WEBVTT - Allspring’s Wise on Passive Bond Fund Risks 0:00:14.760 --> 0:00:17.720 Welcome to Inside Active, a podcast about active managers that 0:00:17.720 --> 0:00:20.200 goes beyond sound bites and headlines and looks deeper into 0:00:20.239 --> 0:00:24.880 their processes, challenges and philosophies and security selection. I'm David Cohne, 0:00:24.880 --> 0:00:27.680 I lead mutual fund and Active Research at Bloomberg Intelligence. 0:00:28.280 --> 0:00:31.160 Over the past decade, passive investing has become the default 0:00:31.160 --> 0:00:34.800 approach across much of the investment world. Button fixed income, 0:00:34.840 --> 0:00:38.640 the conversation is a bit more nuanced. Bond markets are 0:00:38.720 --> 0:00:42.600 structured differently, behave differently, and present a very different set 0:00:42.600 --> 0:00:45.960 of challenges for investors trying to balance risk, return, liquidity 0:00:46.000 --> 0:00:49.680 and diversification, especially in today's environment of higher rates and 0:00:49.760 --> 0:00:53.120 greater macro uncertainty. So today I wanted to explore the 0:00:53.120 --> 0:00:57.040 broader debate around active versus passive investing in bonds, how 0:00:57.080 --> 0:01:00.400 bond markets actually function beneath the surface, and what investors 0:01:00.440 --> 0:01:03.440 may be overlooking when they think about fixed income allocations. 0:01:03.960 --> 0:01:07.440 Joining me to discuss that is Noah Why, Senior portfolio 0:01:07.520 --> 0:01:10.080 manager and head of Global macro Strategy for the plus 0:01:10.120 --> 0:01:12.720 fixed Income team at all Spring Global Investments. 0:01:12.840 --> 0:01:12.920 No. 0:01:13.040 --> 0:01:13.920 I thank you for joining me. 0:01:14.880 --> 0:01:15.920 Thanks for having me, David. 0:01:16.680 --> 0:01:19.959 So you've previously written about the benefits of active management 0:01:20.000 --> 0:01:22.920 in bonds and argue that bonds are fundamentally different from 0:01:22.959 --> 0:01:25.720 equities when it comes to indexing. What do you think 0:01:25.760 --> 0:01:29.160 most investors misunderstand about passive bond investing. 0:01:30.680 --> 0:01:35.000 I think the biggest thing comes down to benchmark construction. 0:01:35.240 --> 0:01:39.080 I think people inherently think about the equity world when 0:01:39.120 --> 0:01:41.480 they think about in investing, and so a lot of 0:01:41.480 --> 0:01:45.800 times they apply that framework to the fixed income universe 0:01:45.840 --> 0:01:49.280 as well, but it is it is a lot different. 0:01:50.680 --> 0:01:53.360 So if you had to make the simplest possible case 0:01:53.360 --> 0:01:56.600 for why active management matters more in bonds than in stocks, 0:01:56.960 --> 0:01:58.240 what would your elevator pitch be. 0:01:59.840 --> 0:02:03.960 Well, I think it really comes down to cost benefit. 0:02:05.120 --> 0:02:08.960 The equity world, as we know, active has been gaining 0:02:09.040 --> 0:02:13.320 share for many, many years, and and there's reasons for that. 0:02:13.639 --> 0:02:19.200 The benchmarks are very difficult to beat. You think about equity, 0:02:19.200 --> 0:02:24.880 benchmark construction is driven by the market cap of the 0:02:24.960 --> 0:02:29.320 underlying securities in that benchmark, and so the more successful 0:02:29.560 --> 0:02:33.200 companies and certainly the meg seven obviously getting you know, 0:02:33.560 --> 0:02:38.880 a lot of attention today. Higher sales growth, better margins, 0:02:39.480 --> 0:02:43.480 get better multiples, and they become bigger parts of the benchmark. 