Published on July 15, 2022

If you were unable to join our quarterly webinar, watch the the replay to hear updates on the Osterweis Strategic Income Fund.


Shawn Eubanks: Good morning, everyone. My name is Shawn Eubanks, and I'd like to welcome you to our second quarter webinar for the Osterweis Strategic Income Fund. So, I'll start by moderating a discussion with Carl Kaufman, Craig Manchuck, and Bradley Kane. And then, after our discussion, we'll open the lines for your questions. So, let's begin. Let's start with Carl. The second quarter was another tough stretch in the markets with pretty much every major index delivering negative returns. Would you mind providing a little perspective on the last quarter?

Carl Kaufman: Sure, Shawn. And thank you all for calling in. Let's start with a few numbers to get things in context. The S&P was down almost 20% in the first half of this year. It's the worst start since 1962. And if we hadn't had a mid-month rally in June, it would've been the worst first half since 1932. Certainly, small cap growth stock struggled even more, losing almost 30%. And the 10-year U.S. Treasury had the worst first half performance since 1788. So yeah, '22 has been rough. The question we ask is, are we there yet? And by there, I mean, is the selloff over, where we can start to look for a turnaround?

There's a couple of things to keep in mind. One, is that this equity selloff, I think, feels more like an asset price correction for equities, much like 2000, 2002 was, but I think it has fewer implications for high yield. High yield in the 2000s was used to fund investments in telecoms and cable. And today, there's no such investment boom that we are seeing, nor is there systemic risk like there was in 2007 to 2009 when there was a buildup in housing finance.

Or, there's no sudden stop like in Covid. So, typically, the collateral damage, which is high yield, should recover when the selloff is over. And just to give you some perspective on what happened post the first halves of 1932 and 1962, the 5-year returns following the 1932 first half were close to 30% a year compounded. And in 1962, 5-years following the first half of 1962, compounded returns for 5-years were about 14 and a half percent. And for the 10-year periods, for both instances, the returns were about 10 and half percent a year. So, I'm not saying that's going to happen again, history may not rhyme this time. But I think, the lower the market goes, the tighter the coil is pulled, and hopefully we do get some sunnier skies ahead.

Shawn Eubanks: Thank you, Carl. Can you talk a little bit about the drivers that are creating these market headwinds?

Carl Kaufman: Sure. Clearly, the Fed tightening cycle is the primary cause, as rising interest rates are bad for both equities, in terms of valuations, and they're bad for investment grade fixed income because as you know, rates rise, prices drop. Unfortunately, the Fed really has no choice. They waited a long time to fight inflation. They're talking about it more than they're doing it. I mean, we're at 8% inflation, we'll get the number tomorrow for the previous month. But, they're woefully behind at this point. And it's proving to be much stickier than they expected. So, once again, they have missed the vote. And so, there is concern about them going too far and causing a recession. So those are the two big headwinds. You've got recession on one hand, inflation on the other. And, once we get through this period, we'll have a clearer picture of what we're looking at.

Shawn Eubanks: Thank you. Brad, maybe you can expand on that a little further. In your view has Fed policy been effective?

Bradley Kane: Well, I think, as Carl mentioned, the asset price correction that we've seen, some of that has been anticipation of the Fed raising rates and reaction of the Fed actually raising rates the last couple of times. So, I'd say it's been a little bit effective, but what we need to see, is we need to see if the anticipation and the actual raising rates has had any effects on real demand. And, for that, if we take a look at mortgage rates, we could see they've been moving higher as rates have been rising, and that's led to a slowing in home sales.

So the slowing home sales has actually led to a lot of the commodities related to home production declining, you've seen lumber prices dropping over 50% since March, copper prices are down almost 30% in the same timeframe, the purchasing manager's index currently in the low-50s has been softening. So, you are starting to see some of the statistics and the market levels coming down. And so, whether this is directly related to the Fed actions, or in anticipation of what's happening with the recession in people's mindset, that's still a little bit up in the air. The one thing I would say, though, when you look at all of these numbers coming down, the thing that's staying up though is unemployment claims have continued to drop and jobs are still relatively plentiful. So, we're having a give and take in the economy, as some prices are coming down, but other things may be driving them to stay up a little bit.

