Credit Crunch: Wellington’s Fitzgerald on Convexity Over Carry

(upbeat music) Welcome to FICFocus, where Bloomberg intelligence fixed income, credit currency and commodity strategists and analysts discuss their short and long-term views on debt markets and issuers. Now here's the Bloomberg Intelligence FIC research team. - Good, Tidings, dear listeners, and welcome to the latest edition of Credit Crunch. Part of the FICFocus podcast series where we focus on all things. Credit, I'm your host, Noel Hebert, Chief US Credit Strategist of Bloomberg Intelligence, that's the research arm of Bloomberg LP on today's episode. Credit investing with Wellington Management's Connor Fitzgerald. Connor, who joined Wellington in 2015, he's lead portfolio manager of the intermediate credit and credit total return strategies. And he's also portfolio manager for long credit, core bond and core bond plus strategy. So a lot, a lot there, a lot to unpack, but Connor, thanks for joining us on Credit Crunch. - Thanks for having me, excited to be here today. - Well, let's see how you feel at the end of the podcast, but we're certainly excited to have you. The tradition on this podcast is usually to start with a little bit of background, to get a sense of basically your career path, how you got to where you are, and then maybe get a little bit into the Wellington platform. But maybe let's just start with the background. I believe you started in an interesting place, and I mean that some people may remember, but I'll let you tell the tale. - Certainly, so I graduated from college in 2006 from Bowdoin College, Small Liberal Arts College up in Maine, moved directly to New York, started working at Lehman Brothers in operations, sort of on the doorstep of the global financial crisis in 2006. I worked on a prop desk at Lehman Brothers, where we were focused on supporting, a variety of different credit focused for proprietary trading strategies. That proprietary trading desk eventually spun out to become a hedge fund, and then that hedge fund was ultimately purchased by BlackRock, so I ended up at BlackRock in early 2009. I started there as what we called an odd lot trader, so I was focused on all trades below five million in size across all sectors and all different corners of the credit markets. That was a great learning experience for me. I also spent a lot of time working on macro, a thematic credit specific research for a monthly markets call that the CIO ran there, so really had an opportunity to develop sort of a wide range of skills both bottom-up credit picking, but also sort of macro top-down thematic type investing, and over time you sort of clawed my way up to become an investment grade credit portfolio manager there across some of our multi-sector and strategic income type strategies. And then I would say in 2015 had a great opportunity to move to Wellington and really focus mostly on corporate credit, was a little bit extra bit of luck in terms of being able to move back to my hometown, a Boston which I was excited to be close to family and friends. But as you say, the allure for me to join Wellington was really just we're all in on active management. We believe in investment talent. And the history of the firm is really that the success of the firm has been driven by bottom-up portfolio managers who sort of have a unique idea to bring to clients to provide solutions, and that's something that makes it really exciting to come to work every day here. - Yeah, absolutely. So great platform there. Maybe let's talk a little bit about your remit, which is as sort of I alluded to in the intro there. It's reasonably expansive, right? Covering a lot of sort of core, core plus type related strategies. Walk me through sort of the various things that you get your sort of fingers in the pies of today, and maybe we start first with sort of the Wellington overall if that's all right. - Definitely. So Wellington is structured as what we call a federation of boutiques. So there's no CIO. Each individual boutique or business is run by a portfolio manager that has sort of full autonomy to run that business. So there isn't one top-down view on interest rates. There isn't one top-down view on credit beta. But then when you think about our research effort, it's basically a shared resource across the firm. So if you think of what the credit analyst says an example, they don't necessarily report to me or any other portfolio manager. They produce a product that we can consume, and we all work and collaborate together to try to get to the best answer. But at the end of the day, it is the portfolio manager's ultimate responsibility to do what's best for their portfolio, that fits their philosophy and process and fits what they've explained to clients that they do for them. But I think we really think of that collaborative, open architecture as our edge, and the way I try to share it as sort of a real life example as if we're doing a round table on a controversial credit. We might have four or five different credit portfolio managers in the room. We might have an investment grade, a high yield credit analyst, an equity analyst, a long-short hedge fund portfolio manager in that sector. And because there's no one single most important individual at the head of the table, it's really a pretty unique form to get sort of all different perspectives and insights on the table, and challenge each one of those, have a robust debate, and then sort of go back to our desk and try to make the best decision for our own individual client. - Yeah, I guess that maybe big gets a couple of questions there. I mean, it's an interesting setup. And I guess sort of, when you're thinking about that, I mean, how much of, I guess, your own investment process, I mean, obviously your sort of index oriented for a lot of your product, but how much of sort of, like where you're shading the gray areas, comes out of those sort of group meetings, or is a lot of it just sort of instinct, I mean, I really like the way that you framed the Lehman and BlackRock stuff is sort of clawing your way up to the top. How much of that is just sort of hard one experience versus, you know, listen, it's this sort of collaborative environment, and you know, you're starting to think new ways about different things. - Yeah, so I'll start by, if I talk about some of the products that I work on, because they are a little bit different and sort of live in different lanes, but I'll start with the credit total return product, which is, it's more of a non-benchmark total return focus product, and we can get into the benchmark where benchmark focus ones in a second. But I'd say my investment philosophy was heavily influenced by my time at Lehman Brothers, at a hedge fund at BlackRock during a pretty choppy period coming out of the GFC, and I remember an individual I worked with at the hedge fund, said that the path that Hallas paved with carry. And so one of the things that really is like the hallmark of that credit total return approach is that we're much more focused on the price distribution of outcomes for corporate bonds in terms of how we underwrite our investments and far less focused on income. And obviously there's a lot of investment processes that are, you know, exceedingly successful over a long period of time that have the heavy focus on, you know, building income into the