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Bob Olstein's Olstein Strategic Opportunities Fund 2nd Quarter Commentary

- By Holly LaFon

August 24, 2016


Dear Fellow Shareholders:

For the fiscal year ended June 30, 2016, load-waived Class A shares of the Olstein Strategic Opportunities Fund had a return of -15.31% compared to total returns of 0.22% and -3.67% for the Russell 2500(R) Value Index and the Russell 2500(R) Index, respectively. For the three years ended June 30, 2016, load-waived Class A shares of the Olstein Strategic Opportunities Fund had an average annual return of 4.65% compared to average annual returns of 8.14% for the Russell 2500 Value Index and 8.61% for the Russell 2500 Index over the same time period.


Market Outlook & Strategy

Throughout the twelve-month reporting period, lethargic economic growth in combination with specific negative economic and political events (includ- ing the United Kingdom's vote to exit the European Union), sharply increased market volatility and contributed to mounting uncertainty about future economic growth and overall market returns. There are times when the combination of certain events, such as the recent Brexit vote, the slow- down in the Chinese economy, falling commodities (oil) prices, and the uncertainty that accompanies a general election, punish equity markets with extreme negative sentiment. This was especially the case for the equities of small- to mid-sized companies for a significant part of the Fund's fiscal year. In fact, over the eight-month period from its high on June 23, 2015 (one week prior to the start of the recently ended fiscal year) to its low on. February 11, 2016, the Russell 2500 Index fell 23.28% in value. Such negative sentiment and sharp downward market moves tend to hit a value-oriented portfolio of small- to mid-sized companies such as the Fund's particularly hard, causing a period of short-term underperformance.


Yet despite recent negative market sentiment and an increase in market volatility, we maintain a cautiously optimistic outlook for equity investing for the remainder of 2016. We believe that the past fiscal year will prove to be one of those periods where many investors reacted to negative news without due regard for individual company long term fundamentals. During such periods we maintain our investment discipline by focusing on four primary, company-specific factors: (1) a commitment to maintain a strong financial position as evidenced by a solid balance sheet; (2) an ability to generate sustainable free cash flow; (3) management that intelligently deploys cash balances and free cash flow from operations to increase returns to shareholders; and (4) a stock price which in our opinion misprices a company's future ability to generate normalized future free cash flow.

Portfolio and Performance Review


At June 30, 2016, the Fund's portfolio consisted of 43 holdings with an average weighted market capitalization of $2.70 billion. Throughout the reporting period ended June 30, 2016, we modified the portfolio in light of market volatility. By paying strict attention to our company valuations, we reduced or eliminated positions in which the discounts from our calculation of intrinsic value were no longer large enough to justify the size of our position. At the same time, we increased or added new positions in what we believe to be well run, conservatively capitalized companies selling at a significant discount to our calculation of intrinsic value.

During the reporting period, the Fund initiated positions in thirteen companies and strategically added to established positions in another two companies. Positions initiated during the past fiscal year include: Astronics Corporation (ATRO), Bed Bath & Beyond, Inc. (BBBY), Charles River Laboratories, Inc. (CRL), Citizens Financial Group, Inc. (CFG), FTD Companies, Inc., Hibbett Sports, Inc., IPG Photonics Corporation, Kennametal Inc., Natus Medical Incorporated, SeaWorld Entertainment, Inc., Tessera Technologies, Inc., WestRock Company, and Zebra Technologies, Inc.

During the reporting period, the Fund eliminated its holdings in twenty one companies and strategically reduced its holdings in another eleven companies. The Fund eliminated or reduced its holdings in companies that either reached our valuation levels, or where, in our opinion, changing conditions or new information resulted in additional risk and/or reduced appreciation potential. We redeployed proceeds from such sales into opportunities that we believe offer a more favorable risk/reward profile. During the fiscal year, the Fund eliminated its holdings in: ABM Industries Incorporated (ABM), The ADT Corporation (ADT), Blount International, Inc. (BLT), Daktronics, Inc., Dorman Products, Inc., Entegris, Inc., Esterline Technologies Corporation, Express, Inc., Fossil Group, Inc., Fox Factory Holding Corp., Integra LifeSciences Corporation, Itron Inc., Joy Global Inc., Kadant Inc., Macy's Inc., Sealed Air Corporation, Smith & Wesson Holding Corporation, Standard Motor Products, Inc., Teradata Corporation, UniFirst Corporation, and VASCO Data Security International, Inc.


