need just to live day-to-day. And often our companies have real secular tailwinds, so they're a little bit more detached from the macro, because there are secular trends enabling the businesses to grow.

And then lastly, in terms of governance, we want our companies to be well-run. And so during periods of volatility like we're going through now, we think our companies tend to have really good governance, they optimize for shareholders. And again, they can navigate the storm that much more effectively, and hopefully take share and emerge stronger from all of this.

So I think, like I said, we've done some tactical stuff in the portfolio. But the bedrock is really the quality growth composition of the portfolio that should steward us through this period.

Chris Zand: Thanks, Nael. That perspective is very helpful. Now, our equity strategy has definitely held up much better than the S&P 500 during this stretch. And I know it's in part thanks to the focus on quality growth companies.

And I know one of the key attributes we look for in companies is their ability to pay growing dividends. John, this question's for you. Can you talk about why that matters, especially in times like these?

John Osterweis: Yes, and we have a slide on this. Dividends are a significant component of total return. We really should have some slides, maybe we will for the next session on looking at total return over time and how much of that comes from dividends. We focus primarily on companies that have the ability to grow their dividends.

Because obviously there's some very slow-growing or no-growing companies that pay big dividends, but those are not terribly interesting. We really look at companies that can grow their dividends, because they probably represent and exemplify what Nael was talking about, which is high-quality companies with lots of free cash flow, pricing power, et cetera, et cetera, et cetera.

And so if you look at the right-hand side of the graph, you can see that the kinds of companies we own are growing their dividends at about 15%, a little under just around 15% versus around 10% or a little above for the S&P. So a significant difference, which would suggest we're in much higher quality companies.

Chris Zand: Thanks, John, very helpful. Greg, I'd like to bring you into the discussion now. You've been discussing the importance of balancing our equity exposure between both offensive and defensive companies for a while now.

Can you explain this concept to our listeners and discuss how it's been put in practice within portfolios?

Greg Hermanski: Sure. Thanks, Chris. Portfolio construction, along with investing in quality growth companies as Nael was just talking about, are core pieces of our investment philosophy. As we put together portfolios, we make a point to earmark a set of investments in defensive companies. These are companies that tend to be countercyclical and do well in tough economic conditions.

We also make sure that portfolios are diversified among different industries and investment themes. So in an uncertain environment like we're seeing today, the benefits that come from careful portfolio construction become front and center. Over the last couple of years operating in a very narrow market, the diversification and defense that we've had in portfolios have been a headwind to our relative performance.

This year through the end of last week, we estimate using a representative account as a proxy that our defensive positions have contributed approximately 2.6% of positive performance to portfolios in our core equity strategy. And the defensive stocks are up around 9.4% on average, so this ballast has been a huge help in a difficult down market.

This having been said, we focus on having a well-balanced portfolio that include also our best offensive investment ideas. On offense, we're looking at investment sectors or looking in investing in sectors including Real Estate, Industrials and Technology.

We're looking to find companies whose valuations have been dislocated in this market, but also who we believe can be winners in the new environment that's coming up. On defense, we're leaning into traditional sectors like utilities, insurance, waste management and health care. Even on that defensive side, this has been a really difficult market.

Segments in health care like pharmaceuticals and life sciences, normally they're quite defensive, but they've underperformed this year due to some of the DOGE and Section 232 tariffs that have hit them. But again, it's another reason that portfolio construction and diversification are so important.

So for now, we are going to continue to lean into stocks that tend to be more countercyclical and defensive until we have more clarity about the future. But despite the concerns we have been discussing, we think it is important to be opportunistic.

And to take advantage of market weakness by buying great companies that are selling at discounts to their intrinsic value, and we are actively looking for these names.

Chris Zand: Thanks, Greg, very helpful. Can you discuss maybe a few individual companies in the portfolio that are particularly well-suited for this current environment?

