This is Master in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have an extra special guest. His name is Mike Swell. H e’s the head Of Fixed Income Portfolio Management at GSAM, that’s Goldman Sachs Asset Management Group. They run over $700 billion just on fixed-income side.
And, man, let me tell you, this is a master class in fixed income investing. If you are interested in where to get yield, how to pursue it, what the risks are involved, where there are the best opportunities for fixed income investing, where you’re not getting paid to take risk, I don’t even know what else to say.
One of the most knowledgeable people I’ve ever heard in the fixed income space, I would imagine you probably have to know a thing or two if you’re going to run fixed income for Goldman Sachs.
Absolutely must listen a fascinating, fascinating conversation. I learned a ton of stuff and I consider myself somewhat knowledgeable in the space. I think that I’m going to listen to this episode repeatedly just because it was so dense and so filled with really fascinating information.
He’s had a really intriguing career and has really put up some incredible insight and lots of great numbers over the time. GSAM runs a variety of different mutual funds. There are five or so that Swell is either in charge of supervising or a manager of or a comanager of. So, this isn’t just abstract theory. He really is where the rubber meets the road.
So, with no further ado, my conversation with Mike Swell, the Head of Fixed Income Portfolio Management for Goldman Sachs.
VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My extra special guest this week is Mike Swell. He is the Head of Global Fixed Income Portfolio Management at Goldman Sachs where he oversees about $700 billion in assets. He’s also a managing director at Goldman Sachs Asset Management. Michael Swell, welcome to Bloomberg.
MICHAEL SWELL, HEAD of GLOBAL FIXED INCOME PORTFOLIO MANAGEMENT, GOLDMAN SACHS: Barry, I want to thank you thank Bloomberg for having me today.
RITHOLTZ: So, let’s talk a little bit about the early days. You graduated the London School of Economics in 1987. Do you remember what the yield was on the 10-year back then?
SWELL: It was meaningfully higher than it is today. I — well, it’s roughly zero today, so it’s got to be a lot higher. I would say it was probably in the very high single digits pushing up on 10 percent. I’ll go eight to nine percent.
RITHOLTZ: So, that was still fairly early and what turned out to be a very long bull market, what were those days like? Did anyone have any idea about the legs that the bond bull market would have?
SWELL: Well, I was still in college at the time and so I actually, within LSE for a year and then with the Brandeis University, got my bachelor’s there. And while I was in London, I kind of got exposed to global markets to fixed income. I saw a lot of people applying for internships to Wall Street and said, it sounds pretty good. It sounds competitive. And so, I then kind of applied to a program to get a in the International Finance at Brandeis.
So, I had yet to know exactly what the bond market was until I started my career at Lehman Brothers in 1989. And it was a different world, I mean, in terms of liquidity, in terms of transparency. Back then, you had to wait until the next day to find out what happened with bond prices.
You had this thing called pair sheets, pink sheets, and that was the way you’ve learned about what was going on with companies and what was going on in terms of pricing in markets. So, a very, very different world.
The bond market wasn’t the kind of primary market of liquidity like it is today and something that we talked about for 24 hours a day. Back then, probably, if you had a — if you had a financial, like Bloomberg, you probably would have spent 10, 15 minutes on bods and the rest was on equities.
RITHOLTZ: What about execution? What was it like trying to move any sort of paper around back then versus today?
SWELL: Back then, it was obviously, it was a phone-only markets. So, non-electronic market. Now, obviously, you press a button and you can move billions of dollars of risk and you can move billion dollar — billions of dollars of risk in multiple different markets with a touch of a button whether it’s a treasury market, the mortgage market, the corporate credit market, derivative market.
Back then, was a phone-to-phone negotiation and very often, while there were some Wall Street players in between, typically, what they would do is they would try to find a buyer on the other side.
And so, what now take seconds back then could have taken days to move — to move risk. Just a very, very different world, bigger bid offer spreads. And so, you didn’t see as active trading in the fixed-income markets as you see today.
But the other side of that is that there was a lot more — a lot more yield and with less transparency. There was little more efficiency and if you were a very active player, you the potential for generating earnings and margins by trading bonds was actually pretty — pretty attractive given how wide bid-offer-spreads were back then.
RITHOLTZ: So, given how much more of efficient the market has become, we continue to see active bond managers outperformed passive indexes, that’s the opposite of what we see in the equity side where efficiencies have — given the passive indexer, a huge advantage, why do active bond managers — why are they still capable of beating the passive indexes when their equity cohorts can’t?
SWELL: There are a number of different reasons. There is a lack of homogeneity in the bond market. And so, if you think about something as clear as the treasury market, there is on-the-run treasuries. There’s off the run treasuries. There’s 14-year treasuries. There’s 30-year treasuries.
They traded very, very different levels. You also have an index that is very, very transparant in terms of what is in the index and there’s a lot of ability to be able to purchase securities that are outside of your index. Very different than what’s in the equity market.
Typically, what’s in the equity market and what’s in your index is what is your investable universe. Within the bond market, there are many, many different sectors that sit outside of the — outside of the universe.
The other thing is that given that the indices are very transparent, there’s a market segmentation issue that goes on in bonds where you have some investors that buy the index. They have to buy the Barclays Ag. They have to buy the long corporate index because there are pension fund.
Very, very significant market segmentation issues that creates inefficiencies. So, when there’s enormous amount of demand for one type of asset, you can actually buy something that is meaningfully, meaningfully cheaper. So, if everybody has that — everyone has a limitation that they can only buy five-year credit or shorter, well, if your six-year corporate credit in a year, it becomes five-year corporate credit. Very often, that six-year bond will trade very cheap to the five-year because there are a lot of investors that can’t buy it.
