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Speaker 1: Hello, and welcome to another edition of the Thoughts Podcast.

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Speaker 1: I'm Tracy Alloway and I'm Joe Wisenthal. So, Joe, you

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Speaker 1: and I talk a lot about markets, but it's kind

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Speaker 1: of weird, I guess because like neither of us. Well,

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Speaker 1: I suppose you have you invested a little bit when

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Speaker 1: you were in college right way back in the day.

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Speaker 1: I did a little bit of trading, and I worked

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Speaker 1: for a brief period for portfolio management company. But no,

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Speaker 1: I would say that between the two of us, we

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Speaker 1: do not have a lot of collective experience actually in

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Speaker 1: the market. Right, So have you ever wanted to have

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Speaker 1: an in depth discussion with someone who actually makes investment

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Speaker 1: decisions on daily basis? Yes, this is all I mean,

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Speaker 1: to be honest, is all I want to do every day.

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Speaker 1: You know, there's so many people who just talk and

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Speaker 1: talk and pundits and strategists and people who tweet too much,

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Speaker 1: and it's like, forget all the noise. Let's just talk

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Speaker 1: to someone who you know, actually has to put money

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Speaker 1: to work. I mean, that's what people really want to hear, right, right,

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Speaker 1: And of course it's one thing for us to kind

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Speaker 1: of sit back and say, markets look frothy and this

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Speaker 1: is all there's signs of irrational exuberance. But if you're

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Speaker 1: someone whose job is to actually put money to work,

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Speaker 1: you have to find something to invest in, right exactly,

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Speaker 1: or I mean, or theoretically you could sit out the market,

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Speaker 1: but then you're going to be judged on that question too.

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Speaker 1: But you definitely can't get away with just saying boring

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Speaker 1: stuff like the markets are looking frothy and all of

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Speaker 1: the boring stuff people say all the time. But anyway,

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Speaker 1: why why are you uh, what are you getting at?

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Speaker 1: Are we going to have such a conversation like that

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Speaker 1: today and we're gonna have a good conversation, Yeah, we

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Speaker 1: are actually so. Today for our guest, we have um

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Speaker 1: one of my favorite investment managers. Actually, it's David Shawl.

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Speaker 1: He's a portfolio manager over It and River Investment. You've

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Speaker 1: had him on your show a couple of times. He's

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Speaker 1: a prolific tweeter actually, but he is also someone who

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Speaker 1: makes money do things on a day to day basis.

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Speaker 1: So unlike our conversations, we're not talking to a poker player,

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Speaker 1: We're not talking to a gambler. Were actually going to

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Speaker 1: talk to someone who invests a real life credit portfolio manager.

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Speaker 1: That's who we're talking to. Awesome, Well he's in studio

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Speaker 1: right now. Hey David, Hey guys, thanks for having me on.

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Speaker 1: Shall we start with well, why don't we back up

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Speaker 1: a bit? Why don't you tell us what exactly you

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Speaker 1: do and what kind of portfolios you manage? Sure? So

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Speaker 1: I started a New River about two years ago and

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Speaker 1: right now I manage an Opportunities again to Come strategy.

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Speaker 1: And pretty much what that does is it focuses on

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Speaker 1: fixed income or fixed income like securities in the publicly

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Speaker 1: traded space. So these are instruments such as mortgage reads,

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Speaker 1: reads closed, and funds that have underlying bonds in them,

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Speaker 1: preferred stocks, business development companies, and it's kind of a

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Speaker 1: niche area of the market where a few players play.

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Speaker 1: It's very liquid um and it's a little bit of

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Speaker 1: the wild West in the market, you know. Versus before,

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Speaker 1: I want to ask you a question that backs up

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Speaker 1: even further than that, because the idea of having a

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Speaker 1: job where you can take money and buy stuff and

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Speaker 1: sell stuff seems pretty appealing, but how do you even

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Speaker 1: get there? So, how did you get to this role

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Speaker 1: in life where you work for New River? Investments, and

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Speaker 1: you have this money to invest, what's the what's the

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Speaker 1: path to get there? Sure? So that's a great question.

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Speaker 1: So I started at a bank, Denovo bank called Square

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Speaker 1: one Financial in early too. I was an eight and

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Speaker 1: I started as a credit analyst. And Square one was

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Speaker 1: a commercial bank, but they catered to the venture capital community.

