What, Me Worry?
The second quarter began with the Trump administration’s announcement of a new tariff regime on “Liberation Day” and ended with the United States joining Israel in bombing Iran. Along the way, the reconciliation bill began working its way through Congress and the ongoing conflicts in Ukraine and Gaza produced their own share of concerning headlines. Despite all this, the markets remained curiously calm. Alfred E. Neuman would be proud…
After an initial drawdown of 12% on the S&P 500 following Liberation Day, the markets fully recovered, ending the quarter at an all-time high, up nearly 11% for the period. It is becoming clear that each subsequent headline has less and less impact on investor sentiment. We are loath to wade into politics, but we are reminded of a saying that describes our President well: supporters take him seriously but not literally and his detractors take him literally but not seriously. It feels like the market has decided to stay out of politics and fall somewhere between his supporters and detractors.
After an initial series of smaller trade-related executive orders, Trump unveiled his massive Liberation Day package on April 2nd, imposing a 10% baseline tariff on imports from virtually every country and higher tariffs on countries with whom the U.S. maintained larger trade deficits. This led to a global selloff in risk assets as investors feared the tariffs would be inflationary, triggering flashbacks of supply chain disruptions during the pandemic. On April 9th, the administration reversed course by announcing a 90-day pause on the implementation of the tariffs, which led to a market rally and a new acronym: TACO (Trump Always Chickens Out). Putting cheeky market phrases aside, the tariff conversation is tremendously complicated and retains the ability to cause significant disruptions to the economy. For now, however, the market seems optimistic that cooler heads will prevail.
Unfortunately, geopolitical conflict increased significantly during the quarter. While Israel has continued its siege of Gaza and of Hezbollah in Lebanon, they also expanded their efforts into Iran. On June 21st, the United States joined Israel in its attack of Iran by bombing three alleged nuclear development sites. At the same time, the conflict between Russia and Ukraine continues and shows little sign of reaching a peaceful conclusion.
Lastly, the development that should most concern the bond market is the administration’s “Big Beautiful” Reconciliation Bill, which the independent Congressional Budget Office (CBO) estimates will increase the federal deficit by $2.4 trillion over the 2025-2034 period. This will come on top of the already ~$36 trillion of federal debt outstanding. Given that many nations have curbed their buying of U.S. Treasuries, the question of how this increased deficit will be financed remains unanswered. Stablecoins, a cryptocurrency backed by Treasuries, will create some but not all of the missing demand and regulators are contemplating loosening bank capital restrictions to allow them more leeway to buy Treasuries. We fear there may be some unintended consequences if that change occurs.
So how did the markets respond over the quarter? With a gap-toothed shrug of its shoulders. Pretty much every risk metric in the market improved during the quarter, and perhaps most tellingly the measures of volatility in the equity market (VIX) and the bond market (MOVE) both ended the quarter lower:
*HY reflects the ICE BofA U.S. High Yield Index and IG reflects the Bloomberg U.S. Corporate Index.
While the explanations for muted markets are numerous and an exercise in speculation, we see two potential drivers. First, the financial markets continue to be awash in liquidity. As we have discussed previously, money supply as measured by M2 stands at an all-time high. It jumped 4.5% year-over-year in May, marking its 19th consecutive monthly increase. It has now surpassed the previous all-time high of $21.86 trillion, posted in March 2022. Since 2020, the M2 money supply has risen nearly $7 trillion, or ~45%. One definition of inflation is more money chasing fewer goods. There is certainly more money chasing financial assets today.
Another source of liquidity for financial assets is the Federal Reserve balance sheet. While the Fed’s efforts have reduced the balance sheet through the roll-off of Treasury and mortgage-backed securities, its balance sheet remains significantly elevated compared to pre-pandemic levels.