Greg Hermanski: Sure. I'll give you two names that we think are well-positioned this year. The first is L3Harris, it's a defense company. Defense companies ironically tend to be more defensive, and that's because they have a lot of recurring revenue. They have strong competitive moats, they generate a lot of free cash flow.

Their contracts tend to be long in length, and they have a clear, strategic importance to the country. In particular, we believe L3 is well-positioned because it has invested in capabilities like communications, electronic warfare space, and rocket engines. And these are areas where the U.S. government is focused on increasing its spending.

In addition to that, it appears that the defense spending is a focus area of the new administration. And recent indications from Washington imply that it's an area that is set to increase in the new budget. We love investing in areas where we have tailwinds, and this would be one of those. The second company is Waste Connections.

Waste companies tend to be very resilient during downturns, as they provide critical services, they operate in local monopolies. And as a result of that, they have strong pricing power and generate strong free cash flow. Waste Connections has a long history of growing both organically and through acquisitions.

If there are disruptions in the environment, it may provide the company with opportunities to use their free cash flow to accelerate acquisitions, which will help drive future growth. Both of these companies tend to be defensive in nature, but they also have favorable growth characteristics and should generate strong free cash flow into the future.

Chris Zand: That's great, Greg. Thanks so much. Staying on this theme, Carl, can you talk a bit about how we're positioned in fixed income?

Carl Kaufman: Of course. We're taking an approach that is similar to what Greg just described with a nuance for fixed income. We have been defensive for the last year and a half or so with a large part of the portfolio and also playing a little offense. We are starting to shift now that we're starting to get some market weakness that we have been waiting for to be a little more offensive.

And by that I mean we've had on our buy list a number of different companies' bonds, a little longer duration that we would love to buy on market weakness. We're starting to see that, not as much as we would like in the areas that we like to buy, but we are trying to increase our exposure to longer-dated names. It's just in the early phases.

After two years of being in very short-term defensive and in short-term investment grade bonds, where we have been collecting yields that were similar to the longer end. As we see the longer end of Treasuries move up, hopefully we get a chance to layer in some higher-yielding bonds of good companies.

And we have a lot of dry powder to do that right now, so we're just waiting to see that happen with more frequency.

Chris Zand: Excellent, Carl. Thank you. We've got a number of questions now queued in our online question-and-answer box.

We'll get to those in a minute, but before we do, does anyone in the panel have any final thoughts to share before we open the floor?

John Osterweis: Well, I might go first. As I think everybody knows, we are in real unchartered waters. We normally don't sound quite maybe as political as we sound today, but we are simply responding to programs and initiatives that the Trump administration has put forth. And we're trying to understand the economic impacts of those.

So apologies if we sounded a bit political. But we really think these are significant differences in how the economy is going to unfold over the next year or several years, depending how long these policies stay in effect. All we can do is watch and try to respond both intellectually and in what we do with the portfolios.

So it's very hard to anticipate because there've been so many changes and the changes have been really quite abrupt. So normally we like to anticipate. I think we have to be more reactive at this point.

Carl Kaufman: Well said, John. I'll just add a few topics. I'd like to remind everyone that times like these call for patience and a cool head. The world has seemingly ended a few times before. I've seen it end in the early '80s, 1987, 2001, 2008, 2020, but we're all still here talking about it.

I think this too shall pass. The U.S. has a resilient economy. We've always come out of these challenging times in a good place. Also, if we know anything about the current president, he is prone to changing his mind, so even when things look their bleakest, they may turn out just fine.

It's funny, last quarter we were lamenting that everything was too dull in the marketplace, so I guess we should be careful what we ask for. And with that, Chris, I'll hand it to you for Q&A.

Chris Zand: Exactly, Carl. Look, if you have questions, please enter them into the Q&A box or you can raise your hand. Before we get into those questions, I want to remind everyone that if you have any questions about your specific portfolio. Or there have been material changes in your life, we'd be happy to meet with you either virtually or in person to go over any of those issues and discuss any changes that may be warranted.

