Q&A-Osterweis fund favors defensive stocks as risks lurk

By Edward Krudy

NEW YORK, Sept 22 (Reuters) - A tepid economic recovery and doubts about the Federal Reserve's ability to smoothly withdraw aid from financial markets are reasons to favor more defensive stocks, according to Matthew Berler, a portfolio manager at Osterweis Capital Management.

Many investors have bought into cyclical areas of the market such as materials and industrials, putting stocks in those sectors among the leaders of a near 60 percent rally in U.S. equities.

Berler's bottom up stock picking technique, where he focuses on the fundamentals of individual companies, is leading him to areas like healthcare and utilities.

The San Francisco-based Berler, a former managing director at Morgan Stanley, says the $699.4 million Osterweis Fund OSTFX.O currently has an above average cash position with 70 percent in equities compared to what would normally be 80 to 85 percent.

Below is a question and answer session with Matthew Berler.

Q. What do you think the economic recovery in the United States will look like?

A. Tighter credit together with what we expect will be stubbornly higher unemployment levels, along with a greater propensity to save on the part of the consumer probably means that we are going to see a sub par economic recovery.

What we've done is create a portfolio that should perform even if the economy doesn't pick up significantly.

With the massive stimulus that has come from Washington into financial markets and into the real economy the risk is that if they do start to remove that liquidity from the system that could effectively take the punch bowl away from the stock market.

Q. Given those conditions what are some of the stocks you like?

A. Unilver NV (UN.N) is one of our largest holdings at this point in time, it's a relatively new position we picked up in Q1 when a new CEO was brought in with a clear mandate to turnaround what had been a chronically underperforming global consumer product company.

We picked up Bayer AG (BAYRY.PK). That is another great example of a company that's trading at the same very depressed valuation as the U.S. pharmaceutical companies.

Q. Health care should fit that defensive profile but there are added risks from pending regulation connected to President Barack Obama's reforms plans. What is your view of that sector?

A. Broadly speaking we have a big overweight in health care.

Our sense is that whatever comes out of Washington probably ends up stimulating demand more than what health care in general loses in terms of pricing.

We have a good sized position in a company called HealthSouth Corp (HLS.N). HealthSouth is the leading acute care services company. So they have facilities where people go post surgery to recover and I think the demand for those services could increase as a form of cost reduction.

When you think in aggregate about potentially enrolling 44 million uninsured people into our healthcare system, potentially that could represent a big increase in demand for lab services. So we have a decent position in a company called Laboratory Corporation of America Holdings (LH.N).

A. What is your view of utility companies?

Q. We have a pretty decent position in utility type companies, which is a bit controversial right now because the rule of thumb is that in an economic recovery interest rates will go up and utility stocks will lag.

We picked up NV Energy Inc (NVE.N) last fall in the thick of the crisis when the stock traded down 50 percent of book value. The stock got pounded because of concerns that the Las Vegas economy was going to go down the drain and demand for power would go with it.

We also own one of largest California regulated utilities, Sempra Energy (SRE.N). It's an interesting mix of southern California-based electric and gas utilities, non-California based energy infrastructure, natural gas pipelines, and LNG re-gasification facilities. The third leg to the stool is they're one of the top five global commodity trading companies.

And then we own three different pipeline companies. One is Magellan Midstream Holdings LP MGG.N, which is a refined products pipeline system that runs up the middle part of the United States. (Reporting by Edward Krudy, editing by Andrew Hay)