We have also been focused on the impact of passive investing as a potential cause of dampened volatility in markets. One source of growth in passive investing is the Pension Protection Act of 2006, which prompted a shift in retirement assets from defined benefit plans to defined contribution plans. Defined benefit plans encourage active management as corporations are incentivized to generate the best returns possible to limit their future liability (and capital contributions) to fund predetermined benefits to their retirees. Defined contribution plans, primarily 401(k)s, on the other hand, have led to many individuals picking a basket of passive funds and “setting and forgetting.” This is also true for non-retirement investing, as a plethora of very low-cost investment options are now available. Passive investment dollars now exceed actively managed mutual funds and ETFs. Aside from the aforementioned “set it and forget it” strategy, an actively managed mutual fund typically needs to sell the individual fund holdings when they experience large outflows. A passively managed ETF can be liquidated to another buyer of the ETF without the underlying holdings ever being touched. This has led to less volume and ultimately less volatility around the trading of the assets in funds.
Moving to high yield, the biggest sector in our portfolio, the ICE BofA U.S. High Yield Index experienced a strong second quarter return of 3.6%. On a yield basis, the index has stayed in a range of 7.1% to 8.7% during the period, which investors find attractive for an asset with a duration at or below about 3.35.
To further illustrate the point, we look to the new issue market. The year began with a moderate pace of $69 billion issuance in the first quarter. Not surprisingly, this virtually dried up in April around the Liberation Day volatility. Fortunately, as the saying goes, April showers bring May flowers, and May ended up being the most active month this year as the fears subsided. We took advantage and participated in several attractively priced new issues in the quarter. The coupons of the bonds we bought were almost 3% more on average than the coupons of bonds that we currently own. This recycling to higher coupons is a key underpinning of demand for high yield.
Additionally, as we discuss in our recent white paper, the credit quality of high yield has improved significantly in the past few years, as many weaker borrowers exited this space and now seek financing in the leveraged loan and private credit markets.
Going forward, we will remain selective in deploying new capital. The excess liquidity in the market is masking many of the risk factors covered in this piece. We do not know when, but we know there will be another disruption in the market that could open up attractive entry points for us to utilize our ample liquidity. In the meantime, we will continue looking for opportunities to invest in companies that meet our criteria and provide acceptable risk/reward metrics for our investors.
Thank you for your continued confidence in our management.
Carl Kaufman
Co-President, Co-Chief Executive Officer, Chief Investment Officer – Strategic Income & Managing Director – Fixed Income
Bradley Kane
Vice President & Portfolio Manager – Strategic Income
Craig Manchuck
Vice President & Portfolio Manager – Strategic Income
John Sheehan, CFA
Vice President & Portfolio Manager – Strategic Income
Featuring
Carl Kaufman
Co-President, Co-Chief Executive Officer, Chief Investment Officer – Strategic Income & Managing Director – Fixed Income
Carl Kaufman
Co-President, Co-Chief Executive Officer, Chief Investment Officer – Strategic Income & Managing Director – Fixed Income
Carl Kaufman serves in several key roles for the firm. He has managed the Osterweis Strategic Income Fund since its inception and serves as the Managing Director of Fixed Income, as well as a co-lead Portfolio Manager for the Osterweis Growth & Income Fund. Additionally, in his role as Co-President & Co-CEO he oversees key investment matters and is an integral part of the firm’s Management Committee.
He joined Osterweis Capital Management in 2002, after nearly 24 years at Robertson Stephens and Merrill Lynch.
Carl graduated from Harvard University and attended New York University Graduate School of Business Administration.
Outside his professional endeavors, he enjoys playing classical piano and actively contributes to the community as a member of the Board of Trustees for the San Francisco Conservatory of Music, supporting the arts and enhancing the cultural fabric of the SF Bay Area. Additionally, he enjoys playing golf, an activity that continually challenges his patience and precision.
Bradley Kane
Vice President & Portfolio Manager – Strategic Income
Bradley (Brad) Kane is a Portfolio Manager for the strategic income strategy and a partner at the firm. In his role he provides clients with a low-risk way to increase wealth, leveraging his extensive experience and deep understanding of the market.