Okay. Let's go ahead and open up the floor now to our audience, and we'll start with some questions that have come in through email ahead of the presentation before turning to those that came up during the conversation. First question, given the global concern about U.S. stability and the economy going forward, can we expect more emphasis on investing in foreign companies?

Nael Fakhry: I can take that. I think we're bottoms-up investors, so we're always going to look for the companies where there's a real opportunity. It's a quality growth business, as we define it, and the valuation is attractive. But we're also aware of opportunities materializing in certain sectors, certain geographies.

So we're definitely looking more at really Europe in particular, because we think as Germany and UK, they've announced that they're investing more in their industrial base and in their military infrastructure. And that should help the industrialization of Europe and improve the economy there.

And there's a good base obviously in terms of governance, in terms of how well-educated the populace in Europe is. There's a really strong Health Care and Technology sector, so there are a lot of good things there. Now, there are some challenges in terms of a pretty stagnant population, but if there's a good opportunity, we definitely will try to take advantage.

And I point out we own a few European businesses. So it's definitely a theme that we're considering and actively looking at.

Chris Zand: Thank you, Nael, very helpful. This is another one that came in before the webinar.

Can you explain why we're in this trade war to begin with? Why is the administration so committed to tariffs?

Carl Kaufman: I'll take that one. We have a president who feels that everything has to be a distressed New York real estate deal, and when he feels he's not getting a fair shake, he will act decisively. For some reason, he seems enamored with tariffs that were enacted in the late 19th, early 20th century by a president who then rued that he had done that.

Keep in mind, tariffs are meant to protect emerging economies, nascent and fragile industries from developed nations coming in and wiping them out. In the 19th century, the U.S. was such an emerging economy. Hence, we needed tariffs to protect our emerging economies back then.

We are the world's leading economy now, so we don't need tariffs to protect our industries. We need better industrial policy to stimulate growth in critical industries, which we haven't had for 40 years. So I'll leave it at that.

Chris Zand: Thank you, Carl. Another question that came in, it's about the Federal Reserve. What do you think the Fed should be doing given all this volatility?

Carl Kaufman: I think exactly what they are doing, nothing. As John discussed, if you look at an outcome tree, there are two ways this could go, maybe three. One is certainly higher inflation, which would require higher rates.

Slower economy or recession, which would typically mandate lower rates, or both, which puts the Fed in a very tricky situation. So I think the Fed is wise in not overreacting and making matters worse.

Chris Zand: Thank you, Carl. Here's another question. We've discussed the near-term effects of tariffs. What are some of the long-term effects we should be thinking about?

John Osterweis: Let me take that one. The past 80 years have been a period of more or less free trade where tariffs have come down, and countries around the globe have benefited from that. There is something called "comparative advantage." Companies produce what they produce most efficiently and cheaply, and they sell it to companies that produce other things. They trade with companies that produce other things cheaply.

So if every country produces what they produce best, it benefits everybody. And between that sort of general statement and the fact that products today are extremely complex and supply chains are equally complex, one of the risks of these tariffs is that you roll back a system that's worked really well for 80 years, and you throw not just the U.S. but other countries into recession.

And China, in particular, could face some extreme hardship based on Trump's tariffs. So I worry a lot about slower growth worldwide and maybe even negative growth worldwide. The second thing I worry about with Trump's policies is his attack on the universities and his tying up of funds that would normally back very sophisticated research.

One of the problems with that, is that it is these very sophisticated research activities and the products that come out of that, that are the driving force in the economy. If you think in health care, semiconductors, Internet, all of that. And to not support that to me is, as Carl will put it, it's bad industrial policy.

And we are already seeing a bit of a brain drain where researchers at major universities and other places, are happily taking jobs in Canada or they're moving back to China. Or I heard about some folks, some Spaniards who were moving back to Madrid. So I think the long-term effects, if he doesn't moderate some of these policies, are going to be not terribly beneficial. Let's just leave it at that.

