Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of The Odd Laws podcast.
Speaker 3: I'm joll Wisenthal and I'm Tracy Alloway.
Speaker 2: Tracy, you know, we've been doing this podcast for ten.
Speaker 3: Years, I am aware. Yeah, no, a whole decade.
Speaker 2: And we've been doing episodes about big picture things and
Speaker 2: things that have changed and what's different now in twenty
Speaker 2: twenty five or twenty fifteen when we started. And some
Speaker 2: things are the same, some things that are different, etcetera.
Speaker 2: But I think, and we've mentioned this before, I think
Speaker 2: the one thing that could not be more different here's
Speaker 2: the raids environment. We were right in the middle of,
Speaker 2: like the zerp decade or the Zerp era, maybe in
Speaker 2: twenty fifteen. Maybe at that point, the FED had tried
Speaker 2: to hike one time already and then the market sort
Speaker 2: of slapped it down and said, oh no, no, no,
Speaker 2: no more, We're not ready for more rate hikes, et cetera.
Speaker 2: The raid environment could not be more different than when
Speaker 2: we first started this podcast.
Speaker 3: Absolutely. Can I say one thing about the anniversary, Yeah,
Speaker 3: so we started the podcast in November twenty fifteen. Yeah,
Speaker 3: we were going to celebrate for the month of November,
Speaker 3: but we're now in December, So are we going to
Speaker 3: make this a two month celebration.
Speaker 2: Well, you know, we're having our ten year anniversary party
Speaker 2: in December, so I think it's allowed. Well's just believing,
Speaker 2: you know, it's allowed to bleed the ten years into
Speaker 2: both months, given that we're formally celebrating in December. I
Speaker 2: think this is how I'm rationalizing this framing for this conversation.
Speaker 2: Since yes, we're no longer we're technically no longer an
Speaker 2: anniversary month.
Speaker 3: I guess it's our party and we can celebrate as
Speaker 3: long as we want however we want. But you're absolutely
Speaker 3: right about the rates environment, and you know you could
Speaker 3: see that if you go back and look at some
Speaker 3: of the old episodes. The other thing that strikes me
Speaker 3: looking back at the old podcast episodes is how many
Speaker 3: of them were about shadow banking, which of course nowadays
Speaker 3: recall private credit. And that's another thing that's changed enormously.
Speaker 3: So the private credit market now basically rivals the public
Speaker 3: credit market in terms of size, and there's obviously a
Speaker 3: lot of concern about what that means. The outlooks lots
Speaker 3: of differences.
Speaker 2: Lots of differences. Yeah, completely dramatic and setting aside the
Speaker 2: big picture questions, there are also some small picture questions,
Speaker 2: maybe how you put.
Speaker 3: It, immediate questions.
Speaker 2: At the time we were recording this, it looks like
Speaker 2: the December meeting is basically a lock that there's going
Speaker 2: to be a cut. But up until recently there was
Speaker 2: a lot of market uncertainty.
Speaker 3: If we recorded this two weeks ago, it would have
Speaker 3: looked very different.
Speaker 2: It would looked very different, and you know what happens
Speaker 2: after December highly uncertain on many dimensions the follow through
Speaker 2: for the rate cutting cycle. There have been increases in
Speaker 2: various credit concerns of various source. We've had a few
Speaker 2: small blow ups, but you know, nothing that big. But
Speaker 2: like what Jamie Diamond called the cockroaches, we mentioned it
Speaker 2: on the show that suddenly people are talking about credit
Speaker 2: default swaps uncertain high tech companies, which is very unusual.
Speaker 3: But there's that's what Star Wars meme. I haven't heard
Speaker 3: that word in a long time, that's right.
Speaker 2: But with the AI build out and how much that's
Speaker 2: getting financed by various forms of credit, suddenly people are
Speaker 2: talking about the fact that big tech companies are credits,
Speaker 2: which we don't really think about very much. And so
Speaker 2: there are some big picture of things, but also some
Speaker 2: things happening right here and right now that weren't further
Speaker 2: understanding and further explanation from the people who really understand
Speaker 2: them absolutely well. I'm very excited to say we really
Speaker 2: do have the perfect guests, someone who we've had on
Speaker 2: the show before, but someone we love speaking to. We
Speaker 2: are going to be speaking with Dan Ivison. He is
Speaker 2: the CIO over at PIMCO, which of course everybody should
Speaker 2: know about. So Dan, thank you so much for coming
Speaker 2: back on the Outlaws podcast.
Speaker 4: Thanks for having me, and congratulations on the big ten
Speaker 4: year anniversary. It's an honor to be invited back during
Speaker 4: this series of podcasts.
Speaker 3: Thank you so much.
Speaker 2: Yeah, very kind of you to say, let's start small picture.
Speaker 2: I think this episode will be out before the meeting.
Speaker 2: The market is saying it's going to be a lock.
Speaker 2: They're definitely going to cut rates. But beyond that, when
Speaker 2: you look into twenty twenty six, there's sort of two
Speaker 2: different questions. There's the ongoing uncertainty about who is going
Speaker 2: to be the next FED chair, and then there's just
Speaker 2: the questions about how much appetite this existing committee has
Speaker 2: to continue a rate cutting cycle, So I'd love to
Speaker 2: get you know, what are you thinking about for the
Speaker 2: twenty twenty six and what we could be expecting.
Speaker 4: Sure, so you know, we do think the Fed's likely
Speaker 4: to cut rates at the upcoming meeting. We also think
Speaker 4: that this is a FED that would like to get
Speaker 4: rates a bit lower into twenty twenty six. The challenge,
Speaker 4: of course, is that we expect to see a little
Speaker 4: bit of reacceleration in the economy during the first half
Speaker 4: of the year, and we also expect inflation to remain
Speaker 4: comfortably above the central bank targets. So you know, we
Speaker 4: believe this FED when they say they're going to continue
Speaker 4: to focus on the data, we do think the data is.
Speaker 5: Going to be a bit confusing.
Speaker 4: The general view you know today at PIMCU, with significant uncertainty,
Speaker 4: is that they probably do get rates down another half
Speaker 4: of percent or so next year, which is close to
Speaker 4: what's being priced into the market today. But again, if
Speaker 4: you see meaningful reacceleration in the growth data, and more importantly,
Speaker 4: if you see even a modest up ticket inflation, this FED,
Speaker 4: you know, even with a new chair, will will likely
Speaker 4: be willing to remain on hold and then I think
Speaker 4: the other point, and this came up with one of
Speaker 4: your recent guests, is that there's the front end policy
Speaker 4: rate and then there's the reaction out in longer maturities.
Speaker 4: We do think there's a chance if this FED cuts
Speaker 4: aggressively into strengthening data higher inflation, you may actually get
Speaker 4: a selloff in the long end of the curve. So
Speaker 4: that could be a bit self defeating, and I think
Speaker 4: something that will be a topic into next year if
Speaker 4: we do get that reacceleration that we expect.
Speaker 2: There's a lot you said there that I want to
Speaker 2: follow up on just in that one answer, but just
Speaker 2: very quickly, what is the idea, the gist behind why
Speaker 2: you expect dead Q on reacceleration.
Speaker 4: Yeah, A lot of it's you know, related to significant momentum,
Speaker 4: you know, in terms of capital investment, you know, associated
Speaker 4: with AI as well as the delayed positive growth impact.
Speaker 5: Of the so called Big Beautiful Bill.
Speaker 4: A lot of the corporate tax extensions happened retroactively for
Speaker 4: the consumer of the household in many instances, you're going
Speaker 4: to begin to see the direct impact in terms of
Speaker 4: positive refunds coming into the new year. So again, you know,
Speaker 4: plenty of uncertainty, you know, a lot of cross currents
Speaker 4: in this economy, but we do think there's the chance
Speaker 4: that you'll get some moderate reacceleration in the first half
Speaker 4: of the year. You know, we're looking at a growth environment,
Speaker 4: you know, for next year in the United States at
Speaker 4: least somewhere in the one and a half to two
Speaker 4: percent type range. So again that's an environment we're from
Speaker 4: a traditional tailor rule perspective. We don't think that the
Speaker 4: FED needs to cut a lot more from here, although
Speaker 4: you know, we do think that this FED, particularly with
Speaker 4: new membership and a new chair, would like to get
Speaker 4: rates lower.
