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By Jason Stipp | 04-30-2015 08:00 AM

Osterweis: Fears Over the Fed Are Dead Wrong

As long as the economy is growing, and inflation isn't a problem, any increase in rates caused by the Fed should be a good sign, not a bad sign, says the Osterweis Capital Management chairman and CIO.

Jason Stipp: I'm Jason Stipp for Morningstar. With volatile energy prices, a weak economy, and valuations that might be looking full, there's nothing short for investors to worry about in the market today. Here to offer his take is John Osterweis, founder, chairman and CIO of Osterweis Capital Management.

Thanks for joining me today, John.

John Osterweis: Thank you, Jason.

Stipp: Let's start in fixed income. You invest in fixed income in a couple of the strategies at Osterweis, and I want to talk about credit versus duration. It was a good bet for active managers to take on credit risk coming out of the credit crisis, and a lot of active managers do look quite different than the index because of that. Your thoughts, though, today on credit risk versus interest rate risk. Is credit risk still a good bet generally today for bond investors?

Osterweis: We think it's a very good bet. There is no question that at some point interest rates will go up--maybe later than people have thought--but interest rates are at historically low levels. And to think that they won't go up would expose you to an incredible amount of interest rate risk.

On the other hand, credit is still good. The economy is still expanding, corporate balance sheets are in great shape. The weaker credits, as you mentioned, since '09 have been able to refinance and lower their interest costs. If you think about a below-investment-grade credit, it was having to pay 8%, 9%, 10% interest. Today they've squeezed that down to maybe 5%--effectively, in many cases, cutting interest costs quite dramatically, maybe even in half, which is like deleveraging from a cash flow standpoint.

So, we think credit is still the place to be. There are pockets of credit risk that we find unacceptable. For instance, we avoided the energy sector, particularly the highly levered exploration and production companies, where a decline in the price of oil would put them in a fairly difficult situation. That's an area of the high-yield market that's been pretty dangerous. But the rest of the high-yield market has really been fine.

So we're very focused on credit, but short duration. Our duration is under two years, because we want to avoid the interest rate risk and benefit from the credit exposure.

Stipp: You mentioned energy, and I'd like to speak about energy … on the equity side, because you also invest in energy companies, but not necessarily the E&P companies. You also look at things like MLPs. What's your take on the energy situation right now--where there are values and where you're staying away?

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