Chris Zand: Thanks, John. Here's another question from our audience today. What are your predictions for growth if the 10% tariff stays in place?

John Osterweis: Is it just the 10% tariff or all these others? I guess that would be the question. I think Nael answered if it is just the 10%, we'll be fine.

Things might be a little more expensive, but it's not going to be terribly disruptive. If it's these bigger tariffs, it's going to be disruptive, it's going to be inflationary and it's going to result in lower growth.

Chris Zand: Thanks, John. Another question, are you looking at investments during these Trump years that would run counter to our historic approach of investing in quality growth businesses?

John Osterweis: I'll let my partners answer that, but I think the answer is no.

Greg Hermanski: I'll start. I think there are times when we may move a little bit off of one, but probably not both of them. We really are focused on quality growth companies.

There are times when you have a fantastic business where the balance sheet is a little stretched that we'd feel comfortable depending on what the business was to invest in it.

But we're unlikely to invest in a cyclical business with a really bad balance sheet where we could get ourselves in a lot of trouble.

Nael Fakhry: Yeah. I would say if we have a clear line of... And we've done this several times, if we have clear line of sight on improving free cash flow generation because of the underlying industry structure and/or the business and how it's positioned, and therefore, the balance sheet's going to improve significantly, then that's definitely, that can be a very interesting situation, because you'll get rapidly accelerating free cash flow per share growth and you could see the valuation of the multiple expand, but those are tough opportunities to find and we try to pounce whenever we can.

John Osterweis: I would agree with what Nael just said. In the past, we've from time to time, been able to find a company that on the surface doesn't look all that good. The statistics are unfavorable, the balance sheet may be stretched, profits haven't done much.

But if there's a clear restructuring, and let's say a company has one or two great divisions, and three or four really lousy divisions. New management comes in and they're getting rid of the three or four lousy divisions and really putting money behind the two great ones. That may be a phenomenal opportunity and we would pounce on that.

Greg Hermanski: A good example of one of those that's actually in the portfolio is Boeing. Boeing is a company that the balance sheet got stretched, they issued equity. And they're also looking at selling off some of their other businesses to further delever their balance sheet.

But we believe that the business itself, again, this is a duopoly business, so it's a fantastic business. They're going to start generating a lot more free cash flow and there's in our minds, a clear line of sight to how they do that over time.

So when we first invested in Boeing, we were overlooking some of the balance sheet issues, because we believe in the quality of the business and its position, and the ability to generate more free cash over time.

Chris Zand: Thank you, everyone. Another question, we discussed some of the offensive and defensive compounders. Could someone provide or Nael, could you provide an example of a high-quality business that fits the quality growth framework that you like right now?

Nael Fakhry: Sure. Yeah, I'd point to a couple. I would say one is AutoZone. So AutoZone is an auto parts retailer, and O'Reilly and AutoZone really dominate the market. They're primarily here in North America, here in the U.S., but also AutoZone has a small presence outside the U.S. and Brazil and Mexico. And this is a business that we really like because it's necessary, it's a necessary product.

You have to repair your car. And these are primarily nondiscretionary decisions that a consumer has to make to repair the car just to get to work and to live your daily life. And these two companies really, the industry structure is very favorable, and they really dominate the industry. And meanwhile, you have Advance Auto Parts, which is constantly on the brink of bankruptcy.

And then you have Genuine Parts, which is the NAPA brand, that is just not nearly as well-run. It also has an unrelated industrial distribution business that we think distracts management. So you have these two companies providing a very necessary service. They have the most scale and therefore, they can procure these parts at a favorable cost.

And then turn around and get them to customers, either direct or to the shops that repair the cars, as rapidly as possible at the lowest cost. And so that gives them this very significant advantage and there's a nice tailwind here. There's a near-term tailwind potentially from tariffs because it makes new cars so much more expensive.