0:02:44.040 --> 0:02:48.600 That makes those benchmarks more challenging to beat because the 0:02:48.600 --> 0:02:52.600 better companies get to be bigger. In the fixed income world, 0:02:52.600 --> 0:02:56.720 it's entirely different. Bonds are generally speaking issued at par 0:02:57.320 --> 0:03:01.519 and they mature at par. So how do benchmarks get 0:03:01.520 --> 0:03:05.800 constructed in the fixed income universe. It is ultimately based 0:03:05.800 --> 0:03:09.440 on the total amount of debt that gets issued, and 0:03:09.520 --> 0:03:12.960 so within the fixed income world, you have a challenge 0:03:13.000 --> 0:03:18.800 where investors aren't always exposed to the best opportunities. Instead, 0:03:18.840 --> 0:03:22.519 it's oftentimes the worst companies or the countries that need 0:03:22.560 --> 0:03:24.919 to borrow the most that are running the biggest deficits, 0:03:24.960 --> 0:03:27.680 the companies that need to borrow because maybe they're not 0:03:27.720 --> 0:03:29.880 generating as much cash flow as they need to run 0:03:29.960 --> 0:03:34.160 their operations. So that's really the first part is that 0:03:34.680 --> 0:03:39.240 you are, as a fixed income investor oftentimes exposed to 0:03:40.080 --> 0:03:43.200 less attractive investment opportunities. But it's not just that benefit piece, 0:03:43.200 --> 0:03:46.120 it is the cost piece as well. The cost of 0:03:46.160 --> 0:03:50.080 active management and fixed income is just very, very low, 0:03:50.240 --> 0:03:52.880 So we'd argue there's a bigger benefit to active management, 0:03:52.920 --> 0:03:55.600 there's also a lower cost to be able to get 0:03:56.720 --> 0:03:57.560 that benefit. 0:03:58.280 --> 0:03:59.960 So I want to go back to your first point 0:04:00.360 --> 0:04:04.520 you're saying that bond indexes reward the biggest barrows, not 0:04:04.560 --> 0:04:08.040 necessarily the best opportunities. Why do you think that hasn't 0:04:08.040 --> 0:04:10.080 gotten more attention by investors. 0:04:11.320 --> 0:04:14.200 I think it comes back to, you know, investors really 0:04:14.240 --> 0:04:19.120 focusing on really where is the risk, where is the volatility? 0:04:19.720 --> 0:04:24.080 What ultimately oftentimes drives you know, the outcomes in the 0:04:24.120 --> 0:04:27.760 long run, And the reality is that the equity markets 0:04:28.000 --> 0:04:31.479 generate over the very long run, you know, much higher 0:04:31.480 --> 0:04:34.080 returns and a lot more volatility. So I think it 0:04:34.400 --> 0:04:39.719 really takes the lion's share of the focus and attention 0:04:40.320 --> 0:04:43.560 from investors, uh, you know, to to the point that 0:04:43.720 --> 0:04:46.279 you know, I think that they apply their lessons and 0:04:46.320 --> 0:04:49.359 what they've learned in the equity side of markets, and 0:04:49.400 --> 0:04:52.480 they apply it to the fixed income side without thinking 0:04:52.520 --> 0:04:57.080 about where are their differences and why why do those matter? Okay? 0:04:57.600 --> 0:04:59.520 And you know, in your research you've described kind of 0:04:59.520 --> 0:05:03.400 a fundament mismatch between borrows and lenders. How does that 0:05:03.440 --> 0:05:05.720 conflict create opportunities for active managers? 0:05:07.080 --> 0:05:10.080 Yeah, you kind of think about, right, what is it 0:05:10.279 --> 0:05:15.159 that borrowers are looking for? Borrowers are looking to be 0:05:15.279 --> 0:05:18.400 able to lock in their financing for as long as 0:05:18.440 --> 0:05:24.919 possible at the lowest interest cost possible. Right, what do 0:05:25.040 --> 0:05:28.039 investors want? Right? What do lenders in this market want? 0:05:28.279 --> 0:05:30.520 They want more optionality. They don't want to lock in 0:05:30.600 --> 0:05:33.280 for thirty years or fifty years or sometimes one hundred 0:05:33.320 --> 0:05:37.240 years a set interest rate. They want flexibility, They want 0:05:37.320 --> 0:05:40.240 shorter maturities that allow them to make more decisions over 0:05:40.440 --> 0:05:42.440 over time, and they want to be able to generate 0:05:42.520 --> 0:05:46.559 higher income and higher yield. So really, at the heart 0:05:46.640 --> 0:05:52.000 of the market construction, you have this divergence in interests 0:05:52.080 --> 0:05:56.599 between borrowers and lenders. And again, this is why the 0:05:56.600 --> 0:06:00.400 benchmark construction is so important because ultimately it is the 0:06:00.520 --> 0:06:04.960 issuance that drive the overall exposures for those passive types 0:06:05.040 --> 0:06:05.719 of indicies. 0:06:06.760 --> 0:06:11.160 So, if issuers are extending maturities aggressively when rates are low, 0:06:11.560 --> 0:06:16.440 do passive investors unknowingly absorb risks that active managers can avoid. 