portfolio. Just for me and my personal experience, I would say, you know, I felt like for the first really up until today, like the full 20 years that I've been in this business, the same movie continues to play out in that we have these periods of low volatility where you see folks sort of go down the credit risk spectrum, ultimate maturity spectrum to try to collect marginal units of income at increasingly higher levels of risk. And what I mean by that is, you know, you have a period of low-vol heading into say the taper tantrum, and you push credit spreads really tight, you push long gated yields really low, and then you have this event that sort of causes a reset. And you basically saw, you know, six to seven years of income wiped out in the span of three or four years, depending on what type of bond you're looking at. So the investment philosophy behind the credit total return is really like, let's try to think about how to not only one protect portfolios from events like that, but also when the math gets tipped on its head, and there's actually opportunity to generate a lot of positive total returns by way of price appreciation and corporate bonds. Let's have a process for trying to take advantage of that as well. And that's really the hallmark of that strategy. So I'd say that's kind of very unique to me, but I can't emphasize enough like, you know, being able to do that requires having a deep understanding of all these individual credits. That's something we lean on the credit analysts very heavily. I often try to share that one of the things I love about investing in credit is that for any given company, there's 10, 20, 30 or in the case of a big six bank, you know, a thousand bonds probably. There's only one equity. Each one of those bonds has a unique payout profile for the same fundamental outcome. And I think the holy grail of investing is this idea of like, losing less when you're wrong and making more when you're right. And we really feel like picking the right security in a company's capital structure gives us the best chance to sort of have those odds on our side. And if we do that over time and compound that successfully, that that's what leads to better risk adjusted outcomes, we're obviously not going to get everything right. But again, drilling in on those individual securities, understanding sort of different leverage points across the capital structure and then just understanding the business itself, you know, we definitely couldn't do that without the ability to pull on not only Wellington's credit research but also the equity side of the house as well. A lot there to unpack. And I think maybe we kind of start from the bottom there because I think it's interesting. We kind of allude to, you know, the depth of certain capital structures and sort of finding the right instrument there. I am curious in terms of what that, I mean, maybe we just sort of work through the due diligence process. I mean, sector down the name and then from name down to where you want to be in the curve and that sort of thing. And I guess, If you're interested in the next video, please subscribe to the channel. before we get to that and I get accused of asking too many questions within a single question. But I'm trying to be better at it, but I'm not really good at it. But before we get there, I mean, you sort of allude to, you know, you use the metahord in terms of, you know, the red hell is paid with carry and that sort of thing. So in an environment like now where spreads are limited, I guess maybe is the word I'll use today, you know, do you prefer to sort of be in different parts of the curve? Do you prefer to be in certain kinds of quality to sort of not have exposure to a tight environment so that you can kind of rotate relatively painlessly when the opportunity presents itself or how do you typically think about positioning in an environment like today and then maybe we can get into the due diligence piece? Certainly. So I'll say an environment like today, the rest of me is certainly challenging when Carrie has been a marvellian driver of returns versus spread tightening. He's a fat. I think in environments like this, we do a couple of things. One, right. We tend to move in on the curve. So keep our spread duration lower, reduce our sensitivity to widening credit spreads. That doesn't necessarily mean reach for risky low quality credits that are short on the curve. If anything, I would describe us as having a willingness to sacrifice a little bit of income, versus peers in a period like this to really protect capital and not overpay for risk. So that'll be the first thing. The second thing is that in a period of really tight spreads, getting an idiosyncratic credit call wrong can really hurt the portfolio. So we try to deploy what we call the defense when wins championships mindset, which we certainly didn't coin ourselves. But I think when you just think about the distribution of outcomes on corporate bonds from these levels of spreads, the cost of getting a few of them wrong can wipe out a quarter or even a year of alpha in the lower return opportunity type environments. So we spent a lot of time trying to make sure we don't have any credits that had a downside risk embedded in them. We tend to move up in the capital structure. That usually means preferring investment grade over high yield, secured bonds over unsecured bonds. We could definitely get into this a little bit later, but this period is a little bit unique because I think the area of the market where leverage is increasing and there's a lot of debt issuance building is in investment grade more so than high yield, mainly from the hyper-scaler and artificial intelligence capEx build out. But I'd say in general, we try to move down and risk across all the different dimensions like that. Security is a tricky one. We're willing to sell liquidity in certain parts of the portfolio, especially for shorter maturity securities where we're confident that maturity can actually be a source of liquidity, as they say. But I think over time, we want to be mindful of how much liquidity exposure we have in the portfolio because when we have a true credit shock, the price of liquidity can expand or contract dramatically. We just have to be cognizant of what that means from a market perspective for the portfolio. But in general, this is definitely an environment where we're trying to move more defensive and now is not a time where I think you want, I don't think you want to really reach and swing really hard to try to hit the high end of your alpha target in an environment like this. The expected return opportunity is just not there in our view. I love it when people answer questions and give me a lot more questions to ask. But I'm going to try and stay on track. New diligence. You do are still constructing a portfolio. Let's talk about the identifying the names that are up in quality or shorter duration and what that process looks like today. Maybe if we weave in some of the hyper-skillers stuff that you just mentioned, that's great too. But what do you, in this environment, maybe sticking in this climate, what are you looking forward to that due diligence process? What are you starting with, Heylis, and we're focused on 10 years and in. We're looking at, to your point, maybe certain parts of the cap stack in terms of senior versus