So, I think this is something we're keeping an eye on to see if the slowing levels in the markets will have an impact longer term on layoffs and employment statistics, because you really can't have a slowdown if you are continuing to have employment hitting highs and jobs very plentiful. And so, we haven't seen a meaningful reduction yet in CPI or the PCE, which are good inflation indicators. So that's something we're still continuing to keep an eye on, but we have seen other signs of some soft things. So, there's a balance that we have to keep an eye out for.

The other thing that I want to remind people about is expectations for inflation. Two percent was the Fed's target for a long time. Obviously, we're significantly above that right now. But, an economist, John Mauldin reminds us that, in the '90s, a 3% annual CPI reading was common and not an issue. So, what we saw in the '90s was significantly above what the Fed's target was, and it wasn't an issue. In fact, in 2005 and in 2008, it was at or slightly higher than a 5% annual rate. And that wasn't really an issue for the markets. So, current interest rates are a matter of perspective, a little bit of historical reference. And I think, it's something that the Fed's been trying to get mindsets changed. And I think as you look at where people are, where levels are coming down, it's something that ebbs and flows. I think the more you see the Fed attempting to reign in the inflation and avoid sending the economy into a deep recession. I think that's going to begin to balance people's mindsets out about the outlook.

Shawn Eubanks: Okay. Thanks, Brad. That's helpful. What about the risk of recession? Do you think it's imminent? It certainly is getting a lot of press these days.

Bradley Kane: Yeah, it's definitely getting a lot of press. I'm not sure you can turn on the TV and not see a new pundit every day, talking about a recession in '22, or a recession in '23, or no recession. They really have no idea. A lot of them are looking for press coverage and to sell newsletters, not something we do. We don't think it's imminent. We are going to see a slowdown. I think that is likely, and that's a positive outcome of the Fed raising rates and levels getting reset, because as you have a slowdown that naturally brings inflation under control. And, whether that's out of necessity by people's spending habits or by choice, it will all culminate in helping to slow the economy, hopefully not into a recession, but definitely to take less pressure off the inflationary outlook.

If you just take a look at gasoline, which was recently as high as $7 a gallon in some areas. And yes, it's driven by the war in Ukraine, but it's also self-induced, as we've had a massive pent-up demand to travel post-pandemic. And so, you have demand outstripping supply, but what does that do? Yes, if you're going to go on a long car ride, you're going to be paying a lot to fill up your tank. You're going to have less money to spend elsewhere. But you also may decide not to take that long road trip. You may decide to stay closer to home. And so, then all of a sudden, instead of paying for a high priced gas, you may be lowering the demand for fuel in that area by not going on a trip.

So, it really is a balance of what you're spending your money on and how that will have an impact on the economy. In fact, as I said, if you're spending money on gas in one place, you're probably not spending somewhere else. And so, those inflationary headwinds, some are staying high, and some are getting balanced out by your spending. And I think, as consumers continue to balk at high prices on stuff that was going to have a natural slowdown in their spending will take some of the inflationary pressure away. You're also seeing things change with... A couple of big box retailers have announced that they have significant inventory overhang, because consumers have stopped buying certain products and have spent more on services. Well, eventually those that inventory needs to get discounted to move. And so what happens is it lowers prices, and therefore lowers inflationary spending pressure.

So, it really depends on how consumers make choices, how businesses are making choices to adjust what they're spending on and what they're ordering. And I think all of that has an impact on slowing the economy, which is really what the Fed is trying to do. And as we've talked about in the past, the big thing about inflation is, everybody's purchasing basket is different. So what you see in headlines about inflationary prices going up really depends on what you are buying and whether or not you are in the market for the same products that they're reporting. So while you see it on the nightly news, and it does change people's mindset, people need to remember that they have a different basket than what the person next door may have. And, the mindset of everybody as being inflationary is something that does need to get changed. And, that's really what the Fed's been working on breaking. And I think, that will have a big impact, just what you think you're spending on and what you're spending does have a big impact on what inflation you're seeing.

Shawn Eubanks: Thank you, Brad. Craig, let's switch to you. Can you just talk about some of the market dynamics that you're seeing in the high yield market in particular?