Our Leaders


The stocks which contributed positively to performance for the twelve month reporting period include: WestRock Co. (NYSE:WRK.W), Towne Bank (TOWN), Brady Corporation, Cynosure Inc., and Natus Medical Inc. At the close of the fiscal year, the Fund continued to hold all of these companies in its portfolio.


Our Laggards


Laggards during the twelve-month reporting period include: Joy Global Inc., Harmonic Inc., VASCO Data Security International, Inc., Fossil Group, Inc., and Esterline Technologies Corporation. At the close of the fiscal year, the Fund continued to hold Harmonic Inc. The Fund liquidated its holdings in Joy Global, Fossil Group, Esterline Technologies and VASCO Data Security International during the reporting period. We liquidated the Fund's position in Joy Global (JOY) as we misjudged the severity of the downturn in the mining busi- ness and the extent of pressure the downturn put on the company's operations. We also liquidated the Fund's holdings in Fossil Group (FOSL), the global luxury time- piece and accessories supplier, as we underestimated the shift in consumer taste and preference towards smart watches. We liquidated holdings in Esterline Technologies (ESL) due to the company management's inability to execute on its integration and turnaround strategy within our required time frame. We also liquidated the Fund's position in VASCO Data Security after the company engaged in a dilutive acquisition that compromised our investment thesis.


Review of Activist Holdings


As of June 30, 2016, the Fund was invested in sixteen activist situations, which represented approximately 41% of the Fund's equity investments, and five of its top ten holdings. In general, these situations fit our definition of an activist investment where Olstein Capital Management or an outside investor, usually a hedge fund or private equity investor, seeks to influence company management to adopt strategic alternatives that we expect to unlock greater shareholder value.


The Fund's activist holdings as of June 30, 2016, include environmental technology company, CECO Environmental; developer and manufacturer of medical treatment systems, Cynosure, Inc.; department store company, Dillard's; specialty shoe retailer, DSW Inc.; floral wire service and retailer, FTD Companies, Inc.; video delivery infrastructure company, Harmonic Inc.; money management firms, Janus Capital Group and Legg Mason Inc.; multi-channel retailer, Land's End; kitchenware and housewares manufacturer, Lifetime Brands Inc.; glass container manufacturer, Owens-Illinois; specialty eatery, Potbelly Inc.; towing and recovery equipment company, Miller Industries; parks and entertainment company, SeaWorld Entertainment; specialty retailer of nutritional products, Vitamin Shoppe Inc.; and fast-food restaurant chain, The Wendy's Company. We continue to monitor the progress of the activist investors involved in these situations as they work to increase shareholder value through a specific plan for improving each company's results. While each investment is at a different strategic stage, we believe the actions that have been proposed or implemented should increase shareholder value through improved future operating results.


With each of our activist situations, one of the most important variables we consider, especially during tough economic times, is "how long do we expect it to take for this company to improve its operations and results?" Although we know from experience that successful turnarounds don't happen overnight, we do expect specific improvements in operations to occur within a defined period of time (two years or less), notwithstanding the economic environment. Although a turnaround process may not be in full swing, if a company has adopted what we believe is the right strategy to increase share-holder value within two years, we are willing to wait beyond two years for operating results to start improving if we believe we are being sufficiently rewarded for the risk of waiting, and if our ongoing analysis of the company's financial statements tells us the company is headed in the right direction.


Staying the Course When Facing Headwinds


As economic news and events such as the Brexit vote overwhelm equity markets, we believe it is more important than ever to remain focused on company fundamentals. Market volatility, driven by an onslaught of what we believe is overly discounted short-term negative economic news and unrelenting coverage of financial events which insinuate a doomsday scenario, continues to fuel short-term hysteria and fear - unreliable emotions that unfortunately drive too many investment decisions. In our view, the extreme negative volatility that has characterized equity markets over the past twelve months has proven the importance of remaining rational in the face of unrelenting headwinds.