Speaker 3: Since you mentioned the new chair, this is more of
Speaker 3: a long term, thoughtful question. But obviously, for the majority
Speaker 3: of your career as a bond manager, I don't think
Speaker 3: FED independence has really been much of a concern, right.
Speaker 3: We certainly haven't seen the degree of headlines that we
Speaker 3: are seeing lately with Kevin Hassett emerging as the front
Speaker 3: runner for the new FED chair position. How do you
Speaker 3: as a bond manager view that particular issue and do
Speaker 3: you have to start handicapping the way you invest because
Speaker 3: of this?
Speaker 4: I think to a degree, I think if you go
Speaker 4: back several decades, you know, you can question the concept
Speaker 4: of FED independence a little bit, and I think even
Speaker 4: from the perspective of this fed's expanded mandate in recent years,
Speaker 4: what the market's really focused on is independence related to
Speaker 4: the setting of policy rates, which you know, of course
Speaker 4: have a direct impact. So from that perspective, we are
Speaker 4: monitoring the situation like other investors. We do think less
Speaker 4: independent FED has implications, particularly in longer maturities, where you
Speaker 4: may need a bit more risk premium when you're dealing
Speaker 4: with uncertainty around FED independence. But generally speaking, when we
Speaker 4: think about you know, who's being considered for the FED role,
Speaker 4: including Kevin Hasseert, you know, we do think that there'll
Speaker 4: be a general spirit of independence there. We still think,
Speaker 4: you know, the chair is one vote, so to speak,
Speaker 4: and we have a committee that will continue to focus
Speaker 4: on the dual mandate. So yes, it's a consideration, it's
Speaker 4: an input into our decisions. It's not a major concern.
Speaker 4: We do think that you know, the group that's being
Speaker 4: considered are you know, certainly highly qualified and will likely
Speaker 4: you know, continue to take a sufficiently independent view regarding
Speaker 4: monetary policy.
Speaker 2: Let me ask you kind of the same question, but
Speaker 2: with a slightly different framing. It's December twenty twenty five
Speaker 2: right now, so we've had like over four years now,
Speaker 2: I think over four years now of the FED missing
Speaker 2: on its inflation on the two on getting inflation durably
Speaker 2: back to two And if the FED is going to
Speaker 2: continue cutting as it looks like it's going to do
Speaker 2: in December, that signals a further willingness to ease policy
Speaker 2: even with inflation over its ostensible target setting. Aside the
Speaker 2: strict question of independence, do you think the FED, regardless
Speaker 2: even the current composition and the likely composition going to
Speaker 2: be forward, is just not going to take two percent
Speaker 2: seriously as perhaps it might have in the past.
Speaker 4: Yes, that's a great question, and I think that in
Speaker 4: a general sense the two percent target matters, but not
Speaker 4: so much the current inflation rate. You're absolutely right. We've
Speaker 4: been operating, you know, and living with an inflation rate
Speaker 4: meaningfully above their target for quite some time. But when
Speaker 4: you look at inflationary expectations, and I think when you
Speaker 4: talk to central bankers you know here in the United
Speaker 4: States as well as outside this country, the inflationary expectations
Speaker 4: piece is what's critically important. So when you look at
Speaker 4: longer term break even inflation rate, they've continued to be
Speaker 4: very very well behaved. You saw a bit of an
Speaker 4: uptick at the upbreak of the war in Ukraine, and
Speaker 4: then you saw an uptick around the tariff announcements earlier
Speaker 4: this year. But when you look at a ten year
Speaker 4: tip break even rate, just to use one of several proxies,
Speaker 4: no one measure is perfect, you're down around two and
Speaker 4: quarter percent on CPI inflation. So to the extent that
Speaker 4: inflationary expectations remain well contained, we do think that the
Speaker 4: central banks willing to look through some of the more
Speaker 4: higher frequency data to the extent that you see those
Speaker 4: longer term expectations become unanchored. We do think that's a
Speaker 4: risk for a FED that's too aggressive in cutting rates here.
Speaker 4: We do think that the mindset will change, not only
Speaker 4: the mindset of the Fed, but we think the market
Speaker 4: reaction could be counterproductive, not only in terms of higher
Speaker 4: long term interest rates, but an impact on risk assets
Speaker 4: as well. So you know, the markets have let the
Speaker 4: Fed get away with running fairly accommodated policy into a
Speaker 4: three percent type inflation world. Because again, there are a
Speaker 4: lot of other forces at work that very well could
Speaker 4: be disinflationary over the long term, and there still is
Speaker 4: significant confidence in global central banks and being able to
Speaker 4: generally keep inflation close to the target on a longer
Speaker 4: term basis. So you know, again, so far, so good,
Speaker 4: but you know, this is all going to be a
Speaker 4: key source of uncertainty, you know, into twenty six and beyond.
Speaker 3: I feel like uncertainty is constantly the keyword on our
Speaker 3: podcast nowadays, since longer dated expectations and yields keeps coming up.
Speaker 3: In this conversation, I got to ask, do you believe
Speaker 3: in the term premium or rather, is the term premium
Speaker 3: a useful concept to you as a big bond investor?
Speaker 4: It is, and you know, when we look at you know,
Speaker 4: where we're going to invest, you know, we like to
Speaker 4: get paid for, you know, taking more risk. We do,
Speaker 4: you know, see an elevated term premium certainly relative to
Speaker 4: where we were five or ten years ago, and that's
Speaker 4: made longer maturity investments a bit more attractive. With that said,
Speaker 4: there's lots of reasons why the term premium should be higher.
Speaker 4: Inflation is one of them. Global debt levels, US debt
Speaker 4: and deficit levels are another. We probably live in a
Speaker 4: world today given what's going on in terms of focusing
Speaker 4: on tariffs and bringing back supply chains, you know, to
Speaker 4: domestic markets, the need for you know, higher risk premium.
Speaker 4: So you know, as a firm today, we we like
Speaker 4: longer maturity bonds more, but we're still you know, tend
Speaker 4: to keep our positions concentrated in shorter maturities, and we
Speaker 4: would expect over the next few years a little bit
Speaker 4: of additional underperformance in the very very long end of
Speaker 4: the yield curve. So we do think it's important. It's
Speaker 4: interesting people focus a lot on the deficit situation in
Speaker 4: the United States. As an investor, you don't want to
Speaker 4: lend to a perfect high quality credit you get paid
Speaker 4: so much to do so. So in some sense, we want,
Speaker 4: you know, just enough fiscal irresponsibility where we and our
Speaker 4: end investors get paid more to lend, but not so
Speaker 4: much where it becomes a concern in term the overall
Speaker 4: viability of the system. So we think we're in the
Speaker 4: midst of that type of market environment today, but things
Speaker 4: can go a bit too far if we don't get
Speaker 4: the deficit or the inflation situation under control. Over the
Speaker 4: next couple of a few years.
Speaker 2: Can you talk about the role of bonds in a portfolio? Again,
Speaker 2: this is something that in twenty fifteen, bonds fit beautifully
Speaker 2: into a diversified portfolio because they were paying something, but
Speaker 2: also they had that nice and verse correlation and so
Speaker 2: you got that natural hedge, et cetera. We haven't had
Speaker 2: that very like that beautiful inverse correlation between risk assets
Speaker 2: and bonds for a long time, which undermines one of
Speaker 2: the cases for the diversified investor of having like a
Speaker 2: big slug of perhaps longer duration assets. How do you
Speaker 2: think in twenty twenty five, how do you sell the
Speaker 2: case that diversified investors should still keep some allocation to
Speaker 2: duration or fixed income.
