Listen to Carl’s recent interview on the podcast “Money Life with Chuck Jaffe,” where he discusses his fixed income outlook and the influence of central banks on the market.


Chuck Jaffe: Welcome to the big interview on today's edition of Money Life. I am pleased to be joined right now by Carl Kaufman. He is co-manager of the Osterweis Strategic Income Fund and along with a couple of his colleagues, well he was recently kind of taking a look at where we've been in the past 10 years in terms of central bank policy and things that were allowing him to see where the income was going and where we would be going. It's a really interesting analysis. If you've ever listened to us on the show before, you know that when we have folks from Osterweis on, we're always saying go check out their commentary because it is some of the most thoughtful in the business. If you want to check it out,, just like it sounds, but linked up where you find Carl Kaufman on the Money Life show, recent and upcoming guest page. Carl Kauffman, welcome to Money Life.

Carl Kaufman: Well, thank you Chuck. Glad to be here.

Chuck Jaffe: We've had a 10 year period where it normally gets summed up as bull market, but it's a 10 year period where the S&P 500 was returning comfortably into the double digits. So when you take a look at that and you then look at the returns that you get from the Barclays US Agg Index and everything else, how is it shaping up for the next decade? Because you like to take that long view, and most people right now, we're looking at that long view, and they're a little more cloudy than you are.

Carl Kaufman: Well, it's not that we have a crystal ball, but we look at probabilities. We've had probably, and this is the tyranny of money management, the tyranny of the calendar year, the tyranny of the decade. We happen to have had the last decade start near the bottom of the great financial crisis of 2008. So if you look at 2009 through 2019, you've got 10 years where you started very low, and monetary policy got extremely loose. So, of course, that money does not, unlike central bankers models, does not flow to the real economy. If corporations are not spending that money, it flows into asset prices. So we've had a jump in asset prices over the last 10 years. As you said, the return on the S&P 500 over the last 10 years is 13.6% per year. For treasuries or government bonds, it's about 3.2%. For investment grade corporates, 5.6% and for high yield, it's a 7.5%. So certainly for stocks and for high yield bonds, it's been a pretty good 10 year period.

Now, if you go back to the prior ten year period, which is 2000 to 2009, this shows what happens picking your starting point. It's just not quite as, it's almost as important as picking your parents, but in 2000 we were at the peak of the market. So the 10 year returns for the S&P were negative 0.9% for that 10 year period. That's how important it is. So when you're starting now, you're, I would say arguably nearer a peak than a trough. So looking forward, I think that with interest rates where they are today, which is much closer to zero than they were 10 years ago, I think the tailwind from that is not going to be as big. It's going to be de minimis, I think. Economic growth will likely be slower. We have slower globalization. It seems to have reached its zenith. So I think we're going to be in a slow growth environment for quite a while.

And I think that the fed and the central banks are starting to rethink monetary policy, not urgently, but at least they're talking about it. You saw what happened in Europe. I mean they're at negative rates there in a lot of countries, and their growth is crap. They can't get it started. It's like a wet candle. They just can't seem to get it lit no matter how much money they throw at it. So Christine Lagarde, the new head of the ECB is at least asking the question. I don't know whether they will get there or not, or change behavior, but she's asking the question: do negative interest rates really work? We don't think they do. They're unnatural. The problem is a economists have models, and the models say, "If I pay you to borrow money, the model says you should go out and spend that money and borrow a whole lot."

In reality, what happens is people save more because people understand that unlike economists that there is a cost to borrowing. Even if the interest rate is negative, you still have to pay back the principal even if it's a little less principal than you borrowed, and that's been born true in Japan where you have a very high savings rate, and it's being born in Europe where the Germans are saving like crazy because they have aging populations. They're getting near retirement age, and they know that with 0% or negative percent interest rates, no interest on your savings, you're going to need more money. This drives economists crazy. So they really don't know what to do. They keep on pushing that that help button, and no help seems to show up. So we think that eventually there will be a change in thinking, but it's not going to be immediate.

Chuck Jaffe: And when we get it, I mean the space that you occupy at Osterweis Strategic Income, and I should point out for my audience, ticker symbol O-S-T-I-X, the space that you occupy of course is a high yield space. Well, a decade ago, we had junk that was actual junk. Maybe it had to be more than a decade. I'm not sure I remember when high yield was truly junkie, or at least a high percentage of junk. Are we going to see change that in some way also sees us changing credit quality?

Carl Kaufman: Well, you know, I think that what's happened with low interest rates is companies have been able to support a higher debt load, which normally is a warning sign. It's a flashing yellow light, at least, when companies, you see their leverage ratios go up. But as S&P and Moody's have pointed out, you know, the coverage ratios are so much better. So if you can afford to pay your interest, and you can run your business with a lower interest burden, then you can carry a slightly higher debt load. Now that being said, we're in a slow growth environment. So the typical issue of a high yield debt is your industrial, your cyclicals. You're not going to see Facebook issuing high yield debt. It's an investment grade. They throw off tons of free cash flows. They, they only use debt to buy back stock to counteract their equity grants.