junior, etc. What does that look like? How are you identifying sectors and then how are you identifying names within those sectors that you think offer you the best positioning for the climate that you see us being in right now? I would say we have both a bottom up and a top down process. We get that client question a lot where it's like, you know, are you more of a top down investor or bottom up? I tend to think of the top down as the weighted average aggregation of the bottom up. So I think you got to be both to be successful. But I'd say if we had to pick one or more bottom up as it relates to putting individual ideas into portfolios, I would say my underwriting process is almost backwards. In the sense that we tend to screen for bonds that have mathematical properties where they appear to have positive convexity. They appear to have the ability to go up in price more than they can go down in price. And then we sort of do the fundamental credit work. After we have a simple fundamental credit checklist that I'm sure is not too different from any of our other peers or competitors. But we tend to lean pretty heavily on net debt to enterprise value, sort of alone, to value calculation, just to understand, you know, how far we are from, you know, the debt being potentially impaired and what's the equity cushion underneath. We try to invest in like simple businesses that we can understand with solid margins, decent growth, competitive modes, etc. All the basic things. And most importantly, just free cash flow and China understand like, what's the free cash flow percentage of debt and what does that look like across different parts of the capital structure? And then the last one would just be like liquidity and term structure. You know, there's periods where rolling debt is not a problem. There's periods where it's a big problem and the market's acutely focused on that. So just trying to understand like how much debt is coming to in the next few years. What are the options for the issuers? But at the end of the day, it's really trying to find securities that we think can go up a lot in price. So what I would say is, you know, the best credit that we can find is one where the company's generating a lot of free cash flow and then using that to pay down debt. That doesn't happen that often. The worst credit is going to be a credit where cash flow is going down and debt is going up. Those tend to be the situations that go parabolic in either direction. And then I think the other two potential permutations are ones where cash flow is going up and debt is going up. That's actually how I would characterize the hyperscaler build out today. And then there's ones where cash flow is coming down and debt's coming down. And again, that can be challenging and sort of, you know, those can break either way. But those are sort of the things we try to consider when we look at credits. And then from a top down perspective, I would say we're certainly not quantitative, but we do think about like mathematically what are the expected returns on offer with a little bit of a healthy dose of respect for history. So if we just look at where spreads are today and we shock them to say like 25% of versus history, we try to understand like what are the excess returns across various segments of the market. So we're going to bucket the market by investment grade, high yield, emerging markets, securities products, never got going to bucket it by maturity, by rating, et cetera. And try to hone in on like, where's the best upside down side across those sectors? And what we find is that usually aligns with like where we're finding the best opportunities on a bottom up perspective. And it's not to say that we're, you know, solely betting on mean reversion, valuations only one piece of the puzzle. We also want to understand like what's the overall trend in the sector. So I think one quick example that I think is actually a decent analogy for today is, you know, in the 2012, they call it 2016 period. We had a major investment capital cycle going on in in sale energy, the midstreaming independent EMP segments in particular, and IG, you know, a lot of debt fund to CapEx in the metals and mining space to expand copper capacity, iron ore, et cetera. And then you also had a lot of debt funded M&A, debt funded share buybacks, things like that. They were driving a lot of credit supply. And what we saw was like leverage moving up in credit that moved credit spreads wider while at the same time in the securitized part of the market, we were still experiencing household deleveraging coming out of the GFC. So you basically had a deleveraging story and securitized re-leveraging story in IG. So we spend a lot of time with our sector boutiques and our sector experts, whether it's portfolio management, trading research to likes, like trying to understand like what is the path of fundamentals and leverage in these various sectors because that's, that to us is ultimately the most important driver of like where spreads shake out. And that's super important for how we allocate in multi sector bond portfolios where we can sort of lean on those different parts of the market to drive returns. So you referenced early in the year, like you said, hey, we're not a quant shop. I am kind of curious because I mean within investment grade, we're pushing towards almost 9,000 bonds right in the investment grade index, at least for the Bloomberg investment grade index. And nearly 2000 bonds in the high yield index. Obviously, it's a lot of, it's a lot of names. A lot of paper to sort of keep track of, do you have any sort of systematic filters or overlays that you use to sort of help just sort of, hey, here's the rough guidelines. I want something with this kind of size or liquidity or tenor or that sort of thing. I guess that would be one question and I guess when you're looking for those, you know, those incrementals, do you look at sort of low dollar price or sort of off the curve or do you kind of really. want to be sort of an on the run close to par because you've referenced sort of the complexity profiles being, you know, an area of interest as well. So we definitely have a filtering process. I would say our team has almost always traded, I would say thematically and in like baskets if you will, which has actually helped a lot, I think as portfolio trading has kind of become like the preferred way to transfer risk in investment grade credit markets. So we have tools internally where we can say we want to buy four to seven year triple B investment grade bonds. We don't want to buy any financials. We want to buy names that are only outperform rated by our analysts and with the liquidity score above X and have been issued in the past called 18 months because liquidity tends to trail off after that or something to that effect. And then we can basically hit a button and that sends it to the desk as a portfolio trade. And then I would say just on the portfolio trading ecosystem, I'd say going back like 10 or 15 years now, Wellington has tried to be ahead of the curve in terms of investing in trading technology. I think we saw the writing on the wall that the market would transition away from picking up the phone and calling a sector trader to sell 50 million of XYZ bond and more moving almost to like, you know, a similar model to how the equity market