0:06:17.760 --> 0:06:20.640 I think that is the case, right when you kind 0:06:20.640 --> 0:06:23.839 of look back and it's not, you know, just within 0:06:23.920 --> 0:06:26.840 the overall interest rate exposure of an investors you can 0:06:26.880 --> 0:06:29.680 look at you know, overall you know, sector exposures or 0:06:29.680 --> 0:06:34.039 individual issuers. You see this time in time again where 0:06:34.240 --> 0:06:37.880 investors are often times exposed to kind of the worst 0:06:38.000 --> 0:06:42.240 risk at oftentimes the worst time. And it's not you know, 0:06:42.279 --> 0:06:46.200 you don't blame the borrowers, right, They're doing what is 0:06:46.279 --> 0:06:51.159 economically in their interest. After the global financial crisis, interest 0:06:51.240 --> 0:06:55.240 rates were pushed down to zero by central banks globally. 0:06:55.680 --> 0:06:58.360 And so what did borrowers do. They did exactly what 0:06:58.440 --> 0:07:02.120 central banks wanted them to do. They borrowed more, and 0:07:02.160 --> 0:07:06.719 they borrowed for longer periods of time. Well, the other 0:07:06.960 --> 0:07:11.240 end of that exposure is investors, right, and so the 0:07:11.480 --> 0:07:14.840 other end of that transactions investors that had more and 0:07:14.920 --> 0:07:18.840 more interest rate risk as interest rates went lower and lower. 0:07:19.080 --> 0:07:21.080 And if you look at something like the time period 0:07:21.120 --> 0:07:25.440 from two thousand and eight until twenty twenty two, this 0:07:25.520 --> 0:07:31.840 is that period when interest rates were incredibly incredibly low duration, 0:07:32.040 --> 0:07:36.440 that measure of interest rate exposure for investors went higher 0:07:36.920 --> 0:07:40.480 quartergraph re quarter year after year until it hit a 0:07:40.520 --> 0:07:44.480 cyclical high in twenty twenty two, which was the same 0:07:44.560 --> 0:07:46.960 time that we had the worst bear market in fixed 0:07:47.000 --> 0:07:50.720 income in nearly fifty years. And so I think there 0:07:50.720 --> 0:07:52.920 were a lot of investors that thought, I have an 0:07:52.960 --> 0:07:58.560 exposure to the let's say Bloomberg aggregate index, right, the 0:07:58.640 --> 0:08:02.400 standard largest pass to benchmark that that investors have out 0:08:02.440 --> 0:08:08.560 there in the US without realizing that very gradually, over 0:08:08.640 --> 0:08:11.840 a ten to fifteen year period of time, their interest 0:08:11.920 --> 0:08:17.120 rate exposure actually increased by roughly fifty percent. And they 0:08:17.240 --> 0:08:20.880 had that maximum exposure again when interest rates were incredibly 0:08:20.920 --> 0:08:25.800 low hand, right before interest rates moved higher and suffered 0:08:26.160 --> 0:08:28.800 a lot of you know, capital loss as a result. 0:08:29.840 --> 0:08:31.880 So there's something else I wanted to talk to you about. 0:08:32.600 --> 0:08:34.559 You know. You know, I think a lot of investors 0:08:34.640 --> 0:08:37.680 think that active management simply means just kicking on more risk. 0:08:37.800 --> 0:08:39.360 And you know, that might be the case for some 0:08:39.440 --> 0:08:43.360 equity managers or strategies, I should say, you know, but 0:08:43.520 --> 0:08:45.400 I think your research shows that when it comes to 0:08:45.440 --> 0:08:49.720 fixed income, active actually delivers better risk adjusted returns. And 0:08:49.800 --> 0:08:53.319 so you know what separates you know, you know, active 0:08:53.800 --> 0:08:57.240 risk taking for versus just out reckless yield chasing. 0:08:58.600 --> 0:09:01.400 Yeah, so there certainly are different, many different strategies and 0:09:01.520 --> 0:09:05.040 in many different active approaches, and that's true in the 0:09:05.320 --> 0:09:08.760 fixed income world as well. But I do think this 0:09:08.880 --> 0:09:11.200 again comes down to some of the nuances of a 0:09:11.240 --> 0:09:15.240 benchmark construction in the fixed income universe. There there are 0:09:15.400 --> 0:09:17.880 a number of rules that I think are in place 0:09:18.520 --> 0:09:21.559 more because of the kind of status quo. It's way 0:09:21.679 --> 0:09:24.360 things have been done for a long time as opposed 0:09:24.360 --> 0:09:27.400 to the way things should be done. If you even 0:09:27.440 --> 0:09:32.440 look at the US fixed income market somewhere around you know, 0:09:32.559 --> 0:09:36.440 call it, you know, fifty eight maybe sixty trillion dollars 0:09:36.480 --> 0:09:41.880 in total fixed income assets, roughly half of those, just 0:09:42.080 --> 0:09:45.760 under half, are actually in the benchmark. So you are immediately, 0:09:46.360 --> 0:09:51.080 immediately not even looking at roughly half of the fixed 0:09:51.080 --> 0:09:55.480 income assets that are available to you as as an investor. 