Same thing in the — if you think about the credit ratings, most investors, particularly in the U.S., can only buy investment grade corporate credit and that’s what the index. The index is typically an investment grade credit index.
But when there are opportunities in the double B sector or in the high-yield sector, you have a lot of investors that are limited in terms of their guidelines and limit it in terms of the amount of capital they could deploy to lower credit-related assets. And so, as a result, not as many buyers.
So, use an active manager when you see a disparity when there’s a 3B bond out there that might yield 150 basis points over treasuries but a 2B bond, so it’s a BB bond that might yield 350 or 400 basis points over. Well, the difference in leverage between a BB company or a BBB company is pretty limited. So, active managers can really take advantage of that.
Another area is the agency mortgage market is a very big part of the global indices, the U.S., the Bloomberg Index in the U.S., and it’s a very heterogeneous market. There are different coupons and different types of securities in that market. So, there’s a great ability that if you have expertise in terms of understanding, prepayment risk which is the biggest risk that occurs in agency mortgages, you can buy securities that can perform a lot better than the indices.
So, there are many different reasons why in fixed-income, active managers have consistently outperformed. I think that also is an important point when you think about ETFs as well.
Well, ETFS have grown very, very significantly in the — in the equity market. It’s been a little bit slower in the fixed income market and the reasons that we’re talking about right now and that active managers are more consistently beat indices is the reason why it’s been slower in fixed income.
RITHOLTZ: Quite — quite — quite interesting. Let’s stick a little bit with your career for a bit. You leave Lehman Brothers early ’90s long before they get into trouble and eventually ends up at Friedman, Billings, Ramsey. Is that right?
SWELL: Yes. I spent a lot of years at Freddie Mac in Washington D.C. and in the mortgage markets, securitizing mortgages, trading mortgage securities, working very closely with originators. And then transfer that risk to a firm that was getting involved in the — in the REIT market and particularly in the — in the subprime mortgage market.
So, those were kind of where the bulk of my career was prior to getting to Goldman Sachs.
Right. And you joined Goldman in ’07 to run the structured products group and if memory serves correctly, mortgage has already peaked and we’re rolling over by ’07. Your charge was to look across the spectrum at opportunistically at fixed-income products and alternatives portfolios. Is it exaggerating to say it was fish in the barrel or had it not quite gotten that attractive yet?
SWELL: Actually, my timing was the opposite of fish in the barrel. So, the mortgage market didn’t start rolling over until the end of ’07 and mainly in 2008. And so, my mandate when I got to Goldman was to actually look at the structured product market from initial risk standpoint. So, there was enormous amount of CDO and CLO issuance.
The goal was to look at those markets to become a manager. And when I got there and did a lot of the work, we said, you know what? This is not actually a good investment for investors. They’re levering up an asset that has — that has appreciated massively and there’s no return here for investors and there’s risk.
And so, basically, in ’07, the CDO/CLO market, also, at the same time kind of shut down and I was left with kind of nothing to do. And so, I had to reinvent myself. And one of the things that’s very important for people in this industry and any industry is always be flexible to reinvent yourself.
And so, the crisis occurred. CDO market, CLO market shutdown, but the assets became very distressed and there was a great opportunity to start investing those area. So, I went from trying to be an issuer in that market to being a distressed investor.
RITHOLTZ: Let’s talk a little bit about the demands for bonds these days. You recently said you see, quote, “enormous demand for U.S. fixed income.” Explain.
SWELL: So, people would think that with rates pushing on zero, with kind of recovery in the future in 2001 — 2021 to 2022 that bonds would be completely out of vogue and a lot of concern around eventual inflation in the U.S. and rising rates. I would that forget about it for a number of years.
There is an enormous amount of demand for yield. There are — there’s enormous amount of savings that that exists, there’s enormous amount of market segmentation that exists on a global basis with investors, where investors a lot of investors do not have the option to go into alternatives or to go into the equities. They are fixed-income investors.
Obviously, retirees, conservative can take the volatility of only equities. They need to — they need to generate income to live. You have insurance companies that predominately invest in fixed income. The right policies and they buy fixed-income assets into the side of that.
There’s also a regulatory reason why you find that the insurance companies buy fixed-income assets. Same thing with commercial banks. Commercial banks buy fixed-income.
So, I think that there is going to be an enormous amount of demand for yield and you have to, to some degree, look outside the United States when you think about investing. You can’t just rely upon what you may think investors might do in your country.
We have very, very global fungible markets now. And so, the fact that rates are negative in Europe, rates are negative in Japan, that creates an enormous amount of demand for yield. We think the U.S. market, although we think the yields are very low, it’s kind of like the — we’re kind of the ugly — prettiest in an ugly contest to a certain degree and that our yields at two, three, four percent across different markets in the U.S. actually look very attractive to non-U.S. investors.
So, we think the story for the next couple of years is going to be demand for yield rates because we think rates are going to stay extremely low across the globe and do not fight the Fed. That’s a very important investment thesis. You’re almost always right to not fight the Fed. The Fed has been very, very clear. Rates are going to stay lower for an extended period of time to get out inflation meaningfully higher, number one.
And number two, there’s been a recognition that the full employment rate is not what you think it is. That there are a lot of people that have been displaced from the job market having come back in a long period of time, you need to keep rates low to incentivize companies to actually try to go in and hire those people and to get people kind of better paying jobs than where a lot of people are right now.
