Podcast Summary: Excess Returns – "The Risk Isn't Where You Think | Carl Kaufman on AI Capex, Private Credit and the Hidden Bond Play"

Date: November 21, 2025
Guest: Carl Kaufman (Co-President and Co-CIO of Osterweis Capital Management)
Hosts: Jack Forehand, Justin Carbonneau, Matt Zeigler

Episode Overview

This episode features an in-depth interview with Carl Kaufman, who shares his extensive perspective as a veteran fixed income investor and co-CIO of Osterweis Capital Management. The discussion centers on the evolving risks and opportunities in today's bond market, particularly the transformation of investment grade and high yield quality, the private credit boom, and the implications of AI-driven capital spending. Carl also weighs in on portfolio construction, risk management, the Federal Reserve's latest moves, and lessons for both individual and institutional investors.

Key Discussion Points and Insights

1. Shifting Landscape in Fixed Income Markets

(03:27)

• Evolution of Market Segments
  • Traditionally, the choice for fixed income investors was simply between investment grade and non-investment grade bonds.
  • Modern fixed income now features additional layers: private credit and leveraged loans.
• Quality Drift
  • The high yield market (junk bonds) is now of higher quality than ever; 54% is BB-rated (top of the junk spectrum).
  • Investment grade, conversely, is at its lowest historical quality; over 50% is BBB-rated (lowest investment grade).
• Quote:

  “It’s kind of interesting that the high yield market is probably the highest quality it’s ever been and the investment grade market is the lowest quality it’s ever been.”
  — Carl Kaufman (00:45, 09:14)

2. Private Credit and Leveraged Loans: Hidden Risks

(03:27, 09:42, 37:26)

• Private Credit:

  • Not publicly traded, typically less transparent, and investor capital is locked up for long periods.
  • Many new entrants lack the sourcing advantages of established firms.
  • Competition has squeezed spreads, reducing incremental returns.

• Leveraged Loans/CLOs:

  • Loans often packaged into Collateralized Loan Obligations, exposing investors to risk tranching.
  • Post-2008 rules created some safeguards but complexity and opacity remain.

• Systemic Risk Concerns:

  • Bank lending to these institutions has increased indirectly, potentially embedding systemic risk despite tighter regulation.
  • Recent fraud cases (e.g., Tricolor) are seen as company-specific but defaults in private credit are much higher than in public high yield.

• Quote:

  “People will always find a way around rules and that’s the problem… Banks have gone from being lenders to arrangers and that’s a lower risk business. But they’re still lending money to non-deposit making institutions that make those loans.”
  — Carl Kaufman (09:42)

  “I think defaults in private credit are going to rise… You’re going to see most of the defaults in private credit. I don’t think it’s systemic because every company has a different business model.”
  — Carl Kaufman (37:50)

• Carl's Position:

  • Osterweis avoids private credit and leveraged loans due to high opacity and risk.

3. The 'Two Cycle' Bond Market Framework

(10:52, 11:16, 16:14, 17:43)

• Interest Rate vs. Credit Cycle:
  • Interest rate cycle: Rising rates hurt investment grade bonds most (due to longer duration, less default risk), while falling rates benefit them via capital gains.
  • Credit cycle: Economic growth shrinks risk premiums (spreads), favoring high yield; recessions widen spreads and reward investment grade safety.
• Current Observations:
  • The historical case for owning investment grade in recessions is "less compelling" now because of the quality drift between investment grade and high yield.
• Quote:

  “There is less of a case. There’s still a case to be made, but it’s more of a trade than an investment at this point.”
  — Carl Kaufman (16:29)

4. Investment Process: 'Bond Picking' Like an Equity Manager

(20:35, 27:12, 28:27)

• Mandate Flexibility:
  • Osterweis operates outside of “style boxes” (e.g., high yield only, investment grade only), allowing more cycle-aware allocation.
• Security Selection:
  • Focus on 120 companies (vs. 300–700 for typical funds), prioritizing:
    • Good stewards of capital (prefer cash flow retention over buybacks/dividends)
    • Durable business need (“if they went away tomorrow, would anyone notice?”)
    • Defensive, staple sectors (distributors, equipment rental, less cyclical exposure)
• Active vs. Passive:
  • Indexes in fixed income overweight largest borrowers, which often are most levered and riskiest. Active selection preferred for bond portfolios.
• Quote:

  “We don’t believe in boxes here… In fixed income, the companies that issue the most debt have the biggest weightings — and they’re usually the most levered.”
  — Carl Kaufman (20:39, 27:35)

5. Sector & Position Allocation

(28:27, 35:03, 36:35)

• Sector Concentration:
  • Will overweight “good sectors” (e.g., distributors, rental equipment) if the credit risk balances in their favor; less concern for sector diversification vs. equities.
• Position Sizing:
  • Typical 1% per company; occasionally more (with multiple bonds or maturities).
  • Due to bond characteristics, position sizing remains more stable vs. the equity world.