But the long-term tailwind is there's a shift towards more and more repair. As cars get more complicated, there's a shift towards more and more repairs that have to happen with professionals. And AutoZone's about 30% "do it for me," and so they've got a long runway of growth as they shift and address that more do it for me customer.

Not to mention the part of the market that's sitting outside of the big four that I mentioned, O'Reilly, AutoZone, Genuine Parts, and Advance Auto is still very fragmented. So they're taking share from all of them, and they're shifting more and more of their business to do it for me. Meanwhile, they generate such an extraordinary amount of free cash flow.

And growing free cash flow, they can use that excess cash after reinvesting to drive growth in the business to buy back a lot of stock. So you go through a period like we're going through now, John talked about dividends earlier. Well, when stocks sell off, companies like AutoZone can use the excess cash to actually buy back stock at a discount.

So you get both the growth in revenue and ultimately profitability in free cash flow, but then you get even faster free cash flow per share growth because they're buying back stock accretively. And importantly, they're levered at very modestly, they're very prudently capitalized so we don't have any concerns at all.

And they actually tend to be countercyclical in a time like this where people defer purchases and there's a lot of uncertainty. So they actually see an uptick in business, and we would expect that to happen here. So maybe I'll just leave it at that.

I'm happy to talk about others, but I think that's a good example of the type of quality growth business that we own and want to hold through periods like this.

Chris Zand: Thanks, Nael. Would you elaborate any further around the question of aren't high-quality companies as vulnerable, as less-quality companies in environments as uncertain as the one we're in today?

And taking that a little further, what happens to high-quality companies during periods of recession?

Nael Fakhry: Yeah, so it's a very astute question. I would say high-quality businesses, the way we define them, we started with they have a durable competitive advantage that's reflected in a lot of different metrics, but most importantly, growing free cash flow. That's what creates value for everyone, for every business.

So if we can really underwrite that the company is going to continue generating cash flow even through a downturn, and actually grow free cash flow, then that's a really important starting point. Having said that, these businesses are definitely susceptible in a downturn if the valuation is too high. So that's why we started with what have we done with the portfolio?

We've been tactically very reticent to hold onto companies with high valuations and we've generally avoided them. But yeah, if a company goes in, look at the tech bubble in the early 2000s, these were very high-quality businesses. Amazon, I don't think you could argue it wasn't a high-quality business. It just happened to lose 97% of its value because it traded at such an extreme valuation at the time.

So yes, high-quality businesses can get hit if the valuation is really extended. What's interesting about this, the period of volatility we went into more recently, is a lot of really high-quality businesses like take AutoZone, for example. We bought that at something like 16 or 17 times annual earnings, and now the multiple's actually gone up more recently because it's gotten more of a premium.

So a lot of really high-quality businesses were actually trading at a bit of a discount, at a very significant discount to the broader market and that served us well. American Water was trading in line with the broader market, maybe even actually a slight discount three, four or five months ago, because it was a boring business that generated a very steady high single-digit earnings growth trajectory.

Well, now the market is very appreciative of that kind of quality of business, and so the valuation has gone up. So now the question is on those defensive, really high-quality businesses, are the valuations still attractive or have they gotten stretched?

And meanwhile, some of the businesses that were really good and that we really loved and gotten hit more recently, do we want to be scooping those up? And that's what we're really thinking hard about at the moment.

Greg Hermanski: I can address the question from a different perspective too. One of the dominant companies that we own is Thermo Fisher Scientific, and what makes it such a high-quality business is they have high market shares in a lot of different segments. So they offer services, supplies, kits, and distribution to a lot of different life science companies.

And while if you were to make a case that, "Well, the life science companies are going to get hit because of the NIH issues or because drug research declines." The reason you want to own one of these dominant companies versus another company that's in that sector, is their dominance allows them to go to some of their customers and say, "Hey, we can supply you with everything that you need and reduce your total cost."