Speaker 4: Yeah, so it's interesting. I know this is a ten
Speaker 4: year anniversary show, so you know, went back it looked
Speaker 4: at the performance of bonds versus other things, you know,
Speaker 4: over the last ten years, and the divergence in performance
Speaker 4: over the last decade has been remarkable and it explains
Speaker 4: a lot. If you look at the S and P
Speaker 4: five hundred over the last ten years, in absolute terms,
Speaker 4: you generated a return of about fifteen percent a year
Speaker 4: adjusted for inflation. I think it's up close to twelve
Speaker 4: percent or so I'm rounding a little bit. When you'll
Speaker 4: get the performance of you know, the Bloomberg aggregate index
Speaker 4: over that ten year period, the return annually has been
Speaker 4: below two percent in absolute terms. When you subtract inflation,
Speaker 4: you ended up with negative returns in bonds for ten years.
Speaker 4: So not only has the correlation broken down, but you
Speaker 4: didn't make any money in owning bonds. When you look
Speaker 4: at the starting valuations today under any type of reasonable
Speaker 4: longer term valuation framework, none of which have to mean
Speaker 4: revert quickly, but you know, you look at a you know,
Speaker 4: a Schiller pe type arrangement or equity risk premium type argument.
Speaker 4: You don't need a great correlation on bonds versus equities.
Speaker 4: What the relative valuations would suggest is that there's a
Speaker 4: good chance that bonds outperform stocks over the next five
Speaker 4: or ten years, or at least have returns on a
Speaker 4: risk adjusted basis very very close to stocks. So you
Speaker 4: don't have to rest on a correlation argument. You know,
Speaker 4: you don't have to focus on well bonds do well
Speaker 4: during periods where people are losing their jobs or you know,
Speaker 4: income growth is negative. You can just from a pure
Speaker 4: valuation perspective, find the acid class quite attractive absolute and relative.
Speaker 4: I think the second point around correlations is that correlations
Speaker 4: between stocks and bonds will tend to break down when
Speaker 4: inflation is the primary risk factor. Today, yes, inflation is
Speaker 4: above central bank targets, but there's a lot of uncertainty
Speaker 4: on the economic side. You do have this complex economy
Speaker 4: where tremendous value you know within the tech sector, tremendous
Speaker 4: capital and investment, yet lower income households are feeling considerable pain.
Speaker 4: If AI is very very successful at increasing productivity, that
Speaker 4: could mean significant job loss across key segments of the economy.
Speaker 4: So the bottom line is that risks are more balanced.
Speaker 4: We don't think correlations are going to ever come back
Speaker 4: to the really, really neat clean levels you know a
Speaker 4: decade or so ago, when inflation simply wasn't a problem
Speaker 4: at all, you know, across the global economy. But we
Speaker 4: have seen correlations improve a bit, and we would expecting
Speaker 4: to go forward basis correlations to improve further. I think
Speaker 4: it's important again to look at a global opportunity set.
Speaker 4: I think that the correlation arguments are stronger in areas
Speaker 4: of the world that have the best fiscal position. But
Speaker 4: in general, you know, not only do we think that
Speaker 4: the valuations are quite attractive, you know, we do think
Speaker 4: the correlations will be a bit better certainly that we experience.
Speaker 5: It's coming out of the culture tray.
Speaker 2: Twenty fifteen, bonds were an easy sell. It turns out
Speaker 2: they weren't the best investment. Twenty twenty five maybe a
Speaker 2: harder cell, but the math says that now is actually
Speaker 2: the time to expand your exposure.
Speaker 3: Well, I guess in ten years when we do the
Speaker 3: twenty year anniversary, we will be able to judge. But Dan,
Speaker 3: you know, since we're talking about why people should buy bonds,
Speaker 3: one of the surprising things that happened this year was
Speaker 3: we had the big tariff drama and we saw markets
Speaker 3: go down, We saw a bond yield spike. Everyone was
Speaker 3: talking about the sell America trade. So this idea that
Speaker 3: you didn't want to hold onto US assets because of
Speaker 3: all that policy uncertainty. And now you know, in December
Speaker 3: twenty twenty five, yields have come down quite a lot,
Speaker 3: although I have to say the dollar is still fairly weak.
Speaker 3: You were always kind of resistant to the sell America idea,
Speaker 3: and you pushed back on it. What did you see
Speaker 3: that perhaps others didn't.
Speaker 5: Well.
Speaker 4: Again, I think a lot has to do with starting valuations.
Speaker 4: After a significant period of underperformance across the US fixed
Speaker 4: income or global fixed income, you ended up with a
Speaker 4: decent valuation cushion. So I think that's always important in markets. Yes,
Speaker 4: there was news that in a narrow sense was negative
Speaker 4: for bonds and negative for US bonds or US assets
Speaker 4: in particular. You started with a decent yield cushion. You know,
Speaker 4: we began the year, you know, with yields ten year treasuries,
Speaker 4: you know, up near five percent. A five percent yield
Speaker 4: even in a three percent inflation worlds not that bad.
Speaker 4: I think the second point, though, you know, we weren't
Speaker 4: overly convicted in just owning the United States. And I
Speaker 4: think if I could, you know, you're part of the
Speaker 4: most important thing I can say today is that global
Speaker 4: bond investing is back. For so many years, capitalists poured
Speaker 4: into the US markets. It's poured into the US markets
Speaker 4: focusing on private credit, you know, which has grown you know,
Speaker 4: the most here in this country. But very very quietly,
Speaker 4: you've seen underperformance across the global fixed thing come opportunities
Speaker 4: set where today even you know, from a US dollar
Speaker 4: based investors perspective, there's great yield, great sources of diversification.
Speaker 4: So it's not that we were, you know, insistent on
Speaker 4: just owning US assets. In fact, we've gradually diversified into
Speaker 4: other areas of the market. We just thought that there
Speaker 4: was good value and good yield in the US, a
Speaker 4: sufficient cushion, and then by extending into these other markets,
Speaker 4: a great way to generate incremental return by good old
Speaker 4: fashioned relative value trading in markets today that are less
Speaker 4: correlated than they were during those years coming out of
Speaker 4: the global financial crisis and where you just have a
Speaker 4: really really exciting time to troll dual fashion training across
Speaker 4: yield curves, across markets and avoid what.
Speaker 2: Changed because it seemed like, you know, it felt like
Speaker 2: international investing across any acid class was like a real
Speaker 2: suckers thing. It's like, oh, this is going to be
Speaker 2: the year that we're going to diversify internationally. You didn't
Speaker 2: get paid at all for it. Flipped such that actually
Speaker 2: both stocks too, because international equity markets have done very
Speaker 2: well and have outperformed the US. It's kind of surprising
Speaker 2: in many respects. But what switched such that now there's
Speaker 2: been real opportunities to make money.
Speaker 4: Looking abroad, Yeah, well again, valuations have improved. You know,
Speaker 4: we talked about, you know, the real poor performance of
Speaker 4: the US bond market over the last decade. As we
Speaker 4: all know, yields were outright negative in many areas of
Speaker 4: the world, So we talked about low yields. You subtract
Speaker 4: that low inflation rate, you end up with a negative number,
Speaker 4: and big portions of the global fixed income opportunity set
Speaker 4: you'd have to subtract anything you started with a negative number.
Speaker 4: So a lot of this has just been the repricing
Speaker 4: of markets that started not only at low levels, but
Speaker 4: negative yield levels. Then the second piece relates to policy
Speaker 4: coming out of the global financial crisis. Not only were
Speaker 4: yields low, but you've had such incredible policy activism where
Speaker 4: on any signs of economic weakness you had a massive
Speaker 4: fiscal response, a massive monetary paul response COVID, you know,
Speaker 4: the ultimate example of that. And today, you know, with
Speaker 4: debt levels and deficit levels where they are, policy makers
Speaker 4: don't have that flexibility. So you're back to an environment
Speaker 4: where markets increasingly have to stand on their own based
Speaker 4: on fundamentals and that's just an exciting time. It means
Speaker 4: more risk premium in markets, more term premium, higher yields,
Speaker 4: with significant valuation cushion absolute and relative to what looked
Speaker 4: to be quite expensive equity markets, and then just less correlation.