0:09:56.080 --> 0:09:59.080 Some of those maybe you know, higher risk types of security. 0:09:59.200 --> 0:10:02.439 Some of them may be the lower risk types of securities, 0:10:03.120 --> 0:10:05.360 but you know, at the end of the day, it 0:10:05.440 --> 0:10:09.480 means less diversification. So even with the same amount of risk, 0:10:09.600 --> 0:10:14.079 but utilizing a broader universe of options, you can create 0:10:14.120 --> 0:10:18.800 a much more diverse portfolio utilizing some of these non 0:10:19.280 --> 0:10:23.320 Bloomberg aggregate index types of securities. And that's not even 0:10:23.400 --> 0:10:28.120 getting into the global opportunity set. The Bloomberg egg is 0:10:28.120 --> 0:10:31.800 is just under twenty percent of the total global fixed 0:10:31.840 --> 0:10:34.600 income universe. So I kind of think about this. Let's 0:10:34.600 --> 0:10:38.560 say you're building a sports team, right and you know, 0:10:38.720 --> 0:10:40.840 even if you just look at the US and you say, okay, 0:10:40.840 --> 0:10:43.040 fifty percent of the securities are in the benchmark and 0:10:43.080 --> 0:10:46.160 fifty percent are not. It would be like being a 0:10:46.200 --> 0:10:49.520 general manager for a sports franchise and you make a 0:10:49.600 --> 0:10:51.920 draft pick and then you flip a coin, and then 0:10:52.800 --> 0:10:54.559 after the coin flips, if it's head, you get to 0:10:54.640 --> 0:10:56.600 keep the player. If it's tails, you don't get to 0:10:56.640 --> 0:10:58.160 keep the player. Right, are you going to have a 0:10:58.160 --> 0:10:59.960 better team or a worse team if you will only 0:11:00.440 --> 0:11:03.480 get about half of the overall opportunity set or that 0:11:03.559 --> 0:11:06.760 the universe to be able to choose from. So I 0:11:06.800 --> 0:11:09.520 think there is a big issue here and it can 0:11:09.640 --> 0:11:13.880 lead to you know, more risk through less diversification because 0:11:13.920 --> 0:11:16.960 it's such a smaller subset of the total universe. 0:11:17.440 --> 0:11:19.240 So I think it also brings up an interesting point 0:11:19.240 --> 0:11:21.920 with just the sheer number of securities. And so you know, 0:11:21.960 --> 0:11:24.959 with equities there's a few thousand, you know, at least 0:11:25.000 --> 0:11:27.160 on the US and you know before we can get 0:11:27.160 --> 0:11:29.520 to global, but you know, with the global bond market, 0:11:29.559 --> 0:11:33.480 what is there a million securities? Something like that you 0:11:33.520 --> 0:11:36.560 kind of walk us through how that creates inefficiencies that 0:11:36.640 --> 0:11:40.400 allow active managers to kind of like you touched upon 0:11:40.400 --> 0:11:41.959 it a little bit, you know, talking about how the 0:11:41.960 --> 0:11:45.199 index only carries part of it, but you know, kind 0:11:45.200 --> 0:11:47.400 of walk us through how that creates these inefficiencies for 0:11:47.400 --> 0:11:48.640 active managers to exploit. 0:11:49.720 --> 0:11:53.520 Certainly, I think a lot of this comes down to complexity, 0:11:53.920 --> 0:11:57.559 and oftentimes complexity can lead to opportunity. It can lead 0:11:57.559 --> 0:12:01.240 to missed pricings. And yeah, you know, at the index level, 0:12:01.280 --> 0:12:04.600 you're right, there's just an enormous amount of securities. But 0:12:04.679 --> 0:12:08.280 you can even break this down to let's say one issuer, 0:12:09.160 --> 0:12:12.959 use something like you know, JP Morgan. JP Morgan is 0:12:13.080 --> 0:12:17.439 a massive fixed income issuer, one of the largest constituents 0:12:17.440 --> 0:12:20.640 and