Craig Manchuck: Sure. Good morning, Shawn. The market is finally parsing and separating some of the wheat from the chaff, if you will. It's seen a separation of what people consider to be safe havens versus everything else, to some extent. And that had not been the case through much of the end of 2020 and 2021, where people were just buying everything. But, with that, they're not always necessarily viewing things correctly. So, in one case, for example, we've seen the food retailers and food service companies continue to be fairly well bid and well supported, and people are comfortable in that space. Yet, they're less comfortable with the fast food or QSR companies, and they are experiencing some of the same dynamics, both have to hire people and both are experiencing raw material price increases, but they're much more concerned about what's going on with the fast food companies, even though historically those do well in a recessionary environment. So, that's a little unusual.

We're also seeing some weird things in the mortgage market for example. We have a couple investments in that space and the mortgage originators have traded down quite sharply. Obviously, mortgage originations will come down as rates go up. However, on the flip side, the market is giving these companies almost zero credit for mortgage servicing rights or MSRs. And these MSRs are enormously valuable, because obviously everyone who's got a mortgage in a higher rate environment is less likely to refinance that mortgage so that the duration of the time to service that mortgage gets longer and longer. And obviously the associated fees get better. And mortgage delinquencies are still very, very low. So, that value is not being properly allocated and associated with these companies. And those bonds have probably gotten a little bit too cheap.

One other dynamic I think that we're seeing are a number of really good quality, but private or one-off names have gotten very, very cheap as well. Again, the whole market trades down. And what happens in these situations is there's less information outstanding, fewer people are spending the time to dig and look for value because they've got so many other problems and headaches in their portfolio. So, they're trying to address those problems rather than really identify very attractive private names that are one-off. The preponderance of high yield investors want beta and they want market performance. So, we're seeing a lot of that type movement. So, the cream is rising to the top a little bit, but at the same time, there's some tremendous value that has been created through this selloff that we think will be able to be captured over the next couple quarters.

Shawn Eubanks: That's great. Thanks, Craig. Has the market volatility impacted the new issuance market in the last quarter or so? And, what are you expecting for the remainder of the year?

Craig Manchuck: It has. I mean, year-to-date, new issuance is about $75 billion in high yield. In convertibles, it's been a relative pittance as well. At this time in 2021, we had $520 billion in issuance. So if you run rate the two, we're down about 65 to 70% in terms of issuance. That should be a positive, the less of an overhang, the less supply out there. However, in the sponsor-backed LBO space, there's still about 60 to 70 billion dollars of committed financings that exist, that are sitting effectively on bank balance sheets that need to get out there and to clear the market. So, for example, Citrix Systems, I think is the biggest one. That's about 16 and a half billion dollars. That's a committed financing deal, where Vista Equity is going to be buying Citrix. That's going to be tricky, because this is a business that generates 600 million dollars of EBITDA. So they're paying about 26 times enterprise value to EBITDA to buy that company.

Typically, if you think about what the sponsors do is they want to put in 20 to 30% equity check... Well, that's just way too much debt and way too much leverage for these guys to be able to actually finance that in the market. So, still unclear how that's going to work. But, there was the recent deal that just cleared the market a couple weeks ago for a company called Intertape Polymer, which is a build and supply manufacturer, and it was purchased by a company called Clearlake Capital. They ended up actually having to issue their loans at 92 cents on the dollar. So effectively, the banks took about an eight point hit on a billion and a half dollars of term loans in order to get them out the door. And then, they issued 400 million dollars of bonds at 82 cents on the dollar. So an 18-point hit on their committed financing in order to get those out the door at about 14, 14 and a half percent.

So in some ways what the market is doing is more accurately parsing the risks in these transactions, because this deal for Intertape was 7.2 times levered through the term loan, roughly 9 times leveraged through the bonds. And those are just lofty, lofty leverage numbers. We're not very comfortable investing in those leverage terms, but if other people are, they got paid to do that, because they're able to invest at roughly 14, 14 and a half percent. So if they're comfortable with the business, as we start to see these prices normalize, I think the market again, further will continue to sift out and separate out risk and will be more accurately priced as we go forward.

Shawn Eubanks: Those are some great examples. Maybe just if we can go back to Carl, can you sum up your overall outlook and really are we there yet?

Carl Kaufman: Okay. No one knows if we are there yet. The high yield market, certainly it came close to 9% yield to maturity. It's rallied little bits off of that bottom, 860 right now. The real question is going to be earnings. Are earnings going to be better than expected this quarter? We'll see. We've seen a couple of research reports that imply that the inflationary environment... Clearly those that are raising prices are getting more revenue dollars in and that they've been able to maintain their margins. So if you have maintenance of margins with rising revenue dollars, you should have rising profit dollars, which actually brings your leverage down over a fixed debt load. So, if that is the case this quarter, we may have hit an intermediate bottom, but we do have the Fed at the end of the month, will probably be raising 50 to 75 basis points, who knows. And we'll see what the market reaction is to that.