Speaker 4: You have situations even over the course of the last
Speaker 4: couple of months where a political surprise in Japan or
Speaker 4: France creates lots of local volatility in those markets. Uncertainty
Speaker 4: and French politics impacts UK politics because they have similar
Speaker 4: challenges in terms of getting their deficit situation under control
Speaker 4: in economic productivity higher. So it reminds us a lot
Speaker 4: more like the mid nineties, you know, back before you
Speaker 4: had this massive volatility, suffocation from policy, and again with
Speaker 4: deficits where they are, with inflation where it is today
Speaker 4: versus central bank targets. It's likely that over the next
Speaker 4: several years, you know, you're going to continue to be
Speaker 4: in this type of environment good value, good relative value,
Speaker 4: and then much less correlated markets, which you know lead
Speaker 4: to you know, some some good opportunity to generate incredential
Speaker 4: return above starting yield levels.
Speaker 3: Well, we wanted to talk about private credit as well, because,
Speaker 3: as we said in the intro, this is one thing
Speaker 3: that has changed quite a lot since twenty fifteen. People
Speaker 3: obviously have different characterizations of private credit, but I'm curious
Speaker 3: how you think about that space and how you would
Speaker 3: define or how you would measure things like transparency and
Speaker 3: opaqueness and customization in the credit waterfall and things like that,
Speaker 3: because again, one person's extremely transparent market can be another
Speaker 3: person's opaque morass of potential defaults.
Speaker 4: Yes, I talked for the rest of the show here
Speaker 4: in this topic. First of all, surprise it took this
Speaker 4: long to get to the private credit topic. But look
Speaker 4: at you know, not much of this is new. You know,
Speaker 4: when I joined PIMCO back in the late nineteen nineties,
Speaker 4: I spent the good portion of my initial time at
Speaker 4: the firm focusing on the underwriting of private assets. You know,
Speaker 4: we call them pure privates, but these were you know,
Speaker 4: four A two privates that were created as part of
Speaker 4: the Securities Act of nineteen thirty three, one forty four
Speaker 4: A privates, which are quite popular. I think the first
Speaker 4: one was issued back in nineteen ninety. The technology that's
Speaker 4: being utilized to fund AI infrastructure today, some of these
Speaker 4: off balance sheet contingent or make whole guarantee type frameworks
Speaker 4: were around in the mid to late nineteen nineties. The
Speaker 4: difference today is that you have this massive capital investment need,
Speaker 4: so the deals are larger, but a lot of the
Speaker 4: technology has just been dusted off, so to speak, for
Speaker 4: the new era. And the other point that's important, and
Speaker 4: when we're talking about historical returns, I think this explains
Speaker 4: a lot, is that what's been so unique in terms
Speaker 4: of credit asset performance in general has been the post
Speaker 4: global financial crisis period. Well, we have it at a
Speaker 4: sustained period of economic weakness. In fact, one of my
Speaker 4: favorite data series is looking at how lower quality lending
Speaker 4: performed since way back during the Michael Milken days when
Speaker 4: he helped to create that market. If you go back
Speaker 4: to the early nineteen eighties all the way up to
Speaker 4: the global financial crisis, if you had just blindly bought
Speaker 4: the lowest quality credit that's out there proxy by high
Speaker 4: yield senior secured loans direct lending blend the index, you
Speaker 4: would have ended up with only about a half a
Speaker 4: percentage point of incremental performance versus high quality bonds over
Speaker 4: that entire period. And the way it worked was that
Speaker 4: you made a lot of money. You have a lot
Speaker 4: of money, a lot of money, a lot of money.
Speaker 4: Then you gave it all back. Then you made a
Speaker 4: lot of a lot of lot, gave it all back, and
Speaker 4: we'd go back to the late eighties when you had
Speaker 4: that period initial period of aggressive underwriting. You had the
Speaker 4: savings and loan crisis of the early nineties, you had
Speaker 4: the LTCM or the Asian Financial crisis in the late nineties,
Speaker 4: than the Internet bubble and the telecom issues of the
Speaker 4: early two thousands, then of course the Global Financial Crisis.
Speaker 4: That was a more normal credit environment since the GFC
Speaker 4: just blindly buying the lowest quality credit on the board,
Speaker 4: whether it's private credit or lower quality public credit, you
Speaker 4: generated seven percent a year more than high quality bonds,
Speaker 4: and that explains a lot. Not surprisingly, you've seen massive
Speaker 4: growth in that area of the market. Now, you know,
Speaker 4: weaker credit tends to perform well when stocks go up
Speaker 4: fifteen percent a year. But again, you know that's where
Speaker 4: we are today. I hear all the discussion about God,
Speaker 4: you know, underwriting's worse than the public side versus the
Speaker 4: private side. The reality is, when you've grown this much,
Speaker 4: when you've lent so much money to weaker quality borrowers,
Speaker 4: when covenants have weakened, when spreads are tight, when equities
Speaker 4: have gone up consistently as much as they have, you're
Speaker 4: going to have challenges in these markets. So when we
Speaker 4: think about credit, we look at it under sort of
Speaker 4: two continuums. One liquidity. Certain assets are completely illiquid. The
Speaker 4: only decision you get to make is the purchase decision,
Speaker 4: so you better be right. And then at the other
Speaker 4: end of the extreme, you have very very liquid assets
Speaker 4: where you can change your mind on a regular basis.
Speaker 4: And then you have economic sensitivity. You have assets that
Speaker 4: are very insensitive to the economy, that are very very
Speaker 4: high quality. Then at the other extreme, you have assets
Speaker 4: with a tremendous amount of economic sensitivity, a tremendous amount
Speaker 4: of sensitivity to AI related disruption, other forms of economic weakness,
Speaker 4: an anticipated competition, and you just want to make sure
Speaker 4: you get paid enough. And with stocks near all time highs,
Speaker 4: with spreads tight, with covenants weak, they are going to
Speaker 4: be problems. And I think as an investor, you just
Speaker 4: need to acknowledge that you're not getting paid what you
Speaker 4: got to take that risk five or ten years ago,
Speaker 4: and you just want to be defensive. You want to
Speaker 4: be skeptical, But it's not so much private versus public.
Speaker 4: I think it's just thoughtful underwriting and just understanding that
Speaker 4: we're at a time where, given the strong historical performance,
Speaker 4: given the fact that we haven't had a sustained period
Speaker 4: of economics slowing for a long time, some complacency has
Speaker 4: worked their way into these higher risk areas.
Speaker 5: Of the market.
Speaker 3: Well, talk a little bit more about competition in private credit,
Speaker 3: because I imagine it's good to be PIMCO when it comes
Speaker 3: to sourcing deals and maybe negotiating the terms. But does
Speaker 3: even someone like you, a truly big bond manager have
Speaker 3: to deal with competitive pressures where if you don't agree
Speaker 3: to one bond term, someone else will swoop in and
Speaker 3: agree to it and take it away from you.
Speaker 5: Absolutely.
Speaker 4: And again, I think the other point about public and
Speaker 4: private markets is that they're well integrated. You know, we
Speaker 4: could talk about convergence, you know a bit a bit later,
Speaker 4: have have some views there.
Speaker 5: But you know, when an.
Speaker 4: Issuer looks at their options, they're going to test the
Speaker 4: public option, they'll test the private option. And there is
Speaker 4: a lot of competition, a lot of competition for market share.