And in that case, they'll take more revenue from the customer, but also reduce the total cost from the customer, so they end up becoming a share gainer in that environment. Also, in a situation like this where we may be seeing market stress, a company like Thermo has a fantastic balance sheet, and they'll be looking for acquisitions that they can do on the cheap in this type of environment.

So there'll be share gainers, they have the ability to take up price, and they have the ability to do M&A to help drive future growth.

Chris Zand: That's great. Thanks, Nael. Thanks, Greg. Another question from the audience. Is Health Care a good sector to invest in going forward in this environment?

Greg Hermanski: Well, Health Care is a very broad number of different types of businesses, and I had addressed this a little bit in my prepared comments. Health Care's been more difficult in this downturn than traditionally. Normally, if you're in a downturn, you could go to pharmaceutical companies and some of these life science companies and they'd hold up really well in this downturn.

But with some of these very focused tariffs that Trump's trying to change things, it's making it a little more complex. And so for U.S.-based pharmaceutical companies, it's become a little more complex, but there are different parts of health care that are fantastic. We have an investment in UnitedHealthcare, it's an MCO, a very defensive type of business, and so there are segments within there.

Boston Scientific is a high-growth, a defensive business with recurring revenue. So I would say that you need to be careful and be a stock selector in this environment. And we're probably going to wait to see what Trump does on the pharmaceutical side before we make further investments within pharmaceuticals, or some of the tangential companies that serve them.

Chris Zand: Great. Thank you, Greg. Should we buy iPhones now? Should we assume prices are going to go higher?

Carl Kaufman: I'm an Android guy, so don't ask me.

Chris Zand: Anyone else?

Nael Fakhry: The one comment I'd make is that, I guess, that there are exemptions made. More recently, just on Friday, I guess it was announced, Friday night, that there are going to be exemptions which directly benefits Apple, because otherwise, Apple's supply chain would really suffer in terms of higher cost.

So from the perspective of Apple, it seems like for now there are exemptions, but this is the theme of what we've been talking about. There's so much uncertainty, because you don't know where things are going to go and what the policy is going to be.

Ultimately, it seems like there has to be some sort of a settlement, but I think that was the consensus a month ago and that we weren't going to go down this path and obviously that consensus was incorrect.

Chris Zand: Great, thank you. To what extent do the evolving social policies and shakeups at government agencies impact the economy?

John Osterweis: I think we could all answer that by saying it will have effects, and it depends which agency is getting shaken. There's some agencies that apply a lot of regulations, and so the extent, if they're not enforcing those regs, maybe that lowers costs for business.

There are other agencies that support research to the extent they're being shut down or truncated. That would hurt businesses. It's a very complex question to answer, but probably on balance, it's more disruptive than favorable. I don't know if my partners would agree or disagree with that.

Carl Kaufman: I would agree. There's no broad answer.

Chris Zand: All right. Thank you all. This brings us to our last question. How can you take advantage of volatility to our favor?

Carl Kaufman: I can answer from the fixed income perspective. Clearly, we love dips and we can buy higher-yielding paper when they happen.

Bond guys, we like to keep it simple. We'll let the equity guys answer from their perspective.

Nael Fakhry: Go ahead, John. Were you going to say something?

John Osterweis: I was going to throw it to you.

Nael Fakhry: Okay. I was going to say same applies here. And I think the key is having, this is what we touched on earlier, but having a portfolio going in that is resilient so that you can make hopefully the right decisions.

Because the volatility, it can be hard to deal with and obviously emotions get high. So if you have a portfolio that's holding up better and enables you to make better decisions. And you even have stocks that are appreciating and multiples are getting high, it's easier to make those decisions, I think.

Chris Zand: All right. Well, thank you. I'd like to thank our panelists for joining us for today's presentation and lively Q&A. And I'd like to thank all of you for tuning in for today's webinar.

If you have any questions or follow-up items, feel free to email us those or reach out. And we'll be sure to stay in touch with you all as things evolve and new information becomes available. Thanks so much.