And so I think that the move from the Fed this year around, number one, moving to more of an average inflation target, and secondly, the discussion around what really full employment is likely to lead the Fed to be very, very easy for an extended period of time which is going to mean low rates and yield is going to come at a significant …
VOICEOVER: Masters in Business is brought to you by T. Rowe Price. Delivering the strategic investing approach with a long-term perspective to help advisers and their clients feel confident through a variety of market conditions. Since 1937, T. Rowe Price. Invest with confidence.
SWELL: … premium.
RITHOLTZ: So, let’s take a look at that exact issue from the perspective of the average investor. Where does someone who does not have those restrictions that of a public pension fund or a foundation might have, where did they go with their looking for more yields but without taking the sort of crazy risk that got people into trouble in ’08-’09?
SWELL: So, I think there — there are a few different places. I think, number one, I think that individual investors still benefit significantly from owning long-dated municipals. So, an individual, I would own a good chunk of my fixed-income allocation in high-quality long-dated municipals, they’re trading it very comparable yields to where treasuries are. And obviously, taxes are not going down. Taxes are likely to be going up.
And so, there’s a significant benefit there. And I think we’re very confident from a credit standpoint in terms of higher quality investment grade munis that you’re not talking about a significant credit risk.
Secondly, is within the kind of the Bloomberg Aggregate world where most fixed-income lies in kind of the core intermediate fixed income space, there are a lot of things to do to do better than the one percent that exists in treasuries.
Number one is there’s the there’s credit. So, we think that the credit market, like the 2021 is setting up to be a phenomenal year for credit. Obviously, credit spreads have come back a lot since the COVID shock. But we feel that the combination of low rates as well as fiscal stimulus and recovery post COVID is going to lead to an extremely attractive market for credit.
So, number one, is moving down a little bit in quality in credit. Within the unconstrained space, moving a little bit into high yield. And as I mentioned before, we think the BBs offer a very significant yield pickup relative to owning kind of BBBs and investment grade.
Secondly is leverage loans. This is an asset class that’s been an outflow since I’ve been in the business. Leverage loans are higher quality from a credit standpoint than high-yield credit. They have a feature that works for investors sometimes but not — not other times.
And so, their floating rate in nature. A lot of investors have bought them because they concerned about rising rates. Despite the fact that their floating rate, and I mentioned the point that rates are likely to stay low for extended period of time, they offer an extremely attractive level of carry, four or five percent without taking, as you mentioned, kind of crazy, crazy risk.
Second — another point on top of kind of having a little bit more credit exposure in your portfolio and long-dated munis is agency mortgages. And I kind of view them as a way to barbell your portfolio and this is what we’re doing in our core bond portfolios, our traditional Bloomberg aggregate portfolios, we’re barbelling BB credit bank loans along with agency mortgages.
Agency mortgages either guaranteed or implicit guaranteed from the government. What you’re doing effectively is you’re taking a spread for owning prepayment risk. And our view is that number one, is that we feel that prepayment the risk is coming down.
But secondly, and this is a really interesting point is that mortgages offer you a hedge and one of the topics I know that we’re going to talk today about a little bit is the 60-40 kind of balance and do we still feel the 60-40 makes sense and that you’re getting kind of hedge benefits of being in fixed-income.
Agency mortgages are one of the securities where you actually are. And the reason for that is that you have a Fed that is buying the securities. And so, in the event that the U.S. economy goes south, credit spreads potentially widen, you see agency mortgages are an asset class that the Fed is likely to buy and drive down that yield very significantly.
So, we think it’s a very important policy tool. And so, buying on the fringe, buying what by the Fed is not buying, number one, which is BBs and bank loans and pairing that with what the Fed is and can buy a lot more of which is agency mortgages.
RITHOLTZ: That’s quite interesting. I had a pet theory a couple of years ago that there was a shortage of high-quality sovereign bonds. And a number of people in the bond side of things told me, yes, there’s just insatiable demand for paper and there isn’t that much of it. Is that still the case? Are we seeing enough high-quality sovereign paper out there to meet the demand?
SWELL: I — I don’t believe that there’s a shortage of bonds. There is a shortage of bonds at good prices. So, there’s a — that’s a — it sounds kind of silly but it’s actually an important difference. The ECB talk a lot about is there a shortage of bonds for them to buy to implement monetary policy in QE and the answer is, no. Just raise your price.
And that’s what they’ve done. And that’s why yields in Europe are negative. What they’re doing is they’re driving sovereign yields down to the point where you are forced to sell them and do something else with it. What are you doing else with it? You can buy equities and some people are doing that and rebalancing portfolios and buying equities and that, obviously, has a stimulative effect on the economy. And secondly is what they’re doing is they’re forcing people out on the respect from within fixed income to buy credit.
So, to answer your question, I don’t think there’s a shortage. I think in some markets, there’s a — shortage of good prices but I do feel that this movement to the next best asset class, which is what central banks want people to do, that there’s enough yield and enough attractive opportunities.
I think that keeping your money in your own market when the central bank is manipulating the price, I think that that’s something to kind of think about. So, you have, obviously, U.S. rates really low, European rates really low, and Japanese rates really low because the central banks are trying to create stimulus in the economy by keeping rates artificially low.
But there are other markets out there that are not as heavily impacted by central bank policies. So, one of the things that we’re doing in portfolios is not just keeping all of our rate exposure in those markets but diversifying into some of the higher-yielding markets.
And so, if you look at rates in Australia, rates in Canada, rates in Sweden, you Norway, much steeper yield curves and the ability to be able to actually generate yield in the longer end of those curves, the important of that is around hedge efficacy.