behaves in terms of transferring risk. So we've been willing to explore effectively like any and all liquidity outlets for clients, whether it was all to all dark pool, portfolio trading type platforms, just on the idea that like liquidity and minimizing transaction costs being able to partner with clients was a super important part of the value proposition. So I think we've been able to use that tool very successfully to the client, the benefit of our clients. So one thing I'd say that we're talking about more recently is that as that's become sort of like the norm and the standard and more mainstream, it almost seems to us that like the ability to price idiosyncratic risk has become more challenging. I think that presents both risks and opportunities. I'd say on the wrist side that, you know, when you have a credit that transitions from being like a treasuries plus a spread widget, this is a credit that can actually default and we actually need to know what's going on here. And say the price between those two things has expanded. So again, to go back to what I said at the beginning, like avoiding those as paramount, but we also view it as an opportunity where if the cost of that liquidity expands too much relative to the fundamentals, we're willing to take the other side. So we still have a lot of confidence in our traders in terms of their understanding of their sectors and the individual names to really take advantage of those opportunities. And they're very proactive about highlighting to those as they sort of appear. We're obviously monitoring the market as well, but I can't emphasize enough how much like the tripod of portfolio management research and trading is critical to sort of taking advantage of dislocations in the markets, specifically on the fundamental credit side. You reference the portfolio trading ecosystem and I think you make a really good point there certainly around because it kind of cuts both ways, right? That's the core to the aid allows you to sort of be able to trade that $400 million bond that's sort of basically been a museum piece for the last five years or something like that. But on the flip side, right? It may be masks some of the credit risk that might be embedded in some of these names just because you're sticking into a giant pool and gets blended away. I guess, you know, what are the other dynamics that you think are sort of derivative to how technology really or the last five years call it has really sort of changed the way the asset class, certainly in IG and increasingly in high yield as well, trades. I would say I would point to technology, but also point to ETFs in that the explosion of ETFs has created this entirely new outlet for the street to sort of recycle risk and also just manage the overall risk on their balance sheet. So I'm sure you've seen this chart, but there's there's this chart that went around for almost a decade post GFC about how the credit markets keep growing, but the size of dealer balance sheets keep shrinking. I think the technology that they they've been able to create to allow them to warehouse more inventory, warehouse more risk, but also manage those risks and protect themselves has basically allowed them to be much better liquidity providers or conduits, if you will, then they were say five or six years ago. And I think investment grade portfolio trading goes back a couple years. I'd say really exploded like after the pandemic in the last 12 months, I'd say to your point, high yield portfolio trading is starting to explode and become an increasingly higher percentage of volume. So I think it's a great outcome for our clients. I do think it's necessitated people in the buy side to change a little bit how they manage portfolios and how they transfer risk in the market. I feel like we've been, you know, willing and able to adapt to that, but it has just it has changed like the fundamental nature of how the market changes hands compared to five or 10 years ago. And frankly, there's a lot of different counterparts on the street that have taken, you know, different approaches to how they view portfolio trading and transferring of risk. So it has our top 10 counterparties look a little bit different today than they did five or 10 years ago, which I think is sort of indicative of the phenomenon on your highlighting. So we talked a little bit, I guess maybe in the context of that, I kind of referencing back to we talked a little bit of the climate that we're in today. I am kind of curious in terms of because I don't want to get too kind of consumed by being in the titrating environment because obviously the credit market is relatively cyclical. Are there things that you look for when you're saying, hey, listen, you know, return for unit risk here is unusually attractive or unattractive. Is that a very issue or specific dynamic or are there bigger events, I think back to liberation day or some of these other, you mentioned the taper tantrum, some of these other events that create sort of broad selling in the market. I guess what do you look for to say, hey, listen, this is a good time to put risk to work, to take on duration, to take on added spread or sort of lower quality. Like what are sort of the things that you're looking for? I think so I'm separate on it. I'm trying to answer your question on to to threads. Well, the first you mentioned liberation day and I would also throw in the situation with Iran in late March, early April. I'm going to beat it that but it only lasted like a day and a half. So I've got great, great. We wish it lasted a little longer in some respects, but I would say, so there's two things I'd say first, those two events were very unique. In some ways, I think challenging for fixing them investors because yes, it was like a risk off event, but both of those were effectively inflationary or supply side shocks. So when we think about managing fixing, comportfulios, I think you need to think about diversification and diversification to me in fixing, comportfulios is like, what is the role of interest rates in your portfolio versus the role of credit? And in both of those periods, we saw interest rates move higher and credit spreads move wider, which creates a lot of volatility in the price of corporate bonds, for example. I think to oversimplify, the best time to deploy capital is on the back of periods where both rates and spreads move higher because the yield on offer improves dramatically. The price goes down a lot. The duration also falls so you get more income per unit of duration. There's more room for yields to fall. They're arguably more competitive versus other asset classes like equities in some cases. So that's sort of like a simple guidepost in that every time you have, you know, bond prices get pushed down a lot, you should challenge yourself to sort of jump in the pool and take some risk. You obviously got to be choosy with what you buy. And then the second thing I would say is those are, that's for like more of like specific volatility events. The second thing I would say is more longer term when you think about deploying risk in the portfolio on like a structural basis. I'd go back to sort of what I alluded to with the 2012, the 2016 example is like, we really want to try to be, if you're on the right side of long term structural trends and you're sort of flat to long those themes. And