Speaker 4: When you look at a lot of the managers, particularly
Speaker 4: in the private credit space, they announce very very aggressive
Speaker 4: growth assumptions. You know, as an investor sometimes you know,
Speaker 4: I wish in certain quarters people would talk about, you know,
Speaker 4: if we can find value for the end investor, we
Speaker 4: will grow this much. All too often, you know, after
Speaker 4: a pretty bullish environment for credit, it's was simply going
Speaker 4: to grow a lot. So you know, we do see
Speaker 4: time and time again situations where you start the underwriting process,
Speaker 4: you get down to the point where it's time to
Speaker 4: get into a final round and you don't get the
Speaker 4: terms that we feel we need as extenders of credit
Speaker 4: in this marketplace. And that's just again symptomatic of the
Speaker 4: fact that there's a lot of demand for these assets
Speaker 4: and there's a lot of demand relative to the supply
Speaker 4: across many segments of the market. And that's true not
Speaker 4: only of below investment grade risk, but it's very very
Speaker 4: true of certain transactions with an investment grade rating, at
Speaker 4: least from a rating agency. So you know, given tight spreads,
Speaker 4: given the competition, you just have to say no. And
Speaker 4: I'll go back to my earlier point. What's so exciting
Speaker 4: about this market today is that you do not need
Speaker 4: to take on aggressively underwritten credit to generate return the
Speaker 4: high quality area of the market, especially if you expand globally.
Speaker 4: If you take advantage of liquidity, which typically means flexibility
Speaker 4: for end investors, you can have a high quality portfolio
Speaker 4: where you don't have to sacrifice return. Very different than
Speaker 4: where we were ten years ago, but again pretty exciting.
Speaker 4: Now we can go up in quality without again giving
Speaker 4: up return and in some cases ironically picking up expected return.
Speaker 2: I want to go back to something you said, and
Speaker 2: I didn't quite get it, but I think it's important,
Speaker 2: and of course it's very interesting to our audience. You're
Speaker 2: talking about the AI financing, and I think you said
Speaker 2: something contingent, makehold guarantees. I don't tell us about these
Speaker 2: financing as you see them. And what is the history,
Speaker 2: How novel are they relative to past financings, or how
Speaker 2: much is it that these are structures that were very
Speaker 2: much in place for something else are now being reproposed
Speaker 2: into this new exciting area.
Speaker 4: Yeah, I'll start with what's new, which is lending to
Speaker 4: support the growth and AI and related infrastructure.
Speaker 5: There.
Speaker 4: You're talking about several trillion dollars of investment need. So
Speaker 4: that's what's new, But you know what's not so new
Speaker 4: is this idea that companies would like to keep a
Speaker 4: good portion of their debt off their balance sheet or
Speaker 4: come up with structures that limit their overall financial liability
Speaker 4: or give them some flexibility to manage that liability over time,
Speaker 4: and as an end investor to lend to those companies.
Speaker 4: You know, it's important to acknowledge that lenning against tech firms,
Speaker 4: lenning against AI infrastructure, lenning against AI chips is risky.
Speaker 4: That could be a real good investment if you own
Speaker 4: the equity, may not be a great investment if you
Speaker 4: own the bonds, where at most you get your coupon
Speaker 4: and you hope to get par back at the end
Speaker 4: of the day. So a lot of the underwriting of
Speaker 4: these transactions, and there have been a lot and we
Speaker 4: expect a lot more to come over the course of
Speaker 4: the next few years, is to understand the form of
Speaker 4: that guarantee and understand the entity that's providing that guarantee,
Speaker 4: whether it's in the form of lease payments or other
Speaker 4: type of makehold type arrangements. And these types of structures
Speaker 4: are what have been around for many, many years. You know,
Speaker 4: back in the mid in late nineteen nineties. You know
Speaker 4: a lot of times these would be done by Wall
Speaker 4: Street financial institutions, sometimes across a segment of their business
Speaker 4: where they would use a corporate guarantee to arbitrage a
Speaker 4: bit of the radio agency frameworks. At other time times
Speaker 4: these deals were backed by large ships, equipment, other areas
Speaker 4: of the market. So it was the same type of analysis,
Speaker 4: the same type of underwriting checklist, which involves a lot
Speaker 4: of lawyers to ensure that you understand the guarantee how
Speaker 4: you have to realize on that guarantee, and that's not
Speaker 4: so different today.
Speaker 2: And just to be clear, the guarantee we're talking about
Speaker 2: here is okay, here is a hypothetical SPV that owns
Speaker 2: a data center and it borrows money and finances, et cetera.
Speaker 2: And the guarantee question is how much will the tenant
Speaker 2: of that data center, which didn't want to have all
Speaker 2: that DEBTA on their books, maybe like a Facebook or
Speaker 2: one of the hyperscalers, how much are they actually committed
Speaker 2: to being a tenant for the long term They're basically
Speaker 2: that's what we're talking about.
Speaker 4: Absolutely correct. And why it matters here is you're typically
Speaker 4: talking about investment grade rated counterparties on these transactions where
Speaker 4: the infrastructure itself, the assets that are partially backing the
Speaker 4: d a lot of stablone basis would achieve a very
Speaker 4: very low rating. So how do you create a structure
Speaker 4: where you improve the credit quality while meeting the needs
Speaker 4: of those that are looking to borrow within this market.
Speaker 4: So again, the whole key is to make sure that
Speaker 4: something that the radio agencies may assign investment grade rating too,
Speaker 4: is in fact investment grade from a fundamental credit quality perspective.
Speaker 4: And I think that's another theme. You know, in talking
Speaker 4: about private credit, you know there are more economically sensitive,
Speaker 4: lower quality loans, and then there's been a lot of
Speaker 4: growth on the investment grade side. It is very, very
Speaker 4: dangerous to assume something has an investment grade rating just
Speaker 4: because of the rating agencies assign a rating to it.
Speaker 4: It's critically important that you do your own credit work. Today,
Speaker 4: all too frequently you will have an investment grade rating
Speaker 4: from one entity. And again, market participants for years have
Speaker 4: always joked, if you can only find one investment grade rating,
Speaker 4: it's pretty fair to assume everyone else's below investment grade.
Speaker 4: So the bottom line is that there's been a lot
Speaker 4: of aggress of underwriting going on, even with instruments that
Speaker 4: carry an investment grade rating at least from one entity.
Speaker 4: And again when spreads are tight, when documentation is relatively weak,
Speaker 4: it's just critically important that you do your own fundamental
Speaker 4: credit work. I do think Pimpco has some advantages in
Speaker 4: that area, both in terms of experience and resources, but
Speaker 4: it's super important because you're not always getting the terms
Speaker 4: that you want. When you do, you can unlock tremendous
Speaker 4: value for your clients. But this is an environment where
Speaker 4: we have to be really really selective as a bond
Speaker 4: investor at least.
Speaker 3: Yeah, when I think back to the twenty fifteen environment,
Speaker 3: I remember a lot of people were writing stories about
Speaker 3: the triple B bubble in investment grade. So Triple B
Speaker 3: is the lowest tier of investment grade and that had
Speaker 3: been absolutely exploding post financial crisis, and everyone expect not everyone,
Speaker 3: A lot of people expected that to end in tiers,
Speaker 3: and instead it ended with all those like Triple b's
Speaker 3: getting upgraded and a lot of junk getting upgraded as well,
Speaker 3: and having a bunch of rising stars, which I don't
Speaker 3: think a lot of people were necessarily expecting, but talk
Speaker 3: a little bit more about the rating agencies. What are
Speaker 3: the pressures that you think are perhaps driving them to
Speaker 3: rate some of these structures higher than they otherwise might be.