in most of the US fixed income you know, 0:12:20.640 --> 0:12:24.080 investment grade types of benchmarks. Generally speaking, they have kind 0:12:24.120 --> 0:12:27.000 of one equity, right, they have one ticker. You have 0:12:27.040 --> 0:12:30.040 a lot of people sell side and buy side analysts, 0:12:30.120 --> 0:12:33.200 individual investors that are looking at that company, analyzing it, 0:12:33.240 --> 0:12:35.560 trying to figure out what's the right price and if 0:12:35.640 --> 0:12:39.040 it's mispriced, to take advantage of that mispricing. But it's 0:12:39.080 --> 0:12:43.720 really one security. On the fixed income side, they issue 0:12:43.760 --> 0:12:48.640 thousands of securities and that's just one individual company. But 0:12:49.120 --> 0:12:53.800 they also issue all sorts of different terms in those securities. 0:12:53.800 --> 0:12:56.880 Some are more senior, some are more subordinated, Some have 0:12:57.200 --> 0:13:01.719 call options and put options that impact they're pricing. They 0:13:01.720 --> 0:13:04.560 have different maturities, they have different coupons, they may have 0:13:04.640 --> 0:13:08.520 different indentures that are governing what happens in different types 0:13:08.720 --> 0:13:12.760 of scenarios. That just leads to an enormous amount of complexity, 0:13:12.800 --> 0:13:16.520 and therefore there are many fewer investors that have the 0:13:16.600 --> 0:13:20.000 resources to be able to analyze all of those differences, 0:13:20.320 --> 0:13:24.600 which then ultimately leads to mispricing. But it's not just 0:13:24.600 --> 0:13:27.920 those individual issuers too. You can look at additional markets 0:13:27.920 --> 0:13:30.240 that don't even exist in the equity world, things like 0:13:30.600 --> 0:13:34.280 the securitized space, whether it's mortgages, they're asset backed securities, 0:13:34.400 --> 0:13:38.120 or collateralized loan obligations. There's a wide variety of securitized 0:13:38.800 --> 0:13:42.360 types of exposures that simply don't have a counterpart. Same 0:13:42.400 --> 0:13:46.240 thing with municipal bonds. An incredible amount of issuers within 0:13:46.280 --> 0:13:50.160 the municipal market very small, across different states and localities, 0:13:50.280 --> 0:13:53.400 in different types of revenue streams. So there's a lot 0:13:53.440 --> 0:13:59.000 of complexity, but ultimately it means fewer individual investors analyzing 0:13:59.120 --> 0:14:03.720 that complexity, which then leads to different types of inefficiencies 0:14:03.760 --> 0:14:05.400 and opportunities for active management. 0:14:06.240 --> 0:14:09.280 Well, how important would you say flexibility is today just 0:14:09.320 --> 0:14:12.720 in today's bond market? I guess, like, in other words, 0:14:12.800 --> 0:14:14.440 how valuable is it to have a manager who can 0:14:14.440 --> 0:14:19.000 shorten duration, or avoid certain sectors or lean into dislocations 0:14:19.320 --> 0:14:20.800 when markets change quickly? 0:14:22.920 --> 0:14:25.600 I think it is important today. I think all the 0:14:25.600 --> 0:14:29.200 things that we've been talking about are not unique to 0:14:29.320 --> 0:14:33.520 this specific environment. But these are structural types of inefficiencies 0:14:33.560 --> 0:14:35.920 that have existed for a very long time, that have 0:14:36.640 --> 0:14:40.600 a lot of academic literature supporting them, that also we 0:14:40.640 --> 0:14:43.640 think are likely to continue to exist in the future 0:14:43.680 --> 0:14:48.160 and including in the present as well. We talked about 0:14:48.160 --> 0:14:51.200 the overall kind of duration or the interest rate exposure, 0:14:51.200 --> 0:14:54.560 and how investors had the most exposure at the wrong 0:14:54.640 --> 0:14:58.200 time there. We've seen that in other areas. You can 0:14:58.280 --> 0:15:01.880 kind of think about the shale boom. In the kind 0:15:01.880 --> 0:15:05.600 of post global financial crisis period, investors may be reaching 0:15:05.640 --> 0:15:08.400 for a little bit of yield investing and lending on 0:15:08.480 --> 0:15:11.720 easier terms to energy companies than we had a big 0:15:11.840 --> 0:15:15.640 energy cycle in twenty fifteen. In