then if there's an assuming they're positive. And then if there's like a negative structural trend, I think you want to try to trade those flat to short. And if you can just anchor your portfolio around like positive structural trends and avoid the negative ones over time, I think that that will pay dividends. But I actually think we're at a really important inflection point today in investment grade credit that will hopefully bring this example to life. You know, last year spreads were really tight in investment grade credit and they've remained tight this year. I would say last year the reason to be defensive was a little bit more valuation oriented. It wasn't like when we were sitting in client meetings and folks were asking us, you know, what could push spreads wider? We didn't necessarily have like a great reason in the middle of last summer or the fall even. I would say this year, while we expected a lot of supply from the hyperscalers, the number so far year to date, the increased cap ex from some of those companies and just projections for supply are reaching levels that are truly historic in fashion. And this is coming in a time when we have basically all time tight credit spreads in long dated parts of the maturity spectrum. So to me, when you see this wave of re-leveraging, and obviously it's a little bit unique because you have super high quality companies going from negative net debt to EBITDA on positive cash balances to more like cash break even and what net debt to EBITDA? So it's deteriorating from very high level but just this year supply a bonds is extraordinary to the point that you actually have to start to think about like hitting concentration limits in certain names in, you know, a one to two year horizon, not even benchmark well, just absolute amount that you're allowed to own by guideline in the portfolio. So we don't see this capex cycle slowing down, we see it as a major headwind to credit spreads and you know, I think there's risks that if you can buy one of these really high-quality names that, you know, almost double B spreads in some cases in investment grade, that to me seems to be representing a pretty high risk that it could just push credit spreads wider. So in multi-sector portfolios, we've chosen to own less risk in investment grade credit and more and say, securitize products in high yield. We don't necessarily see that that same headwind to spreads, but I think again, to go back to try to answer your question specifically, like I think you want to be on the the right side of those structural trends over time. I want to come back to that in just a second, but maybe just to clarify when you say securitize products in high yield, are we talking like two structured or are we just talking like secured loans or where are we like what kind of asset are we looking at there? So I would say I should those are two separate asset glasses. So like securitize products, meaning, you know, CNBS asset-backed securities, non-agency, obviously mortgages could potentially go in there as well, and then high-yield corporates in like just the traditional high-yield corporate market. Got it. Okay. Where I think there's actually a lot of like idiosyncratic issue or opportunity, like despite really tight spreads, I think there's some pretty, there's some controversial sectors where I think if you want to, you know, take the medium-term view, there's some alpha to be had there. And we can get into that in a moment, but yes, I am kind of curious because you you mention a lot of things that I that I think about as well, I mean, particularly, you know, the scope of issuance, but it seems like there's sort of almost an unending demand side and obviously a lot of people attribute it to the total absolute yield and maybe some of the demand from the insurance sector and just how the insurance sector itself has changed over the last handful of years as they've gotten rolled up more into these sort of alternative asset managers, etc, etc. Is that sort of the right explanation there in terms of why we've seen such resilience or do you think there's just a complacency or is it the the relative position of the dollar and the international demand or is a little bit of everything like what's why have we been able to sort of navigate sort of some of these dynamics, whether it's, you know, the nominal level of supply or we're just sort of some of the risk backdrop, etc. in such a confession. I would say we often hear I definitely hear the yields are attractive, but spreads are tight dynamic a lot. I tend to believe and we try to build, you know, a number of different data points to support this. Like there's still a lot of liquidity in the system from what happened during the pandemic where we did do effectively helicopter money. So when we look at the amount of money and money market funds, when you look at household net worth, relatives, allowabilities, I think more recently we've been trying to focus on in just from like the this is just a public data that shows asset allocation across equities, bonds, cash, alternatives, which would be real estate and otherwise. We're we're looking at a historically low bond allocation and I think that that is obviously partly driven by the run up in stocks, the run up in real estate, which is push those values up where bonds obviously haven't run up as much, especially if you if you're marking it back at like 2020 or 2021. And then at the same time you have like an aging population, you know, pretty significant demographic shift with a lot of baby boomers retiring. And I just think that because bond yields were so low and kudos to people who got this call right, like owning equities made a lot more sense and certainly ran against like the textbook suggestion of like how many equities and how many bonds you should own if you're 70 years old. I think that that's starting to shift where if you have somebody just retired at 65 or 70 years old and they're 70 or 80% equities, you know, the PE on the stock market at 25 call it today. And the 10 year yield at four and a half is very different than say like 10 or 15 years ago when the PE was 12 or 15 and bond yields were at two or three. I just think the value proposition in bonds is much better today than it has been in the past. So I expect us to be in almost like a decade long positive flow environment for fixed income where every backup in yields is just met with somebody, you know, moving a little bit of money out of cash into bonds or you know, in some cases moving a little bit of money out of equities into bonds just to keep that even if you're just trying to keep the ratio the same. So I think that's sort of what explains it. And I think when the fed stop buying bonds, you know, coming through 2022, we talked about this concept of like the great handoff. So the fed was this massive source of demand for fixed income and treasury specifically. And what we've seen now is that the baton has been picked up by the US household. So the US household is starting to increase their allocation to bonds and that that demand source I think can run strong for a long period of time. And then on the insurance side, you know, I hesitate to say golden age, but to me that's almost what it feels like compared to the first 15 years of my career. Like when you just think about, I don't want to say how easy, but like