Speaker 4: Well, again, there are multiple radio agencies that have different
Speaker 4: philosophies to how they arrive at a rating, and there's
Speaker 4: going to be understandable disagreement, you know, within markets. But
Speaker 4: issuers are quite shrewd. You know, they're going to go
Speaker 4: to where they get the most favorable ratings treatment. This
Speaker 4: has always been the case, and I think the important
Speaker 4: point to notice that when stocks are going up fifteen
Speaker 4: percent a year, when the economy is growing, when you
Speaker 4: don't have a sustained period of economic weakness, even poorly
Speaker 4: underwritten credit will mature. We experience that in an extreme sense,
Speaker 4: you know, during the two thousands. What we try to do,
Speaker 4: is active investors is to underwrite two weaker economic environments,
Speaker 4: environments where you know those underlying entities or the infrastructure
Speaker 4: you know that you that you're lending against go into
Speaker 4: a period of weakness. And I think that's where you know,
Speaker 4: good fundamental credit work in this type of environment that
Speaker 4: we're in today that's very much driven by rating arbitrage.
Speaker 4: You know, seeking out investment grade ratings, you know, for
Speaker 4: an insurance balance sheet or reinsurance balance sheet as an example.
Speaker 4: You can lead at times to aggressive decisions. So I
Speaker 4: think it's just a nature of the fact that you
Speaker 4: have multiple agencies and some will be more optimistic in
Speaker 4: certain areas than others.
Speaker 5: But that's great.
Speaker 4: You know, if we didn't have those sources of disagreement,
Speaker 4: that wouldn't be opportunities to generate incremental return, you know,
Speaker 4: versus passive alternatives.
Speaker 2: While we're here on credit. Actually, you know, there's probably
Speaker 2: about a month ago or a month and a half ago,
Speaker 2: that's when we were getting all those headlines about tree color.
Speaker 2: And that was when Jamie Diamond made the sort of
Speaker 2: famous crickets thing. I was getting real corea cockroaches.
Speaker 3: I hate cockroaches and I like crickets, So I want
Speaker 3: to make that clear.
Speaker 2: Crickets are lovely. Yeah, right, I should not associate them
Speaker 2: with credit blow ups. That's completely unfair to crickets. It's
Speaker 2: fair to cockroaches. Jamie Diamond made those cocker I was
Speaker 2: getting worried. I saw all these heads like going another
Speaker 2: antity took a hit on this another entity. I was
Speaker 2: like oh, this is very familiar. I don't like I
Speaker 2: don't like how many times the same company appears in
Speaker 2: the headlines. But we haven't gotten that much actually since then.
Speaker 2: It's not like there have been five more of those.
Speaker 2: I'm just sort of curing is setting aside some of
Speaker 2: the data center, the sexy private credit stuff that everyone's
Speaker 2: focused on. Do you do you think over the last
Speaker 2: several years, was there some systematically bad underwriting going on,
Speaker 2: especially over the last few years, or were there isolated
Speaker 2: cockroaches the first cockroach before they had a chance to
Speaker 2: lay eggs and make babies, the lonely cockroaches.
Speaker 5: Yeah?
Speaker 4: Yeah, So look again, because there's been so much growth
Speaker 4: in lending to lower quality companies, and again, the last
Speaker 4: major cycle was lending to lower quality households. Yeah right,
Speaker 4: you know, there's going to be areas of excess, and
Speaker 4: I think people are focused on these areas.
Speaker 5: But again, when you look at.
Speaker 4: The cumulative delinquencies and losses, yes they've increased a bit
Speaker 4: over the last few years, but these situations have been
Speaker 4: relatively isolated. But again, anytime you've had this much credit expansion,
Speaker 4: you're going to have challenges, and these challenges are happening
Speaker 4: in a relatively strong economy, so we don't think this
Speaker 4: will be a catastrophe. The word I've used is that
Speaker 4: there's likely going to be disappointment in certain areas of
Speaker 4: the credit markets that have performed exceptionally well over the
Speaker 4: last ten to fifteen years. But that shouldn't be viewed
Speaker 4: as an overly controversial statement. That's how markets work. You know,
Speaker 4: credit was very cheap ten or fifteen years ago, high
Speaker 4: quality bonds were very very expensive. Today, credit spreads are
Speaker 4: near all time tights, equities are near all time highs,
Speaker 4: and valuate high quality bonds looks reasonable relative to their history.
Speaker 4: So you know, starting valuations tend to be pretty big
Speaker 4: drivers of future turns. If the economy continues to grow,
Speaker 4: if stocks keep going up fifteen percent a year, yes,
Speaker 4: these will be relatively isolated situations, but if you get
Speaker 4: into a period of economic weakness, losses will go up
Speaker 4: and they'll likely be some disappointment. I think that's the
Speaker 4: best way to categorize it. And then I think the
Speaker 4: second important point when you look at markets in a
Speaker 4: longer term historical context, is that regulators hate bailing out
Speaker 4: the same sectors twice back during the GFC, it was
Speaker 4: lending to the consumer. It was excessive lending from the
Speaker 4: banks that caused all of the problems, almost took down
Speaker 4: the financial system, and not surprisingly, the regulations towards the
Speaker 4: banks and towards consumer lending was massive. And today when
Speaker 4: you look at the world, the household balance sheets, certainly
Speaker 4: middle income and above cohort groups hasn't been stronger this strong,
Speaker 4: and several decades there's record amounts of borrower equity in
Speaker 4: these areas of the market have been very, very strong.
Speaker 4: From an underwriting perspective, the areas that escape the scrutiny
Speaker 4: of the last time, you know, a lot of lending
Speaker 4: to non financial corporates, a lot of this mid market
Speaker 4: private lending that came out of that period relatively unscathed
Speaker 4: from a regulatory perspective, has grown a lot. So I
Speaker 4: think a lot of this just relates to longer term cycles.
Speaker 4: PIPCO is talking in a much different way back in
Speaker 4: two thousand and five, in two thousand and six, where
Speaker 4: we were screaming from the rooftop saying that you know,
Speaker 4: what was going on was so irrational that there were
Speaker 4: major problems ahead. That's not where we are and That's
Speaker 4: why I sometimes sound a bit more negative than we are.
Speaker 4: I think that the idea of disappointment is the way
Speaker 4: people should think about some of these areas of the
Speaker 4: credit markets. And the good news is you don't have
Speaker 4: to accept disappointment. You can simply accept the fact that
Speaker 4: you had a great performance run and that by going
Speaker 4: up in quality, expanding into a global opportunity set that
Speaker 4: hasn't been sufficiently embraced just yet, perhaps voting a little
Speaker 4: bit of non dollar exposure gets you in the same
Speaker 4: place with much more resiliency, much more downside protection, and
Speaker 4: a lot more liquidity or flexibility to change your mind
Speaker 4: in the future as well.
Speaker 3: Since you brought up household balance sheets, can you talk
Speaker 3: to us a little bit about your housing outlook, because
Speaker 3: I believe PIMCO has been pretty bullish on mortgages recently,
Speaker 3: but at the same time we've seen a slight slow
Speaker 3: down in the housing market. But then again, we still
Speaker 3: have long term structural tailwinds, such as a massive undersupply
Speaker 3: of homes in the US. Where do you see that
Speaker 3: going in the coming years, particularly, you know, if we
Speaker 3: were to see inflationary pressures start to pick up and
Speaker 3: those longer end yields start to rise.
Speaker 4: Yeah, so we are very bullish on housing related investments
Speaker 4: in the United States as well as in other areas
Speaker 4: around the world. Agency guaranteed mortgages still traded very widespreads
Speaker 4: relative to corporates. Even in an absolute sense. We think
Speaker 4: it's a very high quality, liquid area of the market
Speaker 4: that again makes a lot of sense to own a
Speaker 4: cross a variety of different mandates. We also like lending
Speaker 4: in the non guaranteed area against the house simply because
Speaker 4: borrowers have record amounts of equity.
Speaker 3: So when you lend its collateral. Yeah, that's what it
Speaker 3: sounds like. You love collateral.
Speaker 4: Yeah, we like good documentation and good, good, good collateral.
Speaker 4: You know, at least all else equal. But you know,
Speaker 4: it's not a major bet on the directionality of homes.