We believe that the most important element of our analytical process becomes crucial during periods of excessive negative market volatility; we only focus on how current economic and financial events are likely to affect a company's future prosperity, which we measure as a company's normalized ability to generate future free cash flow. During negative periods it is essential that we filter a great deal of noise, mainly the onslaught of market news and economic forecasts, by focusing on those company-specific factors that allow us to gauge the resiliency of a company's core business, the quality of its management and the nature of operating challenges it may face via a detailed analysis of all financial statements, footnotes and shareholder reports.


Core Business as a Focal Point


We continually assess a company's core business and source(s) of its competitive advantage that should allow it to overcome temporary setbacks presented by a challenging economic environment. Since companies that maintain or improve their performance during troubling economic times may still find their stocks held back by negative market sentiment, it is extremely important that the core business has the ability to generate sustainable free cash flow over our anticipated holding period of three years or longer. Our analysis focuses on how the company's operations generate sustainable free cash flow, and the level of investment required to improve company performance and eventually grow the business, particularly as economic headwinds recede.


From our experience as investors, we continually keep an eye out for company-specific factors that may signal a potential impairment to future company operations and free cash flow. We seek to avoid situations where a company's core business has failed to keep pace with dramatic changes in the eco-nomic, competitive or technological landscape. We also seek to avoid companies with products and services that have become less relevant to the market yet continue to blame "an unfavorable economic environment" for their secular decline.


Management Capabilities as a Focal Point


For small to mid-sized companies, an assessment of management's skill level and experience is especially critical during challenging economic times. We constantly evaluate the decision-making skills and leadership of a company's management team and assess whether they recognize the true extent of the company's challenges in light of shifts in the macroeconomic environment. We do not speak to management but assess their capabilities via a forensic and inferential analysis of the financial statements and accompanying footnotes, and shareholder communications. How conservative is the balance sheet, is the accounting realistic, are the assumptions credible, are shareholder communications consistent between years and are potential problems openly discussed? We also assess whether management is overly promotional, and whether or not the disclosure practices are adequate enough to be able to have an above average probability of predicting future normalized free cash flow and thus the value of the company.


From our perspective management should have the requisite skills and experience to pursue a strategy that is in the best long-term interests of shareholders while avoiding short-term approaches that may harm the company's long-term prospects and prosperity. Specifically, we not only seek to avoid those companies that, in our opinion, have weak balance sheets or lack significant resources when faced with economic headwinds, we also seek to avoid companies with management teams that do not exert proper control over existing resources through proper cash flow management, balance sheet conservatism, working capital controls, meaningful cost reduction efforts, and appropriate profitability analysis. An ongoing analysis of a company's financial statements, accompanying footnotes and shareholder communications help us determine whether management's actions have resulted, or are likely to result, in meeting appropriate performance benchmarks during a challenging economic environment.


Nature of the Discount as a Focal Point


For small- to mid-sized companies, assessing the underlying causes of why a company is undervalued via an inferential analysis of the financial statements helps us to separate those companies with serious structural, financial or secular problems from those that are simply not performing to their full potential. One of the chief objectives of our analytical process is to understand what is creating the discount between a company's stock price and our determination of its intrinsic value. This undertaking becomes increasingly important during a challenging economic environment as we seek to determine if the issues causing the discount are temporary or prolonged in nature. In a tough economic environment, understanding the nature of the discount also helps us separate viable value investing opportunities from potential value traps. We seek to determine if the discount is the result of misperceptions about the company, a build-up of unmerited negative sentiment, an over-reaction to bad news, a temporary problem exacerbated by the economic environment, or chronic issues the company is not likely to overcome.


Some factors contributing to the discount may stem from the company itself, including failure to keep pace with market trends; poor allocation of capital; too much debt; insufficient operating controls or a weak management team that lacks depth and expertise. Other problems may come from outside the company, such as social change, technological change, regulatory constraints, or misperceptions about the company or its industry. We carefully evaluate the many factors that may have contributed to a company's setbacks, determine the severity of these factors and assess what corrective measures the company must pursue to successfully reinvigorate the business when faced with economic headwinds. In essence, is the company a "value trap" or mistakenly undervalued based on temporary factors?