twenty sixteen that wiped 0:15:15.640 --> 0:15:19.920 out a lot of capital. As active managers, Again, you're 0:15:20.000 --> 0:15:23.120 not just tracking those exposures and getting more of the 0:15:23.160 --> 0:15:26.320 exposure after all of the lending is done. You can 0:15:26.640 --> 0:15:29.440 really dispassionately look at that and say, are you getting 0:15:29.440 --> 0:15:33.479 compensated for those risks given the underlying fundamentals and dynamics 0:15:33.520 --> 0:15:36.760 that are that are in place at that time. So 0:15:36.840 --> 0:15:38.400 when we look today, you know, there's a couple of 0:15:38.480 --> 0:15:40.680 things that we look at. Ye know, one is is 0:15:40.680 --> 0:15:45.240 what's happening within AI. We do expect that to fundamentally 0:15:45.320 --> 0:15:48.440 alter a lot of business models. There's a lot of focus, 0:15:48.440 --> 0:15:52.080 and we think for good reason on software companies. That's 0:15:52.080 --> 0:15:54.920 been an area that's grown dramatically in the last couple 0:15:55.000 --> 0:15:57.360 of decades. I think investors on the fixed income side 0:15:57.400 --> 0:15:59.600 really need to think about, you know, where do they 0:15:59.640 --> 0:16:01.960 have that exposure, whether it's in private markets or the 0:16:02.040 --> 0:16:05.400 syndicated loan market or in public fixed inc in markets, 0:16:05.800 --> 0:16:09.280 is it the proper exposure given how much that has 0:16:09.320 --> 0:16:13.280 grown over the last couple of decades. Conversely, we've seen 0:16:13.320 --> 0:16:16.600 interest rates increase increase pretty dramatically. Given events that are 0:16:16.600 --> 0:16:18.880 occurring in the Middle East, this may be a time 0:16:18.920 --> 0:16:21.400 that investors want to be able to lock in higher 0:16:21.480 --> 0:16:25.560 yields rather than what we saw previously when yields were 0:16:25.600 --> 0:16:28.040 incredibly low and they were taking more interest rate risk. 0:16:28.280 --> 0:16:33.040 We've actually seen duration, so that interest rate exposure, the 0:16:33.120 --> 0:16:36.280 risk that investors had, it's come down significantly from twenty 0:16:36.360 --> 0:16:39.520 twenty two. The cost of borrowing has gone higher. What 0:16:39.560 --> 0:16:42.680 are borrowers doing. They're borrowing for a shorter time period now, 0:16:42.760 --> 0:16:44.800 so this may be a time that investors want to 0:16:44.840 --> 0:16:46.400 move the other direction. So we do see a lot 0:16:46.400 --> 0:16:50.280 of opportunities. We think the value in that flexibility is 0:16:50.640 --> 0:16:52.360 high today has ever been. 0:16:53.120 --> 0:16:56.320 Also want to ask about central bank intervention and the 0:16:56.360 --> 0:16:59.040 potential for distorting markets. You know, if we think about 0:16:59.080 --> 0:17:03.160 mortgage back security during COVID, does passing investing become more 0:17:03.240 --> 0:17:07.800 dangerous when markets are being heavily influenced by the central banks? 0:17:07.560 --> 0:17:11.600 It absolutely does. And this is another component that is 0:17:11.880 --> 0:17:17.480 I think much more pronounced in the fixed income investing world, 0:17:17.520 --> 0:17:21.080 and that is the prevalence of non economic buyers. Right 0:17:22.000 --> 0:17:25.400 there is a spectrum. Some are kind of less economic 0:17:26.280 --> 0:17:29.320 than others. But on the one end you have things 0:17:29.480 --> 0:17:32.800 like central banks, something like the Bank of Japan, the 0:17:32.840 --> 0:17:37.200 Bank of Japan owns roughly fifty percent of the total 0:17:37.400 --> 0:17:42.159 outstanding debt of the Government of Japan. They are not 0:17:42.240 --> 0:17:45.119 buying that debt because they're trying to hit return bogies. 0:17:45.280 --> 0:17:48.560 They're trying to manage their economy, and you see this 0:17:48.640 --> 0:17:52.399 from kind of treasury departments in central governments in different 0:17:52.400 --> 0:17:56.240 places that may be managing to a specific currency target 0:17:56.320 --> 0:18:00.680 or currency pag These are not economic decision. But there 0:18:00.720 --> 0:18:04.639 are also incredibly large and influential institutional buyers in the 0:18:04.640 --> 0:18:08.040 fixed income market that are maybe partially economic. You can 0:18:08.080 --> 0:18:11.679 think of insurance companies or commercial banks. They may be 0:18:11.840 --> 0:18:16.320 having to buy certain types of securities for regulatory reasons. 