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Speaker 1: So a company would raise ten million dollars of the

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Speaker 1: Series A and they might raise a little bit of

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Speaker 1: debt to bridge them to the next equity round, and

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Speaker 1: we'd make the clients keep all their deposits at the bank,

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Speaker 1: and pretty much I was underwriting these these clients, so

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Speaker 1: it might be a formula line of credit. And so

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Speaker 1: it was early two eight and the bank at the

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Speaker 1: time had an outsource investment manager who had loaded them

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Speaker 1: up to the gills in subprime bonds. And the CEO

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Speaker 1: came to me and he said, hey, David, I heard

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Speaker 1: you worked on Wall Street. And so I just moved

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Speaker 1: back from New York. I was in equity research, so

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Speaker 1: I wasn't in fixed them come at all, and he said, hey,

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Speaker 1: I heard you work on Wall Street. We need your help.

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Speaker 1: I said, sure, with what? And he said, We've got

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Speaker 1: a whole portfolio of subpreme bonds that are going bad

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Speaker 1: and we don't know what to do, so we need

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Speaker 1: your help. I said, that sounds really interesting, but I

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Speaker 1: don't know if fix in come at all. And I said,

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Speaker 1: you know, I've done the c f A program and

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Speaker 1: that's kind of all theory and no practice. And he's like,

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Speaker 1: doesn't matter. We need you to come over here. So

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Speaker 1: I went over there. It was, you know, early two

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Speaker 1: thousand eight, and we had probably a portfolio five million

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Speaker 1: of bonds that were going bad. And I remember looking

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Speaker 1: at one of the mark to market reports and I

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Speaker 1: think it was a negative million mark to market and

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Speaker 1: the bank only had equity of twenties. So we were

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Speaker 1: well and solving on paper, and um, they fired the

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Speaker 1: investment manager. The treasurer at the time that was running

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Speaker 1: the portfolio quit. So I was left at the time,

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Speaker 1: in the middle of the crisis, to run cash flows,

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Speaker 1: re prospectuses, model cash flows, kind of figure out, you know,

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Speaker 1: the mess that we were in. And so, you know,

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Speaker 1: I had to meet with regulators, and I'll never forget

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Speaker 1: one of the regulators coming in from the f d

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Speaker 1: a C or Federal Reserve. I don't remember which one

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Speaker 1: it was. And they opened up a intro to mortgage

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Speaker 1: backed securities book. So at that moment I realized that,

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Speaker 1: you know, even they didn't know what was going on,

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Speaker 1: and so I mean it was fascinating. I remember, you know,

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Speaker 1: just looking into these bonds and seeing some bonds that

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Speaker 1: were bought where you know, they decided to pick up

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Speaker 1: an extra thirty basis points of spread by going from

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Speaker 1: the senior A one class to the mezzanine tronch. And

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Speaker 1: I looked at you know, these bonds were six months

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Speaker 1: old and already of them had not even made one payment,

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Speaker 1: not even one payment. So you know, that's how I

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Speaker 1: learned fixed income. I was kind of self taught in

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Speaker 1: a lot of ways. So the portfolio that I managed there,

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Speaker 1: it was kind of a wide range of you were

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Speaker 1: thrown right in the deep end, strown right in the

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Speaker 1: deep end. We ended up raising capital to recap ourselves.

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Speaker 1: But the portfolio ended up managing was kind of a

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Speaker 1: mix of mortgage backed securities, corporate bonds, preferred stocks, municipal bonds,

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Speaker 1: asset back securities, so kind of the kitchen sink of

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Speaker 1: fixed and um kind of with the only two constraints

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Speaker 1: being you know, we had to keep the duration around

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Speaker 1: three years or lower, and we probably could only have

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Speaker 1: about half the portfolio and credit from there. It was

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Speaker 1: kind of my job and I had a lot of

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Speaker 1: flexibility and freedom to kind of be creative and set

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Speaker 1: the portfolio up however I wanted. So if I wanted,

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Speaker 1: you know, of the portfolio in three year bonds, I

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Speaker 1: could do that. If I wanted some in thirty year

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Speaker 1: bonds and some at the front end of the curve,

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Speaker 1: I could do that. And that's kind of the fun

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Speaker 1: part is you know, taking different types of securities with

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Speaker 1: different characteristics of credit duration embedded leverage in creating a

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Speaker 1: portfolio that will perform in the types of scenarios that

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Speaker 1: you're looking forward to. So, David, that kind of leads

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Speaker 1: into the question I wanted to ask, which is, yes,

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Speaker 1: you've got into fixed income in two thousand and eight,

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Speaker 1: which was definitely a special time to be doing it,

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Speaker 1: and to some extent, everyone was learning new things, to

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Speaker 1: put it mildly um during the financial crisis. But you

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Speaker 1: came from an equity background, So what struck you as

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Speaker 1: the biggest difference between equities and fixed income when it

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Speaker 1: comes to investing or analyzing portfolios? Good question. Well, I