So, I think we're close. I don't know how long we stay there. But overall, when you have a correction like we've had in risk assets, by definition, you're getting closer to the bottom. It's just a question of how long we stay there and what the tailwinds are to get the next bull cycle going. We just don't have those, not much visibility there. So that's why we've been keeping a decent amount of cash.

Shawn Eubanks: Okay. Thank you. Let's quickly transition to the fund. And we'll show some performance, which has been strong on a relative basis. And, as we move to that slide, Brad, can you talk about how the fund's positioned right now?

Bradley Kane: given the year's been pretty volatile, and uncertainty over how the economy's going to react to the Fed, we've been staying a little more defensive. We're keeping plenty of dry powder. With short-term rates up, thanks to the Fed, we're getting some more compensation on our cash, and actually commercial paper has been paying a pretty nice yield. So we've been spending a little bit more of our cash, just sitting in short-term, one month commercial paper. Really waiting for the markets to find that balance and that equilibrium. And then, we can really pounce when opportunities arise. But I would say other than the cash and defensive, we haven't changed much this year.

Shawn Eubanks: Okay. Carl, while we display the portfolio statistics and before we open up the floor for Q&A, do you have anything you'd like add at this point?

Carl Kaufman: No, I think we've said a lot. I just want to make sure that people... We tend to think longer term over a cycle. We try not to get too emotional in the down part of the cycle, because we know there will be brighter days ahead. And, this is the time you want to be looking to buy, not sell, because if I were to say, the market is 8.6% yield to maturity. If I were to give you that return for as long as the next three years, I think most people would be very happy with that. Whether it's a straight line or not, who knows. But we are getting closer to a point where you want to put money in, not take it out.

Shawn Eubanks: Great. We'll now open up the Q&A. And as noted on the slide, please ask a question through the Q&A window or raise your hand to ask a question over computer audio or by the phone. Our first question was sent in before today's call, "Has the recent selloff created opportunities? And what areas of the high yield market do you think are most attractive?"

Carl Kaufman: I would say, yes, it has created opportunities. We are trying to buy better quality companies that some of are collateral damage, and when nobody cares, that's when our ears perk up, without getting into too many specifics. I mean, there are just a lot of consumer staple companies that we like, because consumer staples are just that, you buy them regardless. You're not going to stop buying toiletries or whatever it is that you buy to lead your daily life, paper products, things like that. So, we're looking at a lot of different areas, but it does create opportunities. And, hopefully it will create one more at the end of this month.

Shawn Eubanks: Okay. And then, we have a question on fund flows into, out of strategic income. How were they in the second quarter? And, is that trend continuing into the third?

Carl Kaufman: Shawn, you're probably best positioned to answer that question.

Shawn Eubanks: Yeah. I would say that we haven't seen a lot of significant selling. There has been people repositioning their positions and moderate outflows, but nothing that hasn't affected our cash or overall liquidity position. Maybe you can talk a little bit about your liquidity bucket there.

Carl Kaufman: Yeah. I mean, as you can see from the slide, I mean, the cash and under one year is about 17.4%, but we also have a decent percentage of bonds that are longer than one year, but we feel very strongly that they will be redeemed before a year is out. As a matter of fact, one of them just got redeemed post quarter end. So, that gives us plenty of ammo and firepower to do some buying when the time is right.

Shawn Eubanks: Okay. Have an inflation-oriented question here. "Would you expect inflation and commodity prices to rise again from here? Or has the Fed destroyed demand enough already?"

Carl Kaufman: You say commodity prices. Clearly there are some commodities that are dependent on things that the Fed cannot control, like oil. Some commodity prices have already fallen, like lumber and copper, and some have not. So, it's a question of, we have to pass through labor increases. You're seeing what's happening with airline pilots. Wages are moving up way above inflation, because there are shortages there. So I think, it's not going to be a smooth transition. A lot of components of inflation may price lower and some may price higher. But I think, in average, inflation will probably be stubbornly high for longer than people want, until we get the demand destruction that the Fed is aiming for. So, it's a pretty blunt instrument they're using.