Speaker 4: When you're lending against a household that has seventy percentage
Speaker 4: points of of borrow equity, your home can go down
Speaker 4: quite a bit and you're very well protected. That same
Speaker 4: dynamic exists you know, over the UK, across Europe, you know,
Speaker 4: and even in other parts of the world. So you know,
Speaker 4: again regulators don't like building out the same sectors twice
Speaker 4: that's pretty good acid allocation advice. It's quite straightforward. But also,
Speaker 4: you know, you have much better fundamentals across households. But
Speaker 4: to your specific question around housing, it's a tough situation.
Speaker 4: We do think that homes are going to remain elevation
Speaker 4: from a valuation perspective, and affordability is going to remain
Speaker 4: quite constrained because there's no easy answer. You know, you
Speaker 4: bring the mortgage rate down, the home price goes up.
Speaker 4: You know, affordability doesn't change in a meaningful sense. What
Speaker 4: we really need in this country and other parts of
Speaker 4: the world are more homes, more housing units. And again
Speaker 4: because of a lot of the post global financial crisis regulation,
Speaker 4: it's been real hard to build new homes. So our
Speaker 4: base case view is that home price is going to
Speaker 4: moderate here on a national level. You could see, at
Speaker 4: least in real terms, you know, some steady declines over
Speaker 4: the course of the next several years in certain markets
Speaker 4: that are a bit overextended, you know, a bit more volatility.
Speaker 4: But we do think that you know, home price is
Speaker 4: going to remain elevated from a historical perspective, just because
Speaker 4: of the fact that people have locked in very, very
Speaker 4: low mortgage rates thirty years, you know, not just five
Speaker 4: or ten years. You know which which we're you know,
Speaker 4: mortgage durations, you know, popular pre GFC. So you know
Speaker 4: you're not going to see you know, two much turnover.
Speaker 4: And unfortunately that means that homes for you know a
Speaker 4: lot of younger Americans are going to remain out of reach.
Speaker 4: But but again, maybe some incremental benefit, maybe you know,
Speaker 4: this administration get mortgage rates down a bit through some
Speaker 4: creative policy the next couple of years. By the way,
Speaker 4: we'd like that given pimco's current positioning. But again without
Speaker 4: without building new homes which are going to take you know, many,
Speaker 4: many years. You know, there's no easy solution.
Speaker 2: I want to go back. You mentioned this idea, there's
Speaker 2: there's an optimal amount of fiscal profligacy from the perspective
Speaker 2: of the bond investor. Maybe you want them to push
Speaker 2: it a little bit because then you get paid a
Speaker 2: little bit for taking it on. But obviously you don't
Speaker 2: want them to push so forth where you get some
Speaker 2: fiscal dominance spiral leading to higher and high inflation. You
Speaker 2: want to find that sweet spot, you know, I mentioned
Speaker 2: we're talking a little bit about politics, earlier about whether
Speaker 2: independent central bank can be sustained. But when you look abroad,
Speaker 2: you know, it seems like in a lot of pretty
Speaker 2: major current we're not the only country that's having political
Speaker 2: volatility these days. We're concerned about the approach that the
Speaker 2: new Japanese PM is going to take it. So we
Speaker 2: know that rates are higher in Japan. France, very indebted country.
Speaker 2: They seem to have like a new government every two weeks.
Speaker 2: I like lose track of all the times their government
Speaker 2: collapses and so forth. The UK, very indebted country. The
Speaker 2: moment anyone takes office, their approval ratings plunge to negative
Speaker 2: thirty or whatever. There's a lot going on on the
Speaker 2: political front, and that sort of determines whether countries are
Speaker 2: even it's even possible to run what might be more
Speaker 2: responsible fiscal policies. Is that something that I don't know
Speaker 2: keeps you up at night, is the right term, But
Speaker 2: is that something that's a big part of your work
Speaker 2: is trying to understand, especially when you think abroad, understand
Speaker 2: the political dynamics and all these countries that are happening
Speaker 2: right now.
Speaker 5: Yeah.
Speaker 4: Absolutely, And you know we get together once a year,
Speaker 4: you know, talk about the outlook for economies and markets
Speaker 4: over a five year type timeframe. And you know, one
Speaker 4: of our advisors I think put it well was that,
Speaker 4: you know, we used to live in a world where
Speaker 4: you know, economic outcomes would drive politics. If economies were strong,
Speaker 4: you know, politicians usually ended up in a in a
Speaker 4: good situation. They're they're, they're, they're, they're, they're stay in office.
Speaker 4: Today it feels like it's a bit reversed where political priorities,
Speaker 4: geopolitical tensions are driving economics. And I think you see
Speaker 4: that to a degree with tariff policy, you see it,
Speaker 4: you know, to a degree with with various forms of reassuring.
Speaker 4: You see it in terms of these populist tendencies across markets.
Speaker 4: So they're all very, very important and a lot more
Speaker 4: important than they were in the past. And I think
Speaker 4: it takes a lot of humility from someone like myself
Speaker 4: and others that grew up you know, doing you know,
Speaker 4: discounted cash flow analysis and you know, derivative pricing as
Speaker 4: opposed to understanding the political economy. So you know, we
Speaker 4: think that that's important both from the perspective of gaining
Speaker 4: in edge in markets, but also understanding that sometimes will
Speaker 4: be wrong and when you're running the debt levels that
Speaker 4: countries are running or your deficits in overall debt levels,
Speaker 4: there's going to be some unpredictability. And that's why this
Speaker 4: idea of looking to exploit a global opportunity set prudent
Speaker 4: diversification targeting some countries outside the US that aren't running
Speaker 4: you know, six seven percent deficits, and there are high
Speaker 4: quality countries out there, Australia being an example, Germany being
Speaker 4: another example, even the United Kingdom, although they have a
Speaker 4: lot less policy flexibility than we do, given that there
Speaker 4: were smaller open economy with their own currency offer attractive yields.
Speaker 4: So this is less about picking your favorite country from
Speaker 4: our perspective, it's more looking at take advantage of attractive
Speaker 4: opportunities around the globe, with some tilt towards those countries
Speaker 4: that are balancing their budget and that do have a
Speaker 4: better overall fiscal picture. And we haven't talked about emerging markets,
Speaker 4: but they are. You know a few emerging markets that
Speaker 4: you know, this cycle got ahead of inflation, that have
Speaker 4: been in some sense more fiscally prudent than their developed
Speaker 4: market counterparties, and that have very very high yields even
Speaker 4: ad just for inflation rates. So even some diversification in
Speaker 4: some of the higher quality areas of the emerging markets,
Speaker 4: from our perspective, represents real good value or real good
Speaker 4: sources of diversification in return versus some of these assets
Speaker 4: you know here in the United States that have performed
Speaker 4: real well historically, but where when you look at the
Speaker 4: likelihood for forward performance just just look a little bit
Speaker 4: less interesting.
Speaker 3: Actually, this reminds me thinking back to twenty fifteen. Twenty
Speaker 3: fifteen was actually a big year for PIMCO because it
Speaker 3: was your first full year without Bill Gross, right, who
Speaker 3: left in late twenty fourteen. Can you talk to us
Speaker 3: perhaps how the culture of PIMCO has changed over the
Speaker 3: past ten years, and how you would describe that evolution,
Speaker 3: because I imagine it's been a long time, it must
Speaker 3: have shifted a little bit.
Speaker 5: Yeah.
Speaker 4: Look, well, you know, the way Bill left the firm
Speaker 4: was an ideal, to say the least. But you know,
Speaker 4: Bill left us in an incredibly strong position. You know,
Speaker 4: he created a lot of the frameworks that we still
Speaker 4: use today to make decisions. Bill was a strong personality,
Speaker 4: but he believed in teamwork and believe that investing was
Speaker 4: a team sport, you know, so to speak. So from
Speaker 4: that perspective, there didn't need to be a lot of
Speaker 4: change or certainly not radical change. But over this period,
Speaker 4: you know, markets have become you know, so much more specialized.
