Rethinking the Core
Published on January 3, 2025
Investment grade bonds continue to struggle. In this video John Sheehan, portfolio manager for the Strategic Income Fund, explains why investors may want to consider alternatives to traditional core allocations.
Transcript
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John Sheehan: Hi, my name is John Sheehan. I'm a portfolio manager of the Osterweis Strategic Income Fund. I'm here today to talk about the fixed income market, specifically how core fits into an investor's portfolio. When we think about fixed income, there are three primary objectives: income, total return, and capital preservation. There are two primary risks that may get in the way of meeting those objectives. The first is duration risk, or the sensitivity of a portfolio to interest rates. This is the metric that we look most at for the investment grade market. You could see here that the duration has been increasing and sits above six, right now. In the high yield market, we're most concerned with credit risk, being paid our principal and interest on a timely matter. You could see at this graph that the speculative grade or the high yield market has had a default rate of just below 3% over the last five years. Where does the investment grade and high yield markets stack up against these three objectives? The investment grade market has a reasonable income, has about 2.9% over the last five years. However, the total return has been flat or even negative. One way to think about that is every dollar of income that you've earned, you've lost in the value of your principle. The capital preservation is usually what attracts people towards this higher quality market. We did have poor performance in 2022 when the investment grade market was down 13.5%. The high yield market, not surprisingly, does very well in income generation. Its total return was below its income. This is attributed to the default of some of the securities in the index, and then also the market value of existing securities. Capital preservation is what gives people the most pause around the high yield market. It has done better than investment grade over the last five years, but you cannot ignore the fact that in 2008, the market was down 26.5%. Where does the Osterweis Strategic Income Fund compare versus these two markets? Income generation just a little bit below high yield. Our total return, however, is better than both investment grade and high yield over the last five years, and our capital preservation is also better than both. In 2022, when the investment grade market was down 13, the Strategic Income Fund was only down five and a significant outperformance of the high yield market in 2008 when we were down five again, versus the high yield market down 26. We feel like we most overlap in income. We're akin to the high yield market. Our total return is better than both, but more similar to the high yield market. And our capital preservation, or our drawdowns, are more in line with the investment grade market. The Strategic Income Fund hits all three objectives that investors look for in the fixed income market. We've been able to achieve this through managing those two primary risks, managing our duration risk, and credit selection. This is what is driving our Sharpe ratio, which is a risk measurement of returns, significantly better than both of those markets. Thank you for your time. Look forward to speaking in the future. |
Featuring
John Sheehan, CFA
Vice President & Portfolio Manager – Strategic Income
Prior to joining the Strategic Income team at the end of 2023, John Sheehan spent five years as 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.
He is a principal of the firm and a Portfolio Manager for the strategic income strategy.
Mr. Sheehan graduated from Georgetown University (B.A. in Economics). Mr. Sheehan holds the CFA designation and is a member of the CFA Society of San Francisco.
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