At zero, you don’t feel like you have a lot of upside if the world goes bad in your bond portfolio. But if you’re yielding one, one and a half percent, you obviously have a lot more upside.
And then lastly, diversifying a little bit into some of high-quality emerging markets. A country like Mexico has meaningfully higher both nominal rates and real rates in the U.S. and active managers can look at that and say, OK, what is the risk of investing Mexico? Do I want to hold the currency risk or not, but I actually have a real positive real rate.
And in the event that the U.S. slows, well then, it’s likely that Mexico slows and you should see kind of a rally and accommodated policy in both countries. More room to rally in a country like Mexico. So, getting a little bit more diversified in your sovereign exposure, we think, makes a lot of sense.
So, over the weekend, I read this really interesting piece on Bloomberg. China opens its bond market with unknown consequences for the world. So, let’s — let’s look at that. What does it mean that China’s opening their bond market and what might that mean to global interest rates?
So, you asked the question earlier about the shortage of high-quality bonds by seeing liberalization in China and expansion of issuance from the Chinese government, from high-quality Chinese corporates into the global markets, creating more access or more liquidity, clearly is going to be good for investors and savers.
And it can potentially crowd out some of the investment that’s been made in other high-quality markets. So, if you look at Europe at negative or zero rates, you look at the U.S. at very low rates, you look at Japan, if you create more quickly and more access to Chinese sovereign bonds that are right now yielding three and a quarter, three and a half percent, that may actually eventually crown out of their investors.
You also look at the Bloomberg Global Aggregate Index. It has a pretty high percentage of China in it and it’s growing. And so, as a result, it can actually be a yield enhancer for investors. But on the margin, it could have some negative implications to sovereign bond markets where yields are so low.
We’ve actually think that the liberalization of the Chinese capital markets is a — not a good thing. It’s a good thing for investors. The Chinese bond market is actually pretty attractive at those kind of yields where the central bank in the event that there is a slowdown globally or a slowdown in China.
You have China in a very different policy position in the U.S., Europe, and Japan. And so, you have lot of ability for rates to go down in China. And now that you have access, we think that’s a big positive. We think it’s been such an important change in the capital markets.
We actually have issues an ETF in the non-U.S. market to get people access to the Chinese bond market because it’s very hard for people to get direct exposure. But as they liberalize clearing and custodial issues it’s going to become a very important part of the broader capital markets.
RITHOLTZ: Mike, let’s talk a little bit about the Federal Reserve. I keep reading people, saying that the Federal Reserve is destroying purchasing power, damaging the dollar, and driving rates to zero, but I’m compelled to ask the question. How influential is the Federal Reserve in setting longer-term interest rates?
SWELL: So, on your first question, there’s no free lunch when it comes to policy. When it comes to policy, it’s all about trade-offs. It’s about what environment are we in and what risk do I want to protect against?
And so, when the Fed makes a decision to keep rates low for an extended period of time. It does have negative indications it does hurt savers. It does hurt banks.
But they’re looking at a crisis situation. The COVID shock was a real, real crisis situation. They were concerned that you’d see capital markets completely shut, companies access to debt and equity financing pretty much gone and that could lead to a really, really bad economic scenario.
And if we look at ’07, ’08 financial crisis, the Fed was slower to act. They were slower. They acted into a smaller degree in terms of lowering rates, they acted to a small degree in terms of purchasing assets. And we’re still feeling the pain of that as a result of the fact that we do did not see a V-shaped recovery, we saw a very, very slow recovery and it was very, very tough for companies to start spending again, to start raising capital again. The learned their lesson.
And so, in this COVID shock, they came in really big. They drove rates down to zero and they bought everything. And they bought more than they ever bought in the past and they bought different asset classes including removing the freeze from the credit markets.
Very, very important now. It doesn’t come without a cost but they to do it and we’re still in the shock. We still have companies that haven’t opened. We have companies on the brink of potential bankruptcy. So, the need for keeping rates lower, keeping capital markets open, is — it’s a trade-off. And so, there’s no kind of perfect answer.
But for my perspective, they’ve done the right thing. Now, to answer your — the second part of your question is the Fed in this case and in a crisis situation, they’ve had an impact on interest rates across entire curve. So, not only have they — their main policy tool is, obviously, short-term rate, so there, they have a lot of control.
And typically, you would see five-year rates, 10-year rates, 30-year rates will be driven by the economic supply-demand factors.
In this case, the Fed has become big across the entire curve. Obviously, when you introduce QE, QE not only impact short end (ph) but QE is buying bonds and driving yields lower.
And so, they’ve had an impact across the entire curve. That’s not the long-term goal. I would expect to see the supply demand inflation to be the bigger drivers on the long end of the curve and over a long period of time, the Fed is going to have much more control of the short and the long end is going to be driven by other factors. But in a crisis, the Fed has done the right thing and has as impacted rates across the entire curve.
RITHOLTZ: Let’s assume that Janet Yellen gets approved by the Senate for Treasury Secretary. What do you think of this combination of Janet Yellen to Treasury and Jerome Powell at the Fed. What does that mean for fixed income investors?
SWELL: So, we were examination of genealogist treasury drone Paulista said was a means for fixed income investor we were fortunate enough a couple of weeks ago before Chair Yellen was announced as the potential replacement for Treasury. We had her in our daily investment forum where the equity, fixed income teams, and the alternative teams meet every day to discuss markets. We were fortunate enough to have her in.