6. AI Capex Boom: Echoes of Past Bubbles?

(31:34)

• Analogies to Dot Com Era:
  • Technology giants (Meta, Oracle) now leveraging debt for AI infrastructure spending.
  • Echoes Cisco’s behavior in the late 90s/early 2000s, even as major suppliers like Nvidia begin offering client financing.
• Skepticism:
  • Carl is wary: large promises may not yield adequate returns, and complex financing structures (non-recourse to parent) hint at underlying risks.
• Quote:

  “Cisco was the Nvidia of its day… It’s happening with Nvidia already… It has echoes of 2000. I don’t think it’s going to repeat, but it’ll certainly rhyme.”
  — Carl Kaufman (31:34)

7. Risk Management Philosophy

(46:47, 47:28)

• Focus on Fundamentals & Duration:
  • Concentrated, research-heavy selection of bonds with strong underlying businesses.
  • Use of short-duration and highly liquid positions to stay defensive during risky markets.
  • Ready to deploy cash during periods of market dislocation.
• Quote:

  “When the market sells off, everything sells off, including the short-term stuff. Short-term bonds trade off a lot less… That’s the cushion we like to build in.”
  — Carl Kaufman (47:28)

8. Macro Outlook: The Fed and the Economic Cycle

(49:33, 50:42)

• Fed’s 'Boxed In' Dilemma:
  • Dual mandate (inflation and employment) forces trade-offs—recent years focused on inflation, but unemployment may soon dominate as stimulus effects fade.
  • Lower rates are themselves inflationary; Fed at risk of fueling higher inflation if it cuts too soon.
  • Global buyers of Treasuries (e.g., China) have receded, increasing U.S. financing costs.
• Quote:

  “The Fed’s kind of caught in the box, right? Their two mandates are inflation and employment… Unfortunately they have to favor one or another. They can’t do both.”
  — Carl Kaufman (50:42)

Notable Quotes & Memorable Moments

• On Quality Shifts:

  “The high yield market is probably the highest quality it’s ever been and the investment grade market is the lowest quality it’s ever been.”
  — Carl Kaufman (00:45)

• On Private Credit ETFs:

  “It’s revolting… The institutional buyers are selling… so they need new buyers. And what better buyer than the little guy? I don’t like it. I don’t think it’s right.”
  — Carl Kaufman (41:28)

• On Market Cycles:

  “We don’t make bets… I’d rather have an economist just tell me where we are and what to look for because that’s more important.”
  — Carl Kaufman (19:46)

• On AI Infrastructure Spending:

  “Trillions don’t grow on trees. Think about how much revenue this is going to have to produce to get even a 10% return on capital…”
  — Carl Kaufman (31:34)

• On Patient Investing:

  “Be patient, don’t fear missing out, always get another chance. Only invest what you can afford to lose and be able to sleep at night.”
  — Carl Kaufman (56:29)

Important Timestamps

• Understanding Modern Fixed Income Segments: 03:27
• Private Credit Risks & Defaults: 09:42, 37:26, 41:28
• Two Cycle Framework: 11:16
• Quality Shift in Bond Markets: 16:14
• Describing Bond Selection as Stock Picking: 20:35
• Bond Indices vs. Active Management: 27:12
• Sector Allocation & Positioning: 28:27, 35:03, 36:35
• AI Capex & Tech Bubble Parallels: 31:34
• Risk Management Strategies: 46:47, 47:28
• Fed's Position and Macro Risks: 49:33, 50:42
• Key Investing Lesson: 56:29

Final Takeaways

• Risk in Bonds Isn't Where You Think:
  Traditional rules of thumb around safety in investment grade and risk in high yield no longer quite apply—the real risk may now reside in the less regulated, opaque private credit segment.
• Cycle Awareness and Flexibility Are Vital:
  Investing according to where we are in both rate and credit cycles—rather than rigid mandates—positioned Osterweis in front of market shifts.
• Active Bond Portfolio Construction Matters:
  Passive investing via bond indexes may overweight the most indebted and least desirable credits. Careful selection and high conviction can yield both higher returns and better draw-down protection.
• Be Skeptical of Fads and ‘New’ Asset Classes:
  Private credit pushed to retail investors, and surges in AI infrastructure spending, both carry echoes of past bubbles—proceed cautiously.
• Investment Philosophy:
  Maintain patience, avoid FOMO, and always ensure that investments align with genuine risk tolerance and sleep-at-night comfort.

In Carl Kaufman's Words

“Be patient, don’t fear missing out, always get another chance. Only invest what you can afford to lose and be able to sleep at night.”
— Carl Kaufman (56:29)