you think about the quality, you could build a 6% portfolio that has reasonably high credit quality today. And that's awesome for insurance companies that are trying to write annuities and other sorts of products where they're promising a return. And you just think about like 10 years ago, what you would have to do to build a 6% fixed income portfolio. You would probably have to buy triple C's emerging market credit just to get there. And so now it's just this like almost nirvana for those types of insurance companies. And we're just seeing we definitely are seeing that we're seeing growth in those products. We're seeing demand for fixed income come alongside it. And so there is, you know, definitely a lot of demand for fixed income. But to go back to the supply point, you know, I think supply can eventually erode that and eventually there's a price for additional supply and additional credit risk. And we would just highlight that the credit curve, you know, the credit spread curve is actually pretty flat today. So you're not giving up a lot of income sort of moving in the credit curve and you're reducing your downside total return outcome in the event that the supply eventually sort of breaks that that demand side of the equation. Yeah, that all sounds good to me. I think you bring up one thing that I've tried to think about. I'm not sure that I ever got to particularly far along the line, but it was definitely that COVID helicopter money period and not just obviously domestically, but globally in the amount of liquidity or capital that got created out of that cycle and sort of trying to understand how that's filtered through and where it still sits because obviously it hasn't doesn't feel like it's been fully absorbed. So it does definitely seem like that would be something that's still out there. I guess, you know, kind of putting a little bit or a lot of the different pieces together here. I guess I'm curious in terms of, you know, where do you think the most durable sources of alpha come from today, you know, particularly given, you know, your bent or your bias towards a little bit more active positioning, at least in sort of the, you know, credit total return funds. Like how do you think about that or does it sort of vary over time? I think it definitely varies over time. I mean, there's periods of time where interest rate volatility dominates. There's periods where credit volatility dominates and there's periods where I'd say issuer or specific volatility dominates. So when we think about take like a core plus type mandate, when we think about the sources of value add over time, I would say, you know, maybe a third from income and sector allocation, maybe a third from security selection, and a third from like active rates and dynamic credit positioning, meaning willing us to change your overall posture during periods of volatility or hopefully into periods of volatility. But I think in the in the current environment, I definitely think income and carry is sort of an important dominant driver of return today. I just think to go back to what I said at the beginning of the at the beginning of the discussion here, I think that, you know, the environment can change very quickly and you can give up a lot of income in short periods of time. So we sort of look at our income through, in say a core plus portfolio, like an income per unit of drawdown lens where we want to have income in the portfolio, but we want to be cognizant of like in a severe downside outcome. How much is how much is that going to cost us and just try to be thoughtful about the balance of those two things. But if I had to pick one, I would say security selection is the most durable form of alpha. I just think that, you know, markets, down markets, there's always companies that are winning and losing, there's always sectors that are winning and losing. There's companies that are either nearing the end of an investment cycle or at the beginning of an investment cycle. And I think that especially with how much money gets invested in fixing come today based on, you know, to go back again to portfolio trading with like parameters where it's like, I want to portfolio with this rating, this year, all this duration, that sort of, in many cases, agnostic to the forward looking fundamentals of what some of those individual issues are, we really think there's always going to be an opportunity to pick, pick credits. So the way we've set up are some of our multi sector portfolios is sort of like allocation and selection model where our team will decide we want to be overweight, securitized credit and underweight investment grade credit, but we let the security selection experts in those departments, you know, pick the individual assures and let them really focus on that one specific thing. You know, a lot of times in a lot of markets that feel like, like grinding out singles and doubles, but that to us, that's really what works over time is being consistently think there's logic to have people having people being like very narrowly focused on what it is that they're, they're very excellent at and have spent their whole career's doing. So you talk about the current environment, maybe one for more for income in carry. So I guess when you sort of get exposure, how do you think about in terms of, are you thinking about it as sort of like a carry in a hold to maturity term? Are you looking at it in terms of where it sits on the car, obviously, there's not a ton of roll down through at least through the belly of these days, but do you think about it, you know, in terms of carry with the roll down, like how do you sort of think of it from a technical standpoint in terms of like when you buy a position or you take on a position, do you have a certain average life of ownership in mind or is it always thought of as sort of a hold to maturity piece? I would say we look at, we do look at roll down. So so first there's, there's your spread advantage, which is just the amount of carry coming from the spread of the bonds. And then there's sort of a roll down component. We actually decompose the roll down component to interest rate roll down. So for example, there's a lot of roll down, you know, from like the 15 year point on the treasury curve to the 10 year point today, given where 10s, 20s are and there's some cheap bonds in that part of the curve, but we'll also look at like fitted curve for individual issuers and credit if they have, you know, three year bond at 70 and a five year bond at 110, you know, we'll look at like a six month or three month horizon carry calculation that takes into account that roll down and sort of annualizes it. But again, those are those can be moving targets at time to your point. I don't necessarily think about hold to maturity, but I think when we're looking at like shorter dated, securitized products that might have like a one or two year maturity or a very short weighted average life, like we are sort of thinking about how much of that we're going to lose over the course of a year, how much do we need to backfill? And we do use maturity as a form of liquidity in that part of the portfolio. I would say in credit, that's much less the case. We don't, we don't usually deploy a lot of capital and like one, two, or three year credit because that tends to trade almost on top of treasuries. So I'd say it's