0:18:17.040 --> 0:18:20.200 They may be kind of looking and trying to make 0:18:20.320 --> 0:18:23.600 a partially economic decision, but they might be constrained by 0:18:23.800 --> 0:18:27.680 a rating or a maturity, or a particular type of 0:18:28.000 --> 0:18:30.920 industry or that type of thing, and therefore they might 0:18:30.920 --> 0:18:33.760 be limited in what they would actually do did they 0:18:33.800 --> 0:18:37.640 not have to hit those kind of regulatory targets, which 0:18:37.680 --> 0:18:42.000 can lead to mispricing as well. So I think that 0:18:42.119 --> 0:18:45.040 is a really big factor, especially when you look at 0:18:45.080 --> 0:18:47.880 how large some of these buyers are in a fixed 0:18:47.960 --> 0:18:52.439 income market, and you really don't see anything comparable on 0:18:52.480 --> 0:18:53.760 the equity side. 0:18:54.480 --> 0:18:56.680 You mentioned earlier, you know, one of the benefits of 0:18:56.720 --> 0:19:00.280 active bond investing is lower cost. But I just kind 0:19:00.280 --> 0:19:02.680 of want to you know, when we think of low cost, 0:19:02.800 --> 0:19:05.680 it's you know, index investing, and you know like that, 0:19:05.720 --> 0:19:08.840 I think the before active kind of had a rebound recently, 0:19:09.000 --> 0:19:11.880 you know, index investing was kind of the big thing 0:19:11.920 --> 0:19:14.160 that all you know, a lot of retail investors really into. 0:19:14.280 --> 0:19:17.760 But is there a hitting cost passive bond investing, you 0:19:17.760 --> 0:19:18.600 know for investors? 0:19:19.600 --> 0:19:21.919 Yeah, I think it there there is, you know, and 0:19:21.960 --> 0:19:26.440 it's really opportunity cost, right, And I think you brought 0:19:26.440 --> 0:19:28.159 it up earlier, and I think it's you know, you 0:19:28.200 --> 0:19:30.120 really hit the nail on the head. I mean, there 0:19:30.760 --> 0:19:35.119 it is not just about higher returns and taking more risk, 0:19:35.400 --> 0:19:39.359 but is actually those risk adjusted returns and it is 0:19:39.600 --> 0:19:43.440 the cost of a lack of diversification. And so when 0:19:43.440 --> 0:19:45.879 you look at the overall return stream, and this is 0:19:45.880 --> 0:19:49.439 where there's been a lot of research across a broad 0:19:49.520 --> 0:19:53.320 array of different types of fixed income strategies, but the 0:19:53.520 --> 0:19:59.280 median active manager tends to outperform their benchmarks over the 0:19:59.320 --> 0:20:02.120 long running. See that over and over again, and that's 0:20:02.160 --> 0:20:05.400 even true if you adjust for beta, look at something 0:20:05.440 --> 0:20:07.720 like Jensen's elf or you know something that says, okay, 0:20:07.720 --> 0:20:11.600 maybe this manager is structurally overweight a riskier part of 0:20:11.600 --> 0:20:14.119 the market. Are you getting compensated for that? And it 0:20:14.280 --> 0:20:18.840 still holds up the vast majority of time and a 0:20:18.840 --> 0:20:22.600 lot of different active parts of fixed income, And so 0:20:22.640 --> 0:20:24.280 I think in vetters really do need to think about 0:20:24.359 --> 0:20:27.359 that that opportunity cost. What is the opportunity cost of 0:20:27.400 --> 0:20:32.639 maybe being more exposed to, you know, the prices that 0:20:32.640 --> 0:20:35.879 can be driven by non economic actors. What is the 0:20:35.880 --> 0:20:39.360 opportunity cost of not being able to invest in more 0:20:39.359 --> 0:20:42.080 attractive risk adjusted return opportunities that are outside of the 0:20:42.080 --> 0:20:47.160 benchmark due to you know, some kind of archaic type 0:20:47.200 --> 0:20:50.920 of benchmark rule that that hasn't been updated in decades. 0:20:51.280 --> 0:20:53.480 I think all of those different types of things need 0:20:53.560 --> 0:20:57.400 to be taken into account for the cost of passive 0:20:57.440 --> 0:21:00.800 investing when you're comparing it to active investors that have 0:21:01.040 --> 0:21:03.480 more more flexibility to be able to take advantage of 0:21:03.840 --> 0:21:04.760 those limitations. 