Speaker 4: Client needs have evolved, you know, over time, the introduction
Speaker 4: of a more sizable private opportunity set has been important. Technology,
Speaker 4: big data, using you know, trading techniques, portfolio trading in
Speaker 4: other automated you know type, you know, trading strategies are
Speaker 4: all critically important. So you know, we're a much more
Speaker 4: specialized firm today, which is a function of again, you know,
Speaker 4: evolving client needs, but also just you know the realities
Speaker 4: of this world that we live in today, where data
Speaker 4: is abundant, much less expensive to access. So from that perspective,
Speaker 4: we've needed to adapt, you know, even more global. So
Speaker 4: you know, we tend to utilize regional committees in regional
Speaker 4: decision making structures, but a lot stayed the same at
Speaker 4: least in terms of mindset, and we try to really
Speaker 4: leverage you know, the history and the experience the firm
Speaker 4: has had managing and navigating through more challenging markets. Twenty
Speaker 4: two is rough, you know, from both stocks and but
Speaker 4: you know, in general, you know, the environment's been reasonably forgiving,
Speaker 4: but you can always get into these you know, tougher periods,
Speaker 4: and again we try to use these structures that you know,
Speaker 4: build put in place and buill deserves.
Speaker 5: Trying to about a credit for.
Speaker 2: It's funny in your last answer there there were like
Speaker 2: five things you said that could merit full follow ups
Speaker 2: or even full follow up episodes, like about changing client
Speaker 2: needs over time, or what happens when the cost of
Speaker 2: data goes from costly to fairly affordable, et cetera. All
Speaker 2: those sort of interesting things. But just my last question,
Speaker 2: and it sort of relates to technology. You know, when
Speaker 2: it comes to AI in investing, we've talked a little
Speaker 2: bit more on the short term like high frequency side
Speaker 2: and the sort of models that they use and the
Speaker 2: signals that they use, and how that sort of relates
Speaker 2: to AI and their application. But for a firm like
Speaker 2: PIMCO and when you're thinking about longer term holding periods
Speaker 2: and you want to have some a good collateral and
Speaker 2: good documentation, et cetera. Currently today, have you found ways
Speaker 2: to apply cutting edge AI technology to the process of
Speaker 2: good security selection.
Speaker 4: We have, and we're finding ways to utilize the technology
Speaker 4: at an accelerating rate. We do some of this and
Speaker 4: some of our you know, more quant focused strategies, you know,
Speaker 4: where we look to use AI to actually drive alpha,
Speaker 4: But just AI as a tool to drive efficiency has
Speaker 4: been will be critically important to managing an investment platform.
Speaker 4: Just the ease in which you can access data that
Speaker 4: you can use AI to help support overall analysis, both
Speaker 4: at the company level, the individual investment level, but even
Speaker 4: coming through economic history and understanding some of these geopolitical
Speaker 4: trends in themes that are hard, at least intuitively to
Speaker 4: grasp are going to be critically important. In fact, before
Speaker 4: our discussion today, spend considerable time with our head of
Speaker 4: technology and our head of implementation talking about various firm
Speaker 4: wide initiatives. And I think the only other point is
Speaker 4: my own use of AI, both at home and at
Speaker 4: the office has gone up almost exponentially over the last
Speaker 4: year or two. And I'm the last person you want
Speaker 4: to rely on to understand this technology. It's the younger
Speaker 4: folks that we hired over the last year that are
Speaker 4: helping us with a lot of this perspective. So this
Speaker 4: is going to be quite disruptive, probably productivity enhancing, you know,
Speaker 4: at the economy wide level, but it's also going to
Speaker 4: lead to considerable disruption, and it's important that we don't
Speaker 4: get disrupted and that we use this technology to drive
Speaker 4: client returns. But you know, it's going to be important
Speaker 4: in so many ways and we're really really embracing it
Speaker 4: here here at Pimco.
Speaker 2: Dan Ivison, thank you so much for coming on odd Laws.
Speaker 2: That was a fantastic conversation. Really appreciate you taking the time,
Speaker 2: and we're going to check back in with you in
Speaker 2: twenty thirty five and see how well you got how
Speaker 2: well one got paid for taking a little bit of
Speaker 2: duration here.
Speaker 4: Great Joe Tracy, thanks again and correct congratulations on the
Speaker 4: big milestone and so much.
Speaker 3: We thank you so much. Dad really appreciate it.
Speaker 2: Thank you guys, Tracy. I thought that was greatly I
Speaker 2: really enjoyed talking to Dan. Fantastic overview.
Speaker 3: Yeah, so a couple of things stood out to me.
Speaker 3: So number one the idea of no more free lunch
Speaker 3: and credit, although people have been talking about that for
Speaker 3: a while now, and obviously with the great environment changing,
Speaker 3: you can see that argument. The other thing that I
Speaker 3: really liked was his description of policymakers don't want to
Speaker 3: bail out the same thing twice.
Speaker 2: Yeah, that's interesting framework or way to think about it.
Speaker 5: Yeah.
Speaker 3: Absolutely, And it kind of reminded me of there's another
Speaker 3: person in credit who used to tell me a line
Speaker 3: about how he invests, which is follow the bad guys. Right, So,
Speaker 3: like the guys that blew up in one part of
Speaker 3: the market usually, you know, start doing.
Speaker 2: Something to act, they're going to get their acting. Are
Speaker 2: you saying they're going to get their act together? Or
Speaker 2: they're going to do something I'm saying, they.
Speaker 3: Move to the new thing, and then that blows up.
Speaker 3: And so if you can just identify the bad guys
Speaker 3: and just follow their career trajectories, just short everything the
Speaker 3: bad guys do.
Speaker 5: I love that. I love that take.
Speaker 2: You know what was really I had not realized that
Speaker 2: stat he said about how little you got paid for
Speaker 2: taking for buying poor credits up until the GFC. Yeah,
Speaker 2: and then post GFC is just totally flipped that you
Speaker 2: just got you should just go as far out on
Speaker 2: the credit at risk curve as you possibly can, and
Speaker 2: you've just walloped anything safe. And I knew that, I
Speaker 2: guess on some level, but the extreme of that statistical divergence,
Speaker 2: but you know, you have to think we had that
Speaker 2: well it was more than a hiccup in twenty twenty,
Speaker 2: but we did bounce back very fast from it. So
Speaker 2: really what we were looking at is, you know, well
Speaker 2: over fifteen years now of the lines just going up,
Speaker 2: and you have to think about what are the things
Speaker 2: that accumulate over that time, or the patterns that accumulate,
Speaker 2: or the habits, etc. And this idea that there's a
Speaker 2: lot of safety at the far end of the risk
Speaker 2: curve and that people don't care and that maybe now
Speaker 2: some of the perception that there's safety at the far
Speaker 2: end of the risk curve and how much that's been
Speaker 2: burnished into people is very interesting.
Speaker 3: Absolutely. The other thing he said that I thought was
Speaker 3: very poignant was the idea of you have all these
Speaker 3: private credit firms starting up right and promising these astonishing
Speaker 3: returns for investors. And he made the point that, like,
Speaker 3: you can't just say you're going to make all this
Speaker 3: money at private credit because like those deals might not
Speaker 3: be out there and available to you. You have to
Speaker 3: do it on a risk or value adjusted basis. Yeah,
Speaker 3: and as I say that, I see a headline in
Speaker 3: Bloomberg about Capital Group getting into private credit as well.
Speaker 3: So this is the thing. Like it's a booming market.
Speaker 3: There are a lot of competitive pressures, both on the
Speaker 3: lender side and also on the credit rating side, and
Speaker 3: you can see people really scrambling to get into the
Speaker 3: market and accumulate as much as they can. And so
Speaker 3: the temptation, of course is to you know, accept lower terms,
Speaker 3: accept lower quality totally. All right, shall we leave it there.
Speaker 2: Let's leave it there, all right.
Speaker 3: This has been another episode of the Odd Loots podcast.
Speaker 3: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 2: And I'm Jill Wisenthal. You can follow me at the
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