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Speaker 1: think the macro the macro components, So you know, so

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Speaker 1: much is driven by interest rates obviously, So you know,

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Speaker 1: obviously you know key characteristic of fixed incomes duration, So

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Speaker 1: just how interesting for our listeners who don't know the

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Speaker 1: definition of duration? What does that mean? So duration would

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Speaker 1: be the first derivative, so it would be the change

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Speaker 1: in price for a given move and interest rates. So

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Speaker 1: if interest rates move x, the duration will tell you

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Speaker 1: how much the underlying asset will correct. So in theory,

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Speaker 1: if somebody said duration was three in rates went up

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Speaker 1: a hundred basis points, you know, the price would decline

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Speaker 1: three got and vice versa. All right, so I interrupted

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Speaker 1: you and you were sort of talking about the difference

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Speaker 1: between equity and fixed income investing. Yeah, so obviously I

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Speaker 1: think that the macro implications, so you know, the implication,

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Speaker 1: and the Federal Reserve policy, inflation, um, you know, other

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Speaker 1: central banks throughout the world, and then just broadly, credit cycles.

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Speaker 1: I mean credit cycles are a lot different than you know,

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Speaker 1: equities obviously, so you know, there's different types of supply,

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Speaker 1: there's market technicals. Is the goal different because when I

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Speaker 1: think of my biases, when I think of an equity manager,

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Speaker 1: I think of someone who's really thinking about the upside

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Speaker 1: and beating the indices. And when I think about a

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Speaker 1: fixed income manager, I'm thinking of someone who's more about

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Speaker 1: downside avoidances and you sort of know how much you

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Speaker 1: could make, but you're trying to limit the potential losses.

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Speaker 1: Is that a fair characterization of the risk profile or

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Speaker 1: is that not thinking about it the right way? I

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Speaker 1: think it is because at the end of the day, um,

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Speaker 1: you know your upside as you get your principle back

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Speaker 1: and you get paid interest to so you know, so

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Speaker 1: you're right. The risk reward is very different. And you

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Speaker 1: know fixed income as it is and equities, so you know,

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Speaker 1: if you have a year and fixed income, you know

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Speaker 1: you might not have the two x like you'd have

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Speaker 1: inequities to offset that. So you know your risk awards

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Speaker 1: a lot different. But what about your benchmarks are I

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Speaker 1: guess what I'm asking is what sort of return profile

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Speaker 1: are you aiming for? And you must be pegging yourself

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Speaker 1: for benchmarking yourself to a particular thing or goal, right correct?

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Speaker 1: So you know when it was at the bank, it

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Speaker 1: was more of an asset liability framework and more kind

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Speaker 1: of in terms of the Barkley's agg um. Now the

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Speaker 1: Bloomberg Barkley is now stay well done, Joe. Joe is

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Speaker 1: totally on message. That's right. So I think, you know,

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Speaker 1: for people that are not familiar, I would kind of

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Speaker 1: call it the S and P five hundred of the

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Speaker 1: bond world um. And that's pretty heavily weighted in treasuries

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Speaker 1: and corporate bonds. So I would say in more agency

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Speaker 1: mortgage backed security. So those are the main components of

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Speaker 1: the Barkley's agg kind of intermediate intermediate benchmark um, you know,

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Speaker 1: average life duration, you know, in the five is range.

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Speaker 1: Now I want to we want to talk about the

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Speaker 1: market right now, but before we get there, let's see

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Speaker 1: the next up. So you have this portfolio, how do

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Speaker 1: you find what you invest in? What where do you start?

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Speaker 1: Let's say someone let's just imagine a blank slate. Let's

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Speaker 1: say you had a billion dollars to invest it wasn't

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Speaker 1: invested anywhere, whatever it is, or you have a portfolio

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Speaker 1: it's totally messed up and you need to fix it.

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Speaker 1: Where does the process begin to find investments that are

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Speaker 1: a good or be uh sort of suit the needs

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Speaker 1: of whoever money it is, right, so I think the

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Speaker 1: first question would be, is this an open ended return

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Speaker 1: where you're you're shooting for absolute return or total return,

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Speaker 1: or is this an asset liability framework. Asset liability framework

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Speaker 1: would be you know, for instance, a bank or insurance

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Speaker 1: company that has certain types of liabilities do in the

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Speaker 1: future and you're trying to match those. So from that

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Speaker 1: point of view, your investment process is very different because

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Speaker 1: you're trying to meet you know, certain liabilities in the future,

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Speaker 1: whereas kind of an open ended total return you know,

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Speaker 1: kind of more like I'm doing right now. Um, you know,

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Speaker 1: you're not trying to meet any liabilities in particular. So

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Speaker 1: I think, um, you know what I tell people is

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Speaker 1: kind of there's four ways to make money and fixed

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Speaker 1: and come. There's kind of like four drivers. Um, you know,

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Speaker 1: first is duration, so you can take you know, more

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Speaker 1: or less duration, you know, going longer on the curve.