0:21:05.480 --> 0:21:08.879 So your research also showed that passive core bond strategies 0:21:08.880 --> 0:21:12.800 ab underperform the Bloomberg ag after fees, you know, over 0:21:13.320 --> 0:21:15.920 was it five year rolling periods since since O eight, 0:21:17.000 --> 0:21:18.840 and you know, I think it kind of goes back to, 0:21:19.040 --> 0:21:21.520 you know, the whole fees issue. I mean, why do 0:21:21.600 --> 0:21:24.040 you think the whole fee fees are everything now have 0:21:24.200 --> 0:21:25.840 kind of remained so dominant today. 0:21:27.359 --> 0:21:29.920 I mean, ultimately, I think it is kind of the 0:21:30.600 --> 0:21:34.159 bird in the hand instead of the two in the 0:21:34.200 --> 0:21:39.040 bush type of idea. Investors know exactly what the fee is. 0:21:39.440 --> 0:21:42.520 It's explicit, it's stated. And this comes back to, I 0:21:42.840 --> 0:21:46.359 think kind of a shortcut from some very valuable lessons 0:21:46.400 --> 0:21:51.000 that investors have learned over many, many decades around the 0:21:51.160 --> 0:21:55.960 cost of active management and certain types of equity strategies 0:21:55.960 --> 0:21:59.600 where maybe they weren't getting that value and the in 0:21:59.640 --> 0:22:04.040 the cost was higher, and so they've applied many of 0:22:04.119 --> 0:22:07.120 those lessons to the fixed income universe, where we don't 0:22:07.119 --> 0:22:09.440 think it applies. Again, both on the benefit and the 0:22:09.560 --> 0:22:11.879 cost side. The fees and the fixed income side are 0:22:11.960 --> 0:22:16.000 are much much lower, but the value being delivered is 0:22:16.080 --> 0:22:20.720 significantly higher because there are all of these structural inefficiencies 0:22:20.760 --> 0:22:23.840 and opportunities for active managers to add value on the 0:22:23.960 --> 0:22:26.480 fixed income side. So I do think that is that 0:22:26.640 --> 0:22:30.520 the big issue is it is is simple, and it 0:22:30.680 --> 0:22:34.000 is kind of a heuristic that that investors that have 0:22:34.200 --> 0:22:38.560 learned from many years on the equity side of investing. 0:22:39.520 --> 0:22:42.240 So if someone owned a passive aggregate bond fund today, 0:22:42.720 --> 0:22:44.959 what exposures at risk? You know, would you tell them 0:22:45.000 --> 0:22:46.640 that they might not really fully appreciate. 0:22:48.640 --> 0:22:52.200 So it definitely depends on kind of which type of 0:22:52.320 --> 0:22:55.240 multi sector. But if you're looking at US kind of 0:22:55.359 --> 0:23:00.200 of US types of investment grade, we do think that 0:23:00.320 --> 0:23:05.080 there is actually very good value in things like mortgages 0:23:05.400 --> 0:23:08.520 in the securitized space. So you can compare that to 0:23:08.720 --> 0:23:12.280 let's say two thousand and eight, when investors were the 0:23:12.520 --> 0:23:16.120 most exposed to the US housing market, again right before 0:23:16.160 --> 0:23:19.480 the global financial crisis. During the Global financial crisis, they 0:23:19.520 --> 0:23:24.600 had the largest exposure at arguably the worst possible time. Again, 0:23:24.640 --> 0:23:26.440 we don't think that was an accident. I think that 0:23:26.720 --> 0:23:29.280 was the result of the issuance patterns that we were 0:23:29.320 --> 0:23:35.600 seeing back then. Today there is very little issuance. The 0:23:35.680 --> 0:23:39.560 housing market has slowed down significantly, but we think that 0:23:40.080 --> 0:23:45.639 the fundamentals are much much stronger, and if anything, investors 0:23:45.720 --> 0:23:49.320 may be under exposed to that type of market. So 0:23:49.640 --> 0:23:52.480 I think is a potential risk of not having kind 0:23:52.520 --> 0:23:56.480 of enough exposure to some of the more attractive parts 0:23:56.520 --> 0:23:59.280 of the market. We talked a little bit about interest rates. Again, 0:23:59.320 --> 0:24:01.760 we've seen raps move higher as a result of what's 0:24:01.800 --> 0:24:04.800 happening in the Middle East. When we look out kind 0:24:04.840 --> 0:24:08.320