a little bit of both, but more anchored towards like what's our income today, and then also what's the distribution of outcomes for where spreads could go in those different sectors and what that means for total return. But I think just managing in a low volatility environment like Manningshire carry is really important, even nitty gritty things like to use an extreme example in a benchmark portfolio if the benchmark duration is like seven years. If you're going to buy a loan that has no interest rate duration, you then have to buy futures to get the duration back. That costs you something you can use the swaps curve as sort of a proxy, but you also have to take into account the fact that you have to roll those futures every quarter. So we try to think about like what are the true, what's the true cost of carry for every position in the portfolio? How are we funding it? What are we funding it out of in the benchmark allocation? There's a lot of science there, but also a little bit of art over time that I think just comes from experience and managing portfolios, but managing your carry in a low volatility environment is super important. So we want to come back to something that you said in a prior answer, and that was basically just talking about, you know, in your view, the sort of the decade ahead is sort of built really for credit, just giving where we're starting out in terms of yield and evaluation of our rentals, obviously, in the equity side, etc. I guess maybe just walk me through a little bit, I mean, getting those two points like what's the risk? What's the right environment? Obviously, we're in an environment where, you know, there's a little bit more defensiveness to it, but like what are the risks to that living out? I mean, because I look at investment grade this year, you know, my expectations for the year weren't crazy, crazy in terms of total returns, and we're obviously stumbling along a little bit kind of low single digits year to date, given what's happening in the right side. What are the risks to credit over the next? Let's call it three to five years. Like what could go wrong? There's a couple of things we're focused on for the downside. So I think the first is just the AI cat-back cycle. I think every good credit investor, like their process starts with like, where's the leverage building up? Where's the debt coming? And what is the value of the asset that that debt is marked against? I wouldn't, I would by no means claim to be an artificial intelligence expert, although we're all being forced to become AI experts because it is, you know, quickly becoming the biggest driver of markets in the economies. I think that's probably been the case for the last few years, but it feels like it's reaching a fever pitch to me. So I think what we're trying to focus on is like, you know, what's the first, second and third derivatives of the AI build out cycle? And what I mean by that is like, just to use an extreme example, say we got to a point where all these different models were monetized and no one was able to charge sort of a premium pricing for the technology. And that is sort of the history of technology is that it's deflationary that the product gets better and it gets cheaper over time. And at the same time, you know, going into this, we're spending hundreds and hundreds of billions of dollars to build out that asset. So I don't think that that's necessarily what's going to happen, but it is in some ways like that the energy cycle from 2012 to 2016 is sort of instructive as like an extreme analogy in that US shale technology got so good that we're able to pull so many barrels of oil out of the ground that we're able to push global oil down to, you know, frankly unimaginable levels in the years prior. And suddenly you had a lot of companies that had a lot of debt that were no longer economic because they became victims of their own success. So I'd say that's the number one thing we're watching in terms of like keeping our eye out for a credit cycle. On the macroeconomic side, I would say I've been obsessed with this concept of like fiscal dominance and what it means for the US economy. I think one of the things that people missed are underappreciated in 2022 and 2023 was that while yes, the Fed hiked 500 basis points or so from from zero rates and we exited like the zero rate era. This was happening at a time where we were running seven to nine percent fiscal deficits and just massive fiscal support for the US economy and frankly unprecedented levels in history when we weren't at war or we weren't coming out of a recession. And that so those, you know, fiscal and monetary are always super important. The first 15 years of my career, we were all obsessed with like everything the Fed said and what they were going to do to the basis point of the Fed funds rate. I think now the fiscal side is arguably much more important. We think the big, beautiful bills maximum impact is basically being felt in the economy right now that will actually start to fade in the back half of the year. I think the Trump administration would like to pass more fiscal. We think that will be challenging given where inflation is given the rates of move higher and also a little bit of a risk that they don't do so hot at the midterms and what that could mean for the last two years. So we really want to see like how the US economy performs when fiscal benefit or fiscal support is no longer there. And that we think that that's potentially an early next year phenomenon. And I would put a bow on and say, I believe the excessive fiscal for the past five years is a big reason that the US grill story has outperformed some of our peers at a big part of the reason why inflation has stayed above target. Obviously the AI build out is this unique thing that we have and not a lot of other countries have. But I think you want to be very cognizant of what fiscal means for the overall economy in the coming years. And I would dare to say that I think we're approaching a period where it has to fade almost mathematically. Yeah, I'm inclined to agree, but I feel like I've waiting for that for a little while as well. But yeah, no, I think you and I share some concerns there. But I guess I want to stay mindful of time here. So maybe we kind of just pivot and get some quick views in terms of you alluded to some of the macro landscape there. So maybe we just kind of go first to policy. Obviously we're about not even a week removed as we're recording here on the 22nd of June, not even a week removed from Chairman Worsh's first oversight of the FOMC. Any first takes, first blushing questions in terms of what we got and has it changed how you think about the future? think about the the forward path for policy. - My highest conviction view on wars going into last week was that he would want to try to put like his own touch on the Federal Reserve. And I think he delivered that in spades and then some, even if he just look at how short the statement was. I think over time, the market's gonna have to get comfortable with that. And so I do think that's, we're in a bit of a period of transition in terms of like a different Fed. I would argue that probably means more term premium, more volatility for probably longer dated rates, but potentially across the entire curve. But in some ways, I'm optimistic that it will create like a, I