And I think, based on her history and that conversation — between her and Powell, we have a dynamic duo. We have people that completely understand capital markets and the impact that capital markets have on the real economy. We have people that understand how politics work.
I think Janet Yellen’s experience at the Fed will — has definitely sensitized her to the importance of fiscal policy. She was not in control of fiscal policy. But right now, you have two people that have been at the center of major, major crises — global crisis nd U.S. crisis that are going to be responsible for both the monetary and the fiscal side. I view that as the dynamic duo.
And so, one of the reasons why were very constructive on part kind of the credit markets and vol both equity volume and credit vols and rate vol stating relatively low for the next couple years is that with the two of them in office, we think you’ll have a really good balance of relatively easy monetary policy as well as enough fiscal stimulus to keep the engine going which we think will be a very good environment for credit.
That way in the end, fiscal and monetary policy are not going to drive company’s profitability. It’s going to be the economy. And so, the ability for them to be successful in driving the economy, I think that the jury’s out on that one but I don’t think we could have done much better than the two of them.
VOICEOVER: Masters in Business is brought to you by T. Rowe Price. Delivering a strategic investing approach with a long-term perspective to help advisers and their clients feel confident through a variety of market conditions. Since 1937, T. Rowe Price. Invest with confidence.
RITHOLTZ: So, let’s just talk about fiscal policy for a moment. We saw a huge difference between what happens with the CARES Act and the $3 trillion stimulus plan back in March of this year, 2020, versus the sort of very low-key fiscal stimulus of ’08-’09. It was — it was much more focused on unfreezing the credit markets and managing rates than it was doing a traditional Keynesian stimulus.
Since March of this year, there have been repeated rumors of the CARES Act 2 passing. I would have bet anything that before the election, everybody involved would want to pass another stimulus. But that would’ve been a losing bet. It raises the question, if we couldn’t get stimulus through pre-election, are we going to see any sort of real stimulus in the new Biden administration?
SWELL: So, I would have lost the bet as well. There were too many incentives to get a package done prior to the election, obviously, two, three months ago. It didn’t happen. It’s really a sign, not that it wasn’t needed, but was a sign of how bad the political environment is in Washington.
I think as we go into the new year, I think that the need is very material just because we’ve seen good news on the vaccine front, it doesn’t mean that the real economy problems go away — in short order. You still have individuals, a lot of people there out of work that are furloughed.
You still have people that are struggling to make house payments and any sort of significant deterioration in housing credit has its own implications, and then you have also a very significant amount of food insecurity in this country where people are lining up for hours to get food. That’s not where our country needs to be.
And so, I think that the incentives are likely to be aligned to something to pass something. It’s likely not to be as big as what we thought about last year in terms of a $3 billion package. But I think that you’re likely to see something, obviously a higher probability depending on what happens in Georgia. If the democrats do well there.
But even if we’re in a 52-48 Senate situation, I think we’re going to see something. The need is too great and I think the incentives are too greatly, greatly aligned.
RITHOLTZ: So, not a $3 trillion package but something somewhat, a trillion …
SWELL: A trillion area.
RITHOLTZ: Right. A trillion here, a trillion there. It will all — it all adds up eventually.
SWELL: The timing really matters. Like, there are a lot of people in this country that need it. There are a lot of companies that need the bridge to the other side. And the bridge that was given with the fiscal policy, number one, is over.
And so, and again, back to my point is that good vaccine news in the lab doesn’t mean everybody’s getting back to work tomorrow. It’s going to take one to two years until we really see the world and the economic engine pairing (ph) the way that we did a couple years back. And so, we needed a little help to get there.
RITHOLTZ: To say the least. Let’s talk a little bit about what’s been going on in the fixed-income market? What do we think of the yield curve these days? Does it still signal anything? What were your thoughts when it inverted not too long before this recession began last year?
SWELL: I kind of love how people in the financial markets look to the bond people as the smart people and say that bond people not only should know where bond prices are, but should know where equity prices are and where the economy is going. And so, they think that we — we are — we really can predict the — what we think of 30-year bonds versus what we think of two-year bonds.
And what I’ll tell you is that we’re not that smart. And so, I think that the historical analysis of yield curves and how they predict equity as an economic growth is — has been way overstated, particularly in an environment as we’ve been discussing this podcast around massive, massive central bank intervention both from a policy rate perspective as well as from a QE perspective, in terms of buying assets. It’s hard to look at the shape of the yield curve as a predictor for much right now given the amount of, number one, government intervention.
And secondly is, you have to keep in mind that there is massive, massive investor segmentation going on in the fixed-income markets where there are a lot of investors that, like pension funds, the United States — pension fund of the United States buy long-dated fixed income to match against their liabilities. No matter what the shape of the yield curve, they were buying them and the curve was flat. They’re buying them and the curve is steep.
Same thing with corporations that have been sitting on enormous amounts of cash as they’ve issued a ton of debt and are doing nothing with it because they just want to be able to bridge across the COVID crisis to when the economy kind of reopens. They’re buying very short-dated assets.
And so, all the cash is going there. So, I think that it’s very hard to look at the yield curve given — given the environment when both from a market segmentation standpoint as well as from how much policy is having an impact across the entire curve and really make a significant judgment on where the economy is going.
I will say one thing, though, is that I do think that this kind of normalization that’s occurred this year and steepening of the U.S. yield curve tells you a little bit about two things, one is the prospects for additional fiscal policy and enormous amount of government issuance on the long end of the curve with rates so low, it obviously makes an enormous amount of sense for the federal government to issue debt. They’re doing. They’re going to do a lot more of it.
