John Sheehan Interviewed by InvestmentNews

Gregg Greenberg: John, we came into the year expecting about six Fed rate cuts. So far we haven't gotten any. What's going to happen between now and the end of 2024?

John Sheehan: Yeah, we think the Fed is going to be patient, they're going to continue to be patient. I thought it was notable, this last Fed meeting was the same day as the CPI release, CPI month-over-month came in at zero, which is the lowest reading since July of 2022. And on that same day, the Fed lowered the dot plot to only one expected cut in 2024. So they're going to need to see consecutive months of confirmation that inflation is slowing while the labor market stays as healthy as it is.

Gregg Greenberg: So with that in mind, how are you investing assets in the Osterweis Strategic Income Fund?

John Sheehan: Yeah, we are taking what the market's giving us, we are leaning into the inverted curve. So we've been buying a lot of high quality short duration bonds, both in the high yield market and in the investment grade market. We're not people who place bets. We don't speculate on what the Fed's going to do. We're not going to speculate on the election, and this is a conducive environment for taking what the market gives us and we're being paid to wait right now.

Gregg Greenberg: What's the quality in the high yield arena? Because you are getting some nice yields, because we're higher for longer, and one would think that with the economy running pretty well, that should also protect you when it comes to quality or am I wrong on that?

John Sheehan: No, you're 100% correct. The quality of the high yield market today is much better than it has been say 10, 20 years ago. Roughly half of the high yield market is rated BB. Similarly, roughly half of the investment grade market is rated BBB. So you see that very heavy concentration in both high yield and investment grade around the dividing line created by the rating agencies. The economy is good, so that is benefiting high yield companies. They took a lot of the windfall of Covid and all the flood of cash from the government and they extended out maturities. So the maturity wall from high yield investors is very manageable here.

Gregg Greenberg: So which sectors are you finding the best opportunities? Is it the classic high yield sectors or where?

John Sheehan: We take things on a bond by bond basis, we're very much a bottom-up analysis. I think we do our approach very similarly to how equity managers would do it. So quite frankly, we are avoiding some of the big, heavy weight within the index. If you look at the top 10 largest issuers within the high yield index, we only own one of those. So we're very much looking for kind of the under-followed sectors, under followed names within the high yield market.

Gregg Greenberg: Such as? Or you can just give me a sector, is it commercial real estate because there's a lot of worries there, or is it the classic ones like airlines?

John Sheehan: Yeah, we avoid commercial real estate. That's not a very big weight within the high yield market. But yes, we do have a good amount of exposure to the airline space, both in terms of the lessors. We own some airlines as well, and you can see it confirmed in travel data. They've come out of the Covid lockdowns very, very well. So we do have a good allocation to the airline space.

Gregg Greenberg: And this is all part of your flexible strategy, can you describe it?

John Sheehan: Yeah, so when John Osterweis and Carl Kaufman conceived of the fund, they wanted it to be the one fund that our private clients needed to have within the fixed income world. So as a flexible mandate for that reason, if we thought the economy was doing well, it made sense to own credit and get paid that incremental spread. If the economy was slowing, the Fed was cutting, it makes sense to avoid credit, wait for the recession to play itself out and upgrade the quality of the portfolio. That's what we've done for the over 20 years that the fund has been in existence. So our flexible mandate is really used to reduce risk. A lot of the flexible mandates will go really off-script and take bets that we would never consider. So we pick what we think is the most attractive part of the market and invest in the least risky way to express that.

Gregg Greenberg: And then finally, you touched on this a little bit earlier, but I want to get something more solid. What happens on that first rate cut? What do you do?

John Sheehan: Quite frankly, we're not going to do much different. I think 25, even 50 basis points isn't going to materially change the landscape. A good chance the curve will probably still be inverted or flat. So we'll probably still be invested in the front end of the curve. I think the bigger question longer term is the Fed cutting aggressively because we're in a recession, that would make us rethink where we're invested. But if the Fed's just cutting to adjust because inflation has come down and get real rates more in line, we're not going to do much differently than we're doing currently.

Gregg Greenberg: And then finally your inkling about that is...

John Sheehan: I think the rate cut will come on the back of adjusting for inflation. We don't see material slowdown in the economy. We're not overly concerned about a recession at this point in time. Our earnings calls with our portfolio companies, companies are doing well, earnings are doing well, and we don't see signs of a recession looming.

Gregg Greenberg: All right, well, thanks for coming on and talking about it.

John Sheehan: Thank you.