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Speaker 1: There's credit risk, so you know, you can go down

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Speaker 1: in credit. You can buy triple C bonds instead of

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Speaker 1: double B R triple A. The next is liquidity, so

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Speaker 1: you can kind of go down the liquidity spectrum. You

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Speaker 1: know some you know, the pimp Coos of the world

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Speaker 1: or double lines might need to buy you know, much

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Speaker 1: larger issues, whereas a smaller investment managers can buy these

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Speaker 1: small issues or just kind of off the run things.

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Speaker 1: And then the fourth is leverage. And and that's either

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Speaker 1: leverage that you could use you know, through repo or

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Speaker 1: embedded leverage through you know, certain kinds of securities that

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Speaker 1: have that leverage within it. So any time you're shooting

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Speaker 1: for more return or more yield in the market, really

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Speaker 1: you're taking one or more of those four components. And

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Speaker 1: I think the big thing when looking to form portfolios

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Speaker 1: is you're looking to say, at the current time, which

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Speaker 1: of those four aspects is most attractive. And there's certain

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Speaker 1: times when it's you know duration, So after um, you know,

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Speaker 1: Trump was elected and rates kind of sold off. You

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Speaker 1: know a lot of things in duration, you know, really

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Speaker 1: sold off hard, and things tied to the long ends

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Speaker 1: such as um municipal bonds and preferred stocks. You know,

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Speaker 1: you know, some some things tied to those really get

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Speaker 1: hit hard. And there's opportunities, and you know, there's other

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Speaker 1: times when it's really credit so say early in when

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Speaker 1: we had the oil scare and how you'll blow out

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Speaker 1: and um, you know, spreads on much lower rated bonds

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Speaker 1: were far more attractive. So, David, I want to ask

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Speaker 1: you about the current market, thecause amidst all the talk

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Speaker 1: about you know, lofty valuations and froth in the market

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Speaker 1: credit and you know, things like corporate bonds, UM, high

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Speaker 1: ye old bonds, those sold by junk rated companies UH,

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Speaker 1: subprime auto a bs, even some consumer loan a b

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Speaker 1: s or securitizations. Those have all been name checked as

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Speaker 1: potentially risky forms of investment in the current environment, or

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Speaker 1: at least overvalued in terms of what investors are getting

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Speaker 1: back for putting their money in those How do you

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Speaker 1: make investment decisions when everyone is basically talking about things

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Speaker 1: being overvalued in the market. Yeah, it's a great question.

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Speaker 1: I think one thing is just to remind yourself that,

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Speaker 1: you know, for how many years now have have people

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Speaker 1: been saying that? So you know, you know, the mere

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Speaker 1: fact that that's being commented on doesn't necessarily mean that's

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Speaker 1: you know, it may be true, but it may also continue.

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Speaker 1: And that's not to say, you know, we're going to

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Speaker 1: ignore risks in the market. Uh, Like you guys kind

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Speaker 1: of alluded to in the introduction, if your task with

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Speaker 1: managing money, you can't really just sit it out and say,

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Speaker 1: you know, maybe you can in your personal account, but

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Speaker 1: if you're managing assets, you can't really say I'm gonna

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Speaker 1: I'm gonna set this whole thing out. So I think

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Speaker 1: it's looking at the different risks. For instance, UM, do

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Speaker 1: you think that the risk return of you know, corporate

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Speaker 1: issuers is more favorable than for instance, housing related debt,

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Speaker 1: which I think you know, the last crisis was housing

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Speaker 1: related debt, but I think that the fundamentals for housing

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Speaker 1: related debt at this time are actually pretty favorable. You know,

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Speaker 1: consumer balance sheets are being repaired. Um. You know, there's

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Speaker 1: really not non agency being issued, you know, if there

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Speaker 1: is very very little UM. So you know, in my mind,

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Speaker 1: something like the underlying tail winds and fundamentals of housing

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Speaker 1: related debt are a lot more attractive than you know,

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Speaker 1: corporates for instance. You know, but you can't, you know,

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Speaker 1: just stop there, because you know the market may already

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Speaker 1: be pricing in that. So UM. I think a big

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Speaker 1: thing that you look at in the bond market is

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Speaker 1: loss adjusted yield. So you're not just looking at the

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Speaker 1: yields and spreads you're getting, but you're having to loss

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Speaker 1: adjust that. So you're you're looking at different scenarios and saying, well,

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Speaker 1: if if the credit cycle is benign and defaults here

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Speaker 1: run at x, you know, what what does my return

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Speaker 1: look like? But you know, if it's very unfavorable, then

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Speaker 1: what will look like Because I think, you know, you

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Speaker 1: have to have humility in this job and say what

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Speaker 1: I think is going to happen is probably not going

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Speaker 1: to happen. So we're gonna look at various scenarios and

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Speaker 1: we're gonna say, and um rates up X happens in

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Speaker 1: base scenario you know why happens? And rates down see happens?