don't know, more dynamic, like capitalist system in that we're not all sitting around waiting for the Fed to tell us what to do in terms of allocating capital. We just kind of have to stand on our own two feet. You know, everyone's familiar with the concept of moral hazard. I think that, you know, if we go back 30, 40 years when I was just a kid and, you know, Greenspan would like surprise the market. I think there's some element of value to that in that, you know, they're showing that they have their own framework for how they should tweak policy and they're not sort of like afraid of what it means for the market. They're just gonna use their tools, use their analysis, use their research to make the best decision. So I'm sort of optimistic about that going forward versus the like incessant forward guidance and almost over communicating with the Fed, which I think, you know, led to good outcomes and then ultimately led to a blowup, if you will. So that's sort of I only take. I think Warsh inherited a pretty tough hand. Inflations above target, you have a supply shock coming out of the situation that I ran. Fiscal still running pretty heavy and then deficits are a problem. I think the administration ideally would like to get interest rates down to sort of kick the can down the road on when compounding interest expense becomes a problem. So I think he's got a really tough job ahead of him. But I have an essay changed like how we're managing portfolios, change positioning. I think it's too early to, you know, speculate on exactly what he's gonna do. I think we just need to stay attuned to how the inflation and the growth data is evolving and just keep an eye on, you know, what's priced in the market for those, for those various risks. So volatility in term premium, I've inclined to agree with that. I am kind of curious in terms of any implications. If we end up in an environment where we are sort of seeing more volatility just because of the nature of communication, does it have implications also for like spread curves within the corporate side, do you think? I would, I mean, I would think that if you have more interest rate volatility, you should have wider credit spreads because it just makes it harder to hold like a volatile total return instrument. And I think that that's been pretty true over a long period of time, like the simple way to think about is like if you're an insurance company and, you know, yields go up three or five basis points one day, you're like, hey, I get to deploy capital at plus three to five base points from here, but if volatility gets so high that you think there's a risk of yields moving up, you know, 25, 50 or 100 basis points, I think you tend to be a little bit more patient and wait for things to settle. So I do think more volatility in rates, especially if it's sort of symmetric in terms of the direction should lead to wider credit spreads all as equal. And then, you know, the the super tail event would be if Worsh's view is that to beat inflation, he really needs the slowly economy. I think he needs to get interest rates across the entire curve, higher to sort of like increase the real bar and cost in the economy. So you look at real rates as a proxy, which it moved up significantly since February or March, if he really needs a lean against the tide and slow the economy to get inflation back to 2%, I think that's a really challenging environment for credit. And I think we're not quite there. I think I think the market could probably withstand one or two hikes like a tweaking of policy, if you will. But if he stands up and says like, hey, we're in a battle against inflation and we're going to do that by slowing demand with much higher interest rates, I think credit is in for a really bumpy ride for the next, you know, however long that process takes. Is that a would you rotate, you know, to floating rate in that sort of environment or do you think of it as, you know, if we do that, then the future expectation inflation has come down. So you're actually going to be okay to be in duration in that standpoint. I'd say it's okay to be in duration on the back side of that campaign, if you want to call it that. But for the for the first, you know, four or five innings, I think duration would be would not be your friend. I think for me, it would more just be reducing like credit market value, like moving out of credit into treasuries, but keeping your duration the same, then just being really careful about leverage credits where, you know, the access to capital markets and the cost of financing is the dominant driver of whether that company survives or sort of up in quality and just lower credit market value and definitely carrying a lot of liquidity in the portfolio to deploy if, if opportunities present themselves. So we don't really have time, but kind of squeeze one more private credit follow up. Do you see sort of this competition for capital that's out there in positive terms, negative terms, or is it just a neutral impact in terms of where investment grade goes from here? The private credit markets are large enough now that I think in some cases they can compete with that large provision of liquidity that I mentioned in investment grade, like liquid markets. I think where we are seeing much more competition, though is sort of down the credit respect room in more of the leverage lending parts of the market. But I would expect with, you know, in flows into insurance companies and lots of liquidity and lots of folks looking for financing that they'll continue to be a huge part. But I don't necessarily view it as like one or the other. I think it's just another good option for companies. And we haven't seen too many deals where an investment grade company shows to go to the private markets instead of the public markets. I think it's more of an issue when you have like a credit situation that goes south and then need not necessarily rescue financing, but something akin to that where it can be easier to just go to like one private credit firm and do the whole thing versus trying to syndicate and get a bunch of people together to agree on terms. That's where we've seen a much more of like a replacement or competition for the process at the end of the day. For investment grade, I just don't think that these private credit firms are big enough that they can do 25 or 50 billion tight deals. But they're certainly making their way up because three to five years ago, they couldn't do a billion. And now that's that's pretty standard at this point in time. So definitely something to watch and it's definitely getting larger. We are seeing firms set up capabilities to trade private credit the way public credit is traded. So the conversion trade is real. And it's definitely in full force. And I wouldn't be shocked if in five or 10 years, they're much more similar markets than they are dissimilar. But there's probably me bumps along the way in terms of how that how that pans out. Awesome. All Connor. Thanks so much for joining us on the podcast. Today, I'd also like to thank our team or editing team for helping pull this podcast together to our listeners. We do hope you enjoyed this conversation with Connor Fitzgerald. It's lead PM for Wellington Management's intermediate credit and credit total return strategies. Until next time, this has been Crutch Grunge. [MUSIC]