Strategic Income Fund: Built to Withstand Challenging Markets

Bonds have started slowly in 2022 due to persistent inflation, a looming Fed tightening cycle, and the Russia/Ukraine conflict. We believe the Osterweis Strategic Income Fund is well-positioned to address these challenges, as its flexible mandate and defensive approach help to protect against rising rates and market volatility.

The new year has not been kind to fixed income investors. Persistent inflation has motivated the Fed to reverse its easy monetary policy, while the war between Russia and Ukraine has created additional volatility. Thus far, bonds (as well as stocks) have delivered negative returns in 2022.

The Fed has a tough job, trying to cool inflation without causing the economy to slow down too much. We expect they’ll succeed, but even if they do, rising rates are likely to dampen fixed income returns for at least the near term. (Recall that as rates go up, existing bonds lose value.) Furthermore, weakness in the stock market is impacting credit quality, causing spreads to widen and putting additional downward pressure on bond prices.

Despite these headwinds, we believe the Strategic Income Fund (OSTIX) is well-positioned, thanks to our flexible mandate and defensive approach. Our shorter duration profile and tactical cash allocation effectively act as shock absorbers, allowing us to outperform during periods of both rising rates and elevated market volatility and to recover more quickly after major drawdowns. In addition, our management team has been through multiple boom/bust cycles over the past twenty years, so we have considerable experience navigating difficult markets.

Low Duration Protects Against Rising Rates

Managing interest rate risk is central to our investment strategy so we typically maintain a low duration profile, which helps mitigate losses during rising rate environments. (Of course, it has the opposite effect when rates fall, but we prefer to sacrifice some upside to increase our downside protection.) Our duration is currently lower than our peers’ as well as the investment grade Bloomberg Aggregate (the Agg) and the ICE BofA High Yield (ICE HY) indices, as it has been historically.

Additionally, most of our portfolio is invested in non-investment grade bonds, which are generally less sensitive to changes in interest rates than their investment grade (IG) counterparts. We further reduce our duration by investing primarily in issues with shorter maturity dates, reserving our investments in longer maturities for only the most attractive positions.

Our healthy allocation to cash also lowers our overall duration, as does our exposure to convertible bonds, which are less sensitive to rising rates than other types of fixed income securities.