And secondly, it tell you a little bit about kind of where we stand from a monetary policy standpoint. Obviously, money has been very easy. Big increase in money supply.
And so, there are some in the marketplace that think that on the long end, you’re starting to price in some level of a level inflation. I think that’s overrated. I think that inflation is going to be maybe sorry five to 10 years from, not something that investors, whether it’s equity investors or a fixed income investor need to start positioning for.
RITHOLTZ: So, let’s stick with the idea of how the yield curve has been manipulated, managed, whatever word you want to use. Did you ever imagine 10, 15 years ago that you would see so many yields go on a negative all around the world? And is that a realistic possibility of negative rates occurring in the U.S.?
SWELL: So, 10-15 years ago, no. When I was taking economics classes, no. They — rates were eight, nine percent, they didn’t say, well, what does it take for rates to become negative? That wasn’t kind of even — even discussed.
So, the answer is no, but when you think about the environment we’re in, you think about economics. There are some some intuition around negative rates. And now, it’s kind of the discussion that we had earlier around trade-offs.
So, it’s a trade off. The ECB and the Bank of Japan decision to sacrifice savers for the benefit of industry and corporations to be able to have access to financing, to incentivize savers, to move out the risk spectrum, to buy equities, to make equity financing more attractive, to make debt financing more — more attractive, to create more jobs and to get the economy going but it’s at a — at a cost. And it’s obviously on a cost on savers and a cost on financial institutions that rely upon a shape of the yield curve and rely upon yield.
I think that there is some merit to negative yields. The Fed doesn’t want to make that trade off. They’ve said that. But I would say that it is a it is a policy outcome that could get there. To get there, that either they decide to bring it there or the market brings it there.
Envision a world where you see significant slowdown in global growth, equity markets trade off outside the U.S. and the U.S. is viewed as the safe haven. Fed lowers rates even more, starts to buy more, and the U.S. dollar is viewed as that only thing that’s good and the safe haven currency, you can envision a situation where treasuries, maybe the Fed doesn’t bring rates negative, but people decide that to store their wealth, they would rather be in a dollar-denominated asset that they have to pay something small than being an asset that has a lot — of a lot of risk.
And so, it’s — it is a possibility. But from a policy standpoint, the U.S. has so far made the decision to do not go there.
RITHOLTZ: Interesting. You mentioned the likelihood of some form of fiscal stimulus and the need for further treasury issuance. We’ve been hearing rumors, I don’t know, for about 10 years of grand infrastructure buildout which has yet to happen. It seems like a no-brainer for the new administration. Any chance we see a longer dated bonds with rates this low? A 50-year treasury or even 100-year U.S. Treasury?
SWELL: I mean, if I were the Treasury, I would issue a thousand years at these rate levels. I mean, why not? You’re locking in financing for an extended period time of time that dramatically lower yields and it’s very possible that yield, further out on that yield curve are not meaningfully higher than where they are today.
There’s still a lot of demand for very long dated cash flows from pension funds that — and insurance companies they’re trying to match against — match against liabilities and as people live longer and longer, there’s going to be more and more need for longer dated — longer-dated assets.
So, I could see that. To your question on infrastructure, I think it’s going to — it’s really going to rely upon assuming that we have a republican Senate, it’s going to rely upon whether or not the Biden administration is true to its word about working across the aisle, number one. And number two, if they’re going to be successful at doing that.
But there’s a lot of need for, I think, right now, the spending that needs to get done needs to be directly in the pockets of people that have been affected by COVID. But as we work out a couple of years, of longer term, there needs to be a long-term investment plan for this country a lot of countries and infrastructures going to be important, it’s just a matter whether or not the political will there is there to look at an investment that pays off in 5, 10, 15 years versus the way we look at things right now which is all about today and tomorrow and how does impact my poll numbers.
So, hopefully, we get to the point where we make more rational long-term decisions. And I think if we do, I think that infrastructure is likely to be meaningfully on the table.
RITHOLTZ: Quite interesting. Let’s talk a little bit about duration. You mentioned the yield curve steepen but not a whole lot. What -what’s the difference between the three-month and the 10-year? It’s, I think, less than a 100 bps, last I looked.
Is that sort of duration risk worth it? Normally, in a steeper yield curve, obviously, you’re getting paid much more to lend out for a decade. What — what are you thinking in terms of duration and are we going to continue to see such a relatively modest yield curve for the foreseeable future?
SWELL: So, your — the answer to your question can be very different for who am I or who am I representing as an investor, as a fiduciary, in terms of how I answer that question. So, this kind of leads into the topic of kind of the 60-40 dynamic and do bonds at very low yields, still offer investors protection against kind of growth and risk assets. And I think that that at 80, 90, a 100 basis points in that area, you still have a meaningful amount of upside.
And back to my point earlier, it is possible that rates break the lower bound to zero in the event that you have a significant global — global recession. So, I think that 80-90 basis points in terms of owning 10-year treasuries doesn’t feel really good. But it’s still — when you look at equities and how equities perform so well, you don’t want to just don’t own equities unprotected
And I still think, in the rate market, whether it’s the U.S., whether it’s the other markets I talked about earlier, you’re still getting some very significant hedge benefit.
But when you look outright at the U.S. market at 80-90 basis points, 100 basis points on the tenure, is that a great 5- to 10-year investment? Probably not. I would say, as an individual, I would much rather own longer-dated municipals. I think I get a lot of the upside in the event that rates come down and there’s a slowdown in the economy, and I’m getting on a tax-adjusted basis a lot more yield.