Shawn Eubanks: Okay. Can you talk a little bit about your outlook for high yield defaults and in general is high yield of value today?

Carl Kaufman: Sure. There's a couple of things that cause defaults. One is, the inability to pay your interest in principle. Typically, it's principle because most companies can afford their interest. And, what's happened over the last four to five years with very low interest rates is CFOs and CEOs have done the right thing and they've pushed out their maturities at very low coupons. So their interest burdens are much smaller than they used to be. Bonds coming due inside of three years comprise about 15% of the high yield market right now, which is pretty low. So there is no maturity wall that is threatening a huge wave of defaults going forward. So I think defaults are not going to be above average for this point in the cycle if we get a recession, clearly there will be some stress out there. But, I think it will be limited to very highly leveraged companies, which are typically private equity-sponsored, where they've sucked the company liquidity out in the form of dividends and left them in a weakened spot. But, I don't see a huge wave of defaults hitting the market this cycle.

Shawn Eubanks: Okay. What sectors of the high yield market seem most at risk to you currently? And, what sectors are most compelling buying opportunities given the spread widening? Are busted converts interesting yet?

Carl Kaufman: They're getting there. They're not quite there. They're holding up much better than we would've liked. They're yielding less than their high yield brethren at this point. We like to buy those when they're yielding about the same. So we still have some room to go there. But we have found one or two names to look at there. In terms of sectors, it's not so much industry sectors as structural sectors. Craig got to spend some time on the private equity-sponsored private companies. We tend to avoid those, because they're very weak on covenants and their motivations aren't to grow the business, it's to suck capital out of the structure. So I think that's where you're going to see stress and that's where you probably want to be very careful. I think, good companies that are well-managed, and allocate capital accordingly, and try to reduce their debt loads, that's where the opportunities are. Because they will survive the next cycle and they'll be stronger coming out than they were going in.

Craig Manchuck: Hey Shawn, can I just add that, regarding the busted convertible, we would've thought that we would see more attractive opportunities. However, part of the problem was the issuance last year was mostly from very new companies, many of which we have not seen operate over a cycle. And, the coupons were 0 to less than 1%.

Now, a lot of those companies, a company like Peloton for example, those bonds traded in the low-60s now, or Upstart, or Affirm, which are buy now, pay later companies, those are trading down in the 50s and 60s. We've just avoided them because it's too difficult to analyze how they're going to perform across the cycle. We haven't seen it before. So, we're not getting paid any current yield there. But what I do think we could see happen is, we're going to start to see now some better quality companies, I think, that'll issue convertibles in the next year or so, because we've got a rate environment now that's different and lends itself to convertible issuance. So I think there's an opportunity for some new investments in convertibles over the next 6 to 12 months that will be coming at very attractive stock prices and convertible pricing as well.

Shawn Eubanks: Okay. Well, can you maybe just give your thoughts, given the high yield market has been down so much this year and the NAVs come down slightly, less than the overall high yield market, can you talk about the current yield on the portfolio and why people should stay invested in this asset class right now?

Carl Kaufman: Sure. That's an easy one. I mean, the yield to maturity on the portfolio is about 7.8%, but that includes some convertibles that a lot of them have negative yields, because they're trading well above par still. The SEC yield, which is, I guess, the semiofficial number was 6.20So you're getting some decent yields. You have the potential for improvement over the next a year or so. And, as I said before, now is the time to be buying and looking to buy. It's not the time to be selling.

Shawn Eubanks: Great. And, would you say that there's an advantage in private deals today with the decline in the public market?

Carl Kaufman: Some. Not private equity owned private companies, but private companies that are still run by families that may be off-benchmark that are ignored by the ETFs. There are some that actually look pretty interesting.

Craig Manchuck: Yeah. Can I just to add to that? We have a couple in our portfolio. There's one in particular that I keep looking at and talking about. The company's less than two times levered, it's a 2025 maturity in the bonds. A 11 billion dollar revenue business and the bonds yield almost 9%. We've added to the name because it looks attractive. And I think opportunistically, we probably continue to add. When you've got businesses that are so short... Excuse me, so low-levered, we find great comfort in low leverage, especially in this kind of environment. And that strength and balance sheet really matters a lot right now, high levered companies right now are very, very risky. And hence, why we're seeing some of the private equity deals having to come to market at 14, 15%, because they're carrying so much leverage. They've got very little margin for error, and we want to invest in businesses with as low leverage as possible and responsible stewards of capital managing those businesses to take advantage of investment opportunities for their companies.