So what we have is a situation where the quality, you have to sort of redefine it in a way. You can't look at the old metrics and say, "Okay, in 2008, or 2007 when things were yielding double digits and leverage ratios were X on a single B, for example, this was the yield that I expected to get." Well, don't forget treasuries were yielding 5% back then, 6%. The money markets where yielding 5%. So you had to have some premium over that to warrant buying that debt. Now that you're getting not much on your cash, maybe more than you were at that the lows, but you're not getting much on your cash or new treasury.

I think investment grade bonds are yielding 2% right now on average. So you're not getting much income there. So if you can get 5%, is that considered attractive? Relatively speaking, I'm not talking in absolutes here. I'm talking relative, which is the world we live in. It's still pretty good. In Europe, as I said, Europe high yield market is in the twos. So you know, 5% is not a bad yield. It's not what you would expect as an old timer in high yield investment.

I want to clarify one thing you said about the fund. It is a go-anywhere fund. It was one of the first go-anywhere funds. I started in '02. We just happen to not think that investment grade as an absolute return is very attractive right now. So we have been focused on high yield, but we can go to treasuries if we find them attractive. Last time we went to treasuries was in the middle of '07 when the fed started its cutting cycle, and we exited that in the fall of '08 when high yield was just too cheap to ignore. So we have been, we're only about a high fifties percent traditional high yield at this point. We've been lowering that percentage, and we've been shortening our duration because we think we haven't had a meaningful correction in over a year. I think we're probably going to have one this year, and we want to be ready with a lot of cash, and I'm ready to do some buying on dips, which is our typical M.O.

Chuck Jaffe: And for you right now, I mean dips. Dips are the market's reacting to coronavirus and dropping a percent a day, or is it got to be something that flattens it and takes it a little bit more than that?

Carl Kaufman: You know, we take what we can get, but so far we've been buying in January, in the recent a couple of weeks because the underwriting calendar has been very heavy, and there haven't been much in the way of net inflows into high yields. So high yield funds, more benchmark oriented funds, have to buy these big benchmark issues. And so they're selling the shorter dated paper, which doesn't have a lot of beta to it. So it doesn't have a lot of movement. You're just flipping on a reasonable rate. So we're buying that on this dip. If the correction continues, which we'll have to wait and see how bad this gets, but if it continues, usually they sell the short stuff first, then they start selling the longer paper down, but so far that hasn't happened. We haven't been buying a lot of longer dated paper, but we've been buying a lot of shorter data defensive paper.

Chuck Jaffe: Carl, it's very interesting stuff to me. I have more questions. I wish I had more time, but unfortunately we're out, but this was great. I hope you'll come back and chat with me again down the line sometime.

Carl Kaufman: I'd love to. Thank you for having me, Chuck.

Chuck Jaffe: That's Carl Kauffman, everybody. He is co-manager of the Osterweis Strategic Income Fund. OSTIX, the ticker. Go to for more information, not only on the fund, but like I said, you want to check out their analysis because it's really smart. It's one of the fund firms where I do take a look at the papers and the things that they're producing because they're worth looking at. Also, worth doing, sticking around because we just reached the halfway poll on today's show. That means we're just getting warmed up. A little bit later on this show, it will be the market call, and we'll be talking with Mike Larson of Weiss Ratings about stocks. So settle back, relax. We living the Money Life and we'll be back to it right after this message.

A basis point is a unit that is equal to 1/100th of 1%.

Duration measures the potential volatility of the price of a debt security, or the aggregate market value of a portfolio of debt securities, prior to maturity. Securities with longer durations generally have more volatile prices than securities of comparable quality with shorter durations.

The S&P 500 Index is an unmanaged index that is widely regarded as the standard for measuring large-cap U.S. stock market performance.

“The Fed” refers to the U.S. Federal Reserve Board.

“The ECB” refers to the European Central Bank.

The Bloomberg Barclays U.S. Aggregate Bond Index (BC Agg) is an unmanaged index that is widely regarded as a standard for measuring U.S. investment grade bond market performance.

The ICE BofA U.S. High Yield (HY) Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market.

The ICE BofA U.S. Corporate & Government Index tracks the performance of U.S. dollar denominated investment grade debt publicly issued in the U.S. domestic market, including U.S. Treasury, U.S. agency, foreign government, supranational and corporate securities.

Leverage ratio is a financial measurement that looks at how much capital comes in the form of debt (loans), or assesses the ability of a company to meet its financial obligations.

Free cash flow represents the cash that a company is able to generate after laying out the money required to maintain and expand the company’s asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

Standard and Poor’s ratings are expressed as letters ranging from ‘AAA’, which is the highest grade, to ‘D’, which is the lowest grade. Moody’s ratings are expressed as letters and numbers ranging from ‘Aaa’, which is the highest grade, to ‘C’, which is the lowest grade. A Standard and Poor’s rating of BBB- or higher is considered investment grade. A Moody’s rating of Baa3 or higher is considered investment grade. A Standard and Poor’s rating below BBB- is considered non-investment grade. A Moody’s rating below Baa3 is considered non-investment grade. If an issue is rated by both agencies, the higher rating is used to determine the sector. Fund breakdown by credit ratings are based on Standard and Poor’s ratings. Not Rated Securities consists of securities not rated by either agency, including common stocks, if any.

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.

Mutual fund investing involves risk. Principal loss is possible.

Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [xxxxx]