Final Thoughts


Since we launched the Olstein Strategic Opportunities Fund almost ten years ago, we have identified many small- to mid-sized companies that have successfully navigated turbulent economic times to adapt, invest, grow, and restructure for the future. While we 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, and whether or not its ability to generate normalized future free cash flow is properly valued. We believe it is extremely important for company management to adequately anticipate and plan for the impact of macro-economic shifts on their business and ability to generate sustainable free cash flow. From our focused analysis of a company, we judge its resiliency in the face of macro- economic shifts and shocks and incorporate that judgment into our normal- ized cash flow projections.


While it is difficult to stay the course when the press and a majority of investors are reacting to short-term negative factors, our patience has provided us with generous opportunities over the life of the Fund when our analysis indicates the stock price discount from intrinsic value is a result of temporary thinking. We are currently invested in companies that, in our opinion, have the financial strength to ride out current market jitters while offering favorable long-term business prospects. As always, our focus is on the long run (3 - 5 years), and it is our opinion that there is a reasonable probability, based on our portfolio of what we believe are undervalued securities, the Fund can achieve its primary objective of long-term capital appreciation. We value your trust and remind you our money is invested alongside yours.


Sincerely,

Eric R. Heyman

Co-Portfolio Manager


Robert A. Olstein

Chairman, Chief Investment Officer and Co-Portfolio Manager


The above represents the opinion of the Manager, and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. The references to securities are not buy or sell recommendations, but are intended to be descriptive examples of the fund's investment philosophy and are subject to change. Do not make investments based on the securities referenced. As of 6/30/16, the Olstein Strategic Opportunities Fund maintained a position in the following securities referenced above, and is subject to change: Astronics Corporation (0.3%); Bed Bath & Beyond, Inc. (0.5%); Charles River Laboratories, Inc. (0.1%); Citizens Financial Group, Inc. (0.5%); FTD Companies, Inc. (0.3%); Hibbett Sports, Inc. (0.2%); IPG Photonics Corporation (0.3%); Kennametal Inc. (0.1%); Natus Medical Incorporated (0.3%); SeaWorld Entertainment, Inc. (0.3%); Tessera Technologies, Inc. (0.1%); WestRock Company (0.5%); Zebra Technologies, Inc. (0.7%); Towne Bank (0.3%); Brady Corp. (0.3%); Cynosure Inc. (0.2%); Harmonic Inc. (0.3%); CECO Environmental (0.7%); Dillard's Inc. (0.6%); Janus Capital Group Inc. (0.6%); Legg Mason Inc. (0.7%); Land's End Inc. (0.3%); Lifetime Brands Inc. (0.4%); Owens-Illinois Inc. (0.6%); Potbelly Corp. (0.6%); Miller Industries Inc. (0.3%); Vitamin Shoppe Inc. (0.7%); and The Wendy's Company (0.4%). As of 6/30/16, the Olstein Strategic Opportunities Fund did not maintain a position in the following securities referenced above, and is subject to change: ABM Industries Incorporated, The ADT Corporation, Blount International, Inc., Daktronics, Inc., Dorman Products, Inc., Entegris, Inc., Esterline Technologies Corporation, Express, Inc., Fossil Group, Inc., Fox Factory Holding Corp., Integra LifeSciences Corporation, Itron Inc., Joy Global Inc., Kadant Inc., Macy's Inc., Sealed Air Corporation, Smith & Wesson Holding Corporation, Standard Motor Products, Inc., Teradata Corporation, UniFirst Corporation and VASCO Data Security International, Inc. This information should be preceded or accompanied by a current prospectus, which contains more complete information, including investment objectives, risks, charges and expenses of the Olstein Funds and should be read carefully before investing. A current prospectus may be obtained by calling (800) 799-2113 or visiting the Olstein Funds' website at www.olsteinfunds.com.


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. There is no assurance that the fund will achieve its investment objective.


An investment in a portfolio containing small- and mid-cap companies is subject to additional risks, as the share prices of small- and mid-cap companies are often more volatile than those of larger companies due to several factors, including limited trading volumes, products, financial resources, management inexperience and less publicly available information. The activist strategy invests in stocks of underperforming companies and any shareholder activism might not result in a change in performance or corporate governance. These stocks could also experience less liquidity and higher share price and trading volume volatility than stocks of other companies.

This article first appeared on GuruFocus.


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