I — and then, and then lastly, as a active investor in fixed-income, do I want to be overweight duration or underweight duration, I would say that calling the rate move is a really, really tough one and I think having an appropriate allocation across fixed-income equities and other asset classes is the way, really to think about it.
But I will say, though, I think the Fed’s going to be on hold for a long period of time. And as the 10-year Treasury trades in the — in a range from 50 basis points or 150 basis points and if you get out to 100 basis points, you probably want to own a little bit more interest rate risk. Is the Feds going to be on hold and I think that inflation, particularly in the U.S., is going to stay very modest, well below — well below the Fed’s target.
RITHOLTZ: Interesting. Well, a lot of people agree with you. We continue to see record inflows into fixed income ETFs despite interest rates as low as they are. What are your thoughts about that? Who are the buyers of those fixed-income ETFs? Is that Main Street or is that more of an institutional investor? What — what your thoughts are on the activity in that space?
SWELL: So, we talked a little bit earlier about how fixed income ETFs had been a little bit slower to be adopted because of active managers having more success.
But this year, you’re actually seeing more flows into bond ETFs than you’re seeing in equity ETFs for the first time. So, there’s no question that ETFs are being used much more actively. I would say two main holders, investors.
Number one is the — and you know the world a lot better than I do, the RIA community, the wealth managers in the marketplace that have kind of converted their business model from more of an open-ended model to really one that is driven by liquidity and low fees within ETFs.
Those are, I think, that the — the dominant players. That you’re seeing more model portfolios that include ETFs mainly for the purpose of access to different segments of the marketplace. So, the good thing about ETFs is that you can carve up and you can have an industrial-only or this only, your BB only and so and so on. So, there’s a lot of ability to be able to carve portfolios in a more customized way and the fees are very low.
Secondly is you have some institutional players that use ETFs as a way to either gain very quick exposure intraday or to basically exercise arbitrage in between kind of the cash underlying securities that exist in ETF and the ETF.
I would say that those are the dominant players within the ETF market. There’s no free lunch that ETFs gives an investor. People think that while the liquidity is so much better in ETFs and the liquidity in ETFs, on a day when there’s very little trading, might be a little bit better than the underliers. But in a risk environment and in a credit risk environment, when there’s a risk off or a lot of risk on, liquidity ETFs are only as good as the underlier.
So, I think it really comes down to segmentation, the ability to be able to specifically target certain parts of the market as a RIA or an investor that’s trying to target specific risk. And then secondly, to get lower fees and what’s available in the open-ended — open-ended space.
Now, we, as an active manager, we are, obviously, have the ability to be able to buy bonds, we try to buy bonds that we think can outperform the index. We’ve done a good job of that. We also will use ETFs from time to time, but really, it is a way to get risk on in the market very quickly or in periods of time, where ETF liquidity is better than the cash market.
And one things we’ve seen in the credit markets and the COVID shock is that there was a lot of transparency that existed in ETFs. The physical bond market was frozen, but ETFs still traded. And so, as a result, when you didn’t see a lot of trading in bonds, you actually saw ETFs trade and got a lot of price transparency.
And so, we’ll use that as another source of transfer of risk. And so, you’re finding that a lot of investors are actually using it for that purpose. Short-term trades get exposure and then eventually to work into single-name exposure within a cash market.
RITHOLTZ: So, let’s …
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RITHOLTZ: Let’s stay with that for a minute. Back in March, when everything went sideways and both in equities and bonds, we did see a fairly substantial dislocation in the bond market and some of the ETF pricing looked wildly out of whack. Was it really the underlying that was? The problem there was no pricing and liquidity so ETF traders were just making their best guess? What went wrong back then when the NAVs seem to be not exactly on the money?
SWELL: So, think what happened was that you had a very, very quick move in the cash underlier and then you had a lag in the equity prices of ETFs causing, to some degree, some premiums to be very high or discounts to be very wide. That can happen for a very short period of time.
I will say, though, that at that time, particularly the COVID crisis, in credit, in high-yield and investment-grade credit areas that really froze up and there was a massive lack of price transparency in the cash market, ETFs still traded. Investors, RIA’s individuals, they want to get out.
And so, what happened was was they have to get to a price that can obviously clear the market. But when you’re trading an equity or an ETFs, you have two variables you’re thinking about. One is can I then sell that ETF to somebody else and what price do I need to move it down to be able to bring in an investor. That wasn’t the environment because there were only sellers at the time.
So, what was going on was a estimate by the ETF liquidity providers on what is the right price? How far down are these cash bonds?
Now, I will tell you that the traditional liquidity providers in ETFs are fixed-income experts to a great degree that they can actually do that. So, what happened was players like us jumped in and said, OK, we’ll buy that ETF. We’ll buy it down three points or five points or whatever because we have a a high degree of confidence on how to value the underliers.
So, there was a mismatch for a very short period of time between where equities cleared and what the actual pricing was in the underliers. But it was reality that people just didn’t know what the underliers were worth.
RITHOLTZ: But all told, it sorted itself out pretty quickly and the fact that there was even any liquidity at all is — was quite — quite a surprise. And exactly, players like you are the reason why the ETF prices eventually came back to where they were rational. Am I overstating that or is that …
SWELL: No, absolutely, absolutely accurate. And I will say that this level of dislocation that occurred between the cash market and the ETF market, between the cash and the synthetic marketing credit was very, very, very — I think I said that three times — concerning to the Fed. And this is one of reasons why the Fed decided to do something extremely unprecedented.