Shawn Eubanks: How do you assess the impact of quantitative tightening now in over the next year?

Carl Kaufman: Quantitative tightening is a state of mind. If you go about your daily life and change your purchase habits based on the Fed's balance sheet, I think, that's a very rare person that does this. But, clearly, if there's too much liquidity in the system, this will remove some liquidity in the system at the margin. And I don't think they're going to be that aggressive about it, quite frankly. I mean, they've been very measured and taking their time. I haven't seen any sense of urgency from the Fed to lower their balance sheet. So, we'll have to wait and see how it really impacts the markets. But, from my point of view, having a smaller Fed balance sheet is better than having a larger one in terms of the health of the economy.

Bradley Kane: And, yeah, this is Brad. I would just add, it also depends on what they do, how they do it, if it's a matter of letting notes and bonds that they own mature, versus actively selling them into the market, that would have a different impact.

Shawn Eubanks: And, do you feel like the fund is positioned well if we do see a recession going forward? Can you talk about the negative absolute performance in the second quarter?

Carl Kaufman: I'll let Craig take that one.

Craig Manchuck: So, there was some unusual things that happened towards the end of the second quarter. I think what you saw was there was a fear that rippled through the market at the end of the second quarter, that with such a bad performance number many of the high yield guys tried to run to the sidelines and raise as much cash as possible, because they typically run more fully invested. And, many of the things they were selling were the type of things that we like to typically invest in, shorter maturity bonds, higher dollar price, given that they're more likely to be called. Many of those bonds have traded down much more sharply than we would have ever expected. It was a bit of a baby with the bath water, but also it was, they sought to raise cash and they looked to do it by selling the highest dollar priced bonds in the portfolio. And there were very few buyers for those.

So, we have a couple names that traded down sharply, have very, very high yields, secured pieces of paper, somewhat similar to what I referenced before in the 2025 piece of paper that's trading almost 9%. And I think it was a function of what happened with liquidity in the market. People needed to get out, they needed to get out just to do quarter-end window dressing, and they were selling indiscriminately and pushing certain of these names down much harder than we would normally see.

So it was an unusual period. I was quite surprised at the performance in the second quarter, I thought we should have held up better based on the way we were positioned. We didn't experience any credit events in the quarter that caused that. This was all just high pressure from selling. Dealers were not out there supporting the markets. In fact, they were looking to do the opposite. And it was a good environment for anybody who wanted to short names to be out there shorting, right? It was very easy to put pressure on some of these names because there were no real buyers around. So, somebody would buy and then the next trade would be down a point.

And then, we also had the dynamic of the liquidity coming from the ETFs. So, the ETFs have been the primary liquidity source for many of the bigger benchmark high yield funds as well, because it's a cash plug and they can just sell the shares and let somebody else worry about selling the bonds. And as a result, they sell entire portfolios out, regardless of what the names are. So it doesn't matter what they own. In many cases, they don't even know the names of the companies in which they're trading. They just sell them because they have to in order to redeem ETF shares. And, we saw a lot of that particularly in the second half of June. There's another part to the question, I'm sorry, Shawn.

Shawn Eubanks: I guess it was just, how well do you feel like the fund is positioned for the potential for a recession?

Craig Manchuck: For a recession? Again, I think we're positioned well, because typically we're better off being in these shorter names so we have less duration and less spread duration as well. And now, as the dollar prices of the bonds have come down, there's much less price risk going forward. I think we've taken a lot of the pain here. The spread widening has been rapid and also very unusual. Carl and I, we talk about it a lot, but historically when the Fed's raising rates it's because the economy's really good. So, the fear of a recession doesn't creep in at the front end of the Fed raising, it usually creeps in later, nobody expects the Fed to start raising rates and all of a sudden the recession starts in three or six months. It usually takes longer.

And as a result, spreads tend to tighten first, rather than widening right away. So the spread widening that happened in the high yield market, I think was much more rapid than a lot of people anticipated. And I think if we go and look back in hindsight, we're going to find out that there were probably some really enormous allocations from things that were going on outside what we would normally say would be the credit markets, but large allocations from foreign nationals that got pulled out of the market that caused significant selling pressure, much more so than we would necessarily have seen this quickly.