Prior to joining Osterweis in 2013, Brad was a Portfolio Manager and Analyst at Newfleet Asset Management, where he managed both high yield and leveraged loan portfolios. Before that, he was a Vice President at GSC Partners, focusing on management of high yield and collateralized debt obligations. Earlier in his career, he managed high yield assets as a Vice President at Mitchell Hutchins Asset Management. In these positions he learned the importance of staying focused on one’s investing strategy and discovering new securities and investor types without succumbing to trends.
Brad graduated from Lehigh University with a B.S. in Business & Economics. Outside of his professional life, he enjoys playing golf, watching lacrosse and ice hockey, and indulging in his diverse taste in music, including a particular appreciation for heavy metal.
Craig Manchuck
Vice President & Portfolio Manager – Strategic Income
Craig Manchuck, a partner at Osterweis, is a Portfolio Manager for the strategic income strategy. In this role he enjoys investing clients’ assets in a common sense way that is designed to generate good risk-adjusted returns. Throughout his career, Craig has learned the importance of patience and that relationships with company management teams are invaluable.
Prior to joining Osterweis Capital Management in 2017, Craig was a Managing Director of Fixed Income Sales at Stifel Nicolaus, where he was responsible for sales and origination of high yield bonds, leveraged loans, and post reorg equities. Before Stifel, he held a similar role at Knight Capital. Before that, Craig was the Executive Director for Convertible Securities and then High Yield/Distressed Securities at UBS. He has previous experience in Convertible Securities Sales at Donaldson, Lufkin & Jenrette, SBC Warburg, and Merrill Lynch.
Craig graduated from Lehigh University with a B.S. in Finance and NYU Stern School of Business with an M.B.A. Outside of work, he enjoys golfing, wine, gardening, and spending time with family.
John Sheehan, CFA
Vice President & Portfolio Manager – Strategic Income
John Sheehan, a partner at Osterweis, is a Portfolio Manager for the strategic income strategy. In his role he appreciates the opportunity to contribute to clients feeling confident that their investments are positioned to meet their long-term goals. As a portfolio manager, he likes that the bond market is an ever-evolving game that blends art and science.
Prior to joining the Strategic Income team at the end of 2023, John was a portfolio manager for the total return strategy. Before that, he spent more than 20 years working at Citigroup, first as Managing Director responsible for Investment Grade Syndicate in New York City, where he advised issuers on accessing funding in the corporate bond market. Later at Citigroup, he was Managing Director in charge of West Coast Investment Grade Sales in San Francisco, where he covered several of the largest U.S. investment grade credit investors.
John graduated from Georgetown University with a B.A. in Economics. He holds the CFA designation and is a member of the CFA Society of San Francisco. Outside of work, John enjoys swimming and skiing with his family, as well as seeing live music.
For more information about this strategy, please send us an email or call us at (800) 700-3316.
Related Insights
The Fund was rated 4 Stars against 589 funds Overall, 3 Stars against 589 funds over 3 Years, 4 Stars against 547 funds over 5 Years, 4 Stars against 429 funds over 10 Years in the High Yield Bond category based on risk-adjusted returns as of 6/30/25.
The Morningstar Rating™ for funds, or “star rating,” is calculated for mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period has the greatest impact because it is included in all three rating periods.
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The Osterweis Strategic Income Fund may invest in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. The Fund may invest in foreign and emerging market securities, which involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Small- and mid-capitalization companies tend to have limited liquidity and greater price volatility than large-capitalization companies. Higher turnover rates may result in increased transaction costs, which could impact performance. From time to time, the Fund may have concentrated positions in one or more sectors subjecting the Fund to sector emphasis risk. The Fund may invest in municipal securities which are subject to the risk of default.
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A basis point is a unit that is equal to 1/100th of 1%.
Treasuries are securities sold by the federal government to consumers and investors to fund its operations. They are all backed by “the full faith and credit of the United States government” and thus are considered free of default risk.
Yield is the income return on an investment, such as the interest or dividends received from holding a particular security. A yield curve is a graph that plots bond yields vs. maturities, at a set point in time, assuming the bonds have equal credit quality. In the U.S., the yield curve generally refers to that of Treasuries.
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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OCMI-766133-2025-07-08]