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Speaker 1: Or in you know, benign credit cycle this, you know,

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Speaker 1: great credit cycle that, or terrible credit cycle, you know

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Speaker 1: something else. So you're looking at different scenario analysis, and

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Speaker 1: you know, sometimes not all bonds are gonna win for

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Speaker 1: you at the same time. So for instance, at the bank,

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Speaker 1: you know, one of the things I did was I

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Speaker 1: was very long and zero coupon California school district communities.

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Speaker 1: And it sounds crazy, and in isolation, people might not

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Speaker 1: have bottom because they were thirty year zero coupon bonds,

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Speaker 1: but they had very very widespreads and very good risk rewards.

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Speaker 1: And when you mix that with things that were very

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Speaker 1: short at the time, it created a very favorable overall dynamic.

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Speaker 1: So I think one of the things that you can

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Speaker 1: have a bond in isolation that might look ugly or

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Speaker 1: it might look unfavorable, but when you add it into

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Speaker 1: a portfolio, you know you can create superior overall profiles.

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Speaker 1: And I think that's that's the fun of it. You're

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Speaker 1: mixing different ingredients in and trying to create a profile

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Speaker 1: that will match what your overall assessment of the market is. Well,

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Speaker 1: David Shaw, I think that was a I love that

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Speaker 1: last answer. I love that it ended on a thirty

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Speaker 1: year California school district zero coupon bobs because probably an

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Speaker 1: area of the market that not many people have perhaps

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Speaker 1: ever thought about in their entire life. But I think

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Speaker 1: that was a great talking to you. That was like

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Speaker 1: sort of a great explanation of what you do. And

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Speaker 1: then also I loved real quickly name those four things again,

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Speaker 1: the four vectors through which there are opportunities and fixed income. Correct,

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Speaker 1: that's duration, right, sensitivity to raids, credit risk, liquidity risk,

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Speaker 1: and weapons. Great stuff. David Shaw, portfolio manager at New

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Speaker 1: River Investments, Thank you very much for joining us. Thanks guys. So,

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Speaker 1: Joe are you are you? Are you thinking of changing jobs?

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Speaker 1: I am going to switch jobs and put all of

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Speaker 1: my money and I think thirty year California zero. No.

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Speaker 1: I think that was like that was the old trade.

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Speaker 1: I imagine that opportunity is not there anymore. Aectually. Uh

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Speaker 1: by the time people hear this podcast, I have to

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Speaker 1: admit it does sound really fun, he said. He said

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Speaker 1: to use the word fun at the end. The idea

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Speaker 1: of actually having money on the line, not just talking.

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Speaker 1: There's this gigantic world of fixed income trying to find

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Speaker 1: the diamond in the rough. You got to admit it

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Speaker 1: sounds like it would be a pretty cool job. It

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Speaker 1: sounds pretty frustrating to me, actually, just because there's so

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Speaker 1: many there's so many factors to consider, and I guess

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Speaker 1: I'm a risk averse um kind of person. So I

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Speaker 1: would sit down and I would look at a particular

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Speaker 1: bond and I would just basically list off all the

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Speaker 1: things that could go wrong, and I'd probably never invest

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Speaker 1: in anything, and I'd be beaten by all my peers

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Speaker 1: and I would be very very bad at this. Yeah,

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Speaker 1: I know exactly what you're saying I think the journalist

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Speaker 1: mindset is to focus on the downside, probably a good

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Speaker 1: reason why we're in our current jobs and not David's job. Yeah,

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Speaker 1: you're right, all right, Well I feel better, so should

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Speaker 1: we leave it there. I'm Tracy Halloway. You can follow

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Speaker 1: me on Twitter at Trey see Alloway, and I'm Joe

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Speaker 1: wisn't Thal. You can follow me on Twitter at the Stalwart,

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Speaker 1: and you can follow David Shawl on Twitter at David

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Speaker 1: shaw and our producer Sarah Patterson Sarah pat with two teas.

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Speaker 1: Thanks for listening.