Carl Kaufman: I think the short answer is, I think the high yield market is discounting a recession that has yet to happen. Whereas, in past cycles it starts discounting that much further along the tightening cycle. There was a question on the yield to worst in the portfolio, 7.78% is the answer. And another question was, "You believe option adjusted spreads will continue to increase, or has most of the pain already incurred?" I would say, a lot of the pain has already occurred on spreads, although they could go wider. They typically do in recessions, but we're already close to 600, maybe 800, 900 is the bottom, but from what rate level, who knows.

Craig Manchuck: Right. And, we do like to look at things on a case-by-case basis, just because we invest in individual bonds, as opposed to investing in the market, if you will. So we own a number of bonds that are yielding much more than what the benchmark averages are. And then, there are sectors of the market right now that are still tight. So, energy has been an outperformer and we have historically been underinvested in energy and continue to be, as we see days like today with oil prices down 6 or 7% and things like that coming down. That part of the market will be much more susceptible to spread widening than many of the places in which we're currently invested at the moment.

Shawn Eubanks: Can you talk a little bit about the market liquidity in the high yield market? Any concerns there?

Carl Kaufman: Well, we touched on that. The market is certainly no less liquid than it has been in past cycles. And it really depends on your perspective. If you're looking to buy and everybody else is looking to sell, there's really no liquidity problem. If you have to sell through a very narrow door and there's a lot of company, eh, you might feel the market's illiquid. So, we're well-positioned for any decreases in liquidity, but it doesn't feel like it's any more or less liquid than it has been in the past.

Shawn Eubanks: I feel like we've answered all the remainder of these questions throughout this discussion. So, any final words or thoughts?

Carl Kaufman: No, I think we've covered a lot of ground today. We'd like to thank everybody for their continued support. At some point, we will know whether we have a shallow recession, a long-dated recession. My gut tells me the Fed is very nervous with rates above 0% and they will be very quick to cut. And when they do, we'll see what happens, but I think valuations snap back for a while. And we're well-positioned for that.

Shawn Eubanks: Thank you, Carl, Craig, and Brad. And thanks for everyone for joining us today.

Bradley Kane: Thank you.

Craig Manchuck: Yep. Thank you.

Opinions expressed are subject to change, are not intended to be a forecast of future events, a guarantee of future results, nor investment advice.

The Bloomberg U.S. Aggregate Bond Index (BC Agg) is an unmanaged index which is widely regarded as the standard for measuring U.S. investment grade bond market performance. This index does not incur expenses and is not available for investment. The index includes reinvestment of dividends and/or interest income.

Source for any Bloomberg index is Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg owns all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

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.

Fed is short for Federal Reserve.

Yield is the income return on an investment, such as the interest or dividends received from holding a particular security.

Investment grade (IG) includes bonds with high and medium credit quality assigned by a rating agency.

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

Consumer Price Index (CPI) reflects the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

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

A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the assets of the acquiring company.

EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization.

Yield to maturity is the rate of return anticipated on a bond if it is held until the maturity date.

The yield to worst (YTW) is the lowest potential yield that can be received on a bond, assuming there is no default.

Par is the face value, or value at which a bond will be redeemed at maturity.

Par weighted average price is computed by weighting the price of each bond by its relative position size (face value) in the portfolio.

An exchange-traded fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index, although they can invest in any number of industry sectors or use various strategies.

Coupon is the interest rate stated on a bond when it’s issued. The coupon is typically paid semiannually.

Duration measures the sensitivity of a fixed income security’s price (or the aggregate market value of a portfolio of fixed income securities) to changes in interest rates. Fixed income securities with longer durations generally have more volatile prices than those of comparable quality with shorter durations.

CP refers to Commercial Paper.

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

Spread is the difference in yield between a risk-free asset such as a U.S. Treasury bond and another security with the same maturity but of lesser quality.

Performance data current to the most recent month end may be obtained by clicking here.

Fund holdings and sector allocations are subject to change at any time and should not be considered a recommendation to buy or sell any security.

The Fund’s top 10 holdings, credit quality exposure, and sector allocation may be viewed by clicking here.

One cannot invest directly in an index.

Click here to read the prospectus.

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.

Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OSTE-20220707-0546]