The Feds stepped in and said were not just going to buy 12-year treasuries because they are cheap 10-year treasuries, we’re not just going to provide funding to the money markets. We’re not just going to buy agency mortgages to drive down the cost for homeowners and the refinancing, but we’re actually going to give them to credit market because the credit market, and particularly the cash market is frozen, so they now supplant the buy individual bonds, provide direct funding, buy ETFs in the credit market and also extend lending and potential buy municipals as well.
So, very unprecedented action because of these — this kind of dislocations that occurred in the lack of transparency. And what did it do? It actually caused that arbitrage between ETFs and cash bonds to eventually go away and it also reopened the capital markets to allow companies to get back to issued debt to be able to bridge themselves past the economic crisis.
RITHOLTZ: Quit fascinating. Before we get to our favorite questions, I have to at least ask you about some of the funds that your team manages and the four big ones I’m looking at, government income fund, core fixed income fund, bond fund, and strategic income funds, I know compliance gives you limited things you’re allowed to say about them, but broadly, tell us about the strategic differences between those groups?
SWELL: So, government income, if dated, is a combination of government securities as well, the agency mortgage securities, so super high quality, a decent amount of duration there, but not a credit-oriented product.
Core product is a core holding for people. So, we just — we think of 60-40 allocations, something like a core fund, is critical to balance in a portfolio relative to equity and risk assets. The idea in a core found, the investment-grade only, agency mortgages, treasuries, agency debt, as well as investment-grade credit.
And so, our view about it’s really important that you have you — the chunk of your fixed income allocation in superhigh quality to avoid situations that we experience like in the ’07-’08 shock where people had the 60-40 allocation, but when they woke up the next day and rates were down, they figured out that their 40 was also down because it had a lot of credit and subprime mortgages and things like that in there.
So, core is, by definition, core. Then you have our GS Bond product which is more of a — it’s a Bloomberg aggregate product, like core, but it can do high yield and emerging market debt, so it’s intended to be part of your fixed income but have more satellite, higher-return type strategies to increase the yield.
And then strategic, by definition of strategic, it can go kind of anywhere. And so, there, it’s a LIBOR-based product. So, not — it doesn’t have five years or seven years of duration potentially like the other products, but it is a cash-based product where I’s kind of a more of an absolute return product where you can go anywhere within the fixed income markets. And so, that product is trying to generate a little bit, higher levels are recurring, without taking in the interest rate risk.
RITHOLTZ: I’m glad I asked about that. I’m sure our listeners are going to be quite interested in that.
These are our favorite questions that we ask all of our guests. And since we’re talking about COVID and the lockdown, let’s start right — right with that. What are you streaming these days? Give us your favorite work-from-home Netflix, Amazon videos you’re watching?
SWELL: So, favorite on the video side, I would say was a recent movie that I think was very relevant as we were kind of in a very critical election for our country was “The Trial of the Chicago 7.” Not sure if it was Netflix or Amazon Prime but amazing movie about the history of the hippie movement and the protest that the hippies and — went to the Democratic National Convention in Chicago to protest against the Democratic Party, the war and kind of — and then — a number of them got arrested.
And the reason it was — number one, the acting was unbelievable. Sacha Baron Cohen’s in it. He plays Abbie Hoffman and Abbie Hoffman actually went to the same college as me, Brandeis, and so I just found that move to be very telling and its kind of a story about if you think something’s going wrong, speak up and do something about it.
So, I’d say from a movie perspective and streaming, that was — that was definitely number one.
RITHOLTZ: That is my Netflix queue and I’m looking forward to checking that out. Let let’s talk about your early mentors. Who affected the way you look at fixed income? Who helped guide your career?
SWELL: So, I would say that two people, very early in my career, Lehman Brothers had a pretty big impact and it was less about kind of over the course of a long period of time, but single events that had a real big impact on me.
And so, one was this gentleman, Mike McKeever, who had a lot of capital markets. I think he ended up running banking at Lehman. He put me in charge, very early in my career, within the first few months of recounting what happened in the European markets from an issuance overnight so that people, when they came in, they were speaking to clients about the U.S. markets, had some context for what happened in Europe.
And somebody asked me a question about, during the meeting, about a European issuer. And I kind of hesitated and I kind of gave an answer like, yes, that’s what happened, in a way that Mike McKeever very much knew that I didn’t know what I was talking about.
And so, in the meeting, he called out and said, are you a 100 percent sure that on your answer is correct? And I said, not really. He said — and in the meeting he said this is not high school more, this is not college. If you’re not — if you’re not sure, you say you’re not sure and you get back to someone. But you’re talking about people’s careers, our client’s money at stake and you can’t fake it.
And so, obviously, I was distraught and I couldn’t believe that somebody tore me to shreds in front of a lot of people but he was 100 percent right and it kind of helped me very early in my career to take work seriously and that facts matter.
RITHOLTZ: Quite interesting. Let’s talk about books. What are you — some of your favorites and what are you reading currently?
SWELL: A bunch. So, I kind of have a theme in the books that I read, almost all are nonfiction and I would say that the two themes are, I read a lot on investments and I read a lot about income inequality and historical racism in country. And so the few books that I could think of that really kind of had an impact on me was Devil in the Grove which is an amazing book about Thurgood Marshall and his plight into the South, particularly into Florida, to help wrongly accused a black men who were accused of either murders or put in — put in jail for life or actually — actually sentenced to death and to go into these places and defend them.
And I think that’s — there, obviously, had been a lot of books and movies since but this specific story about a gentleman in Florida had a — just a massive impact — impact on me.
Just Mercy is a very similar book, recent movie and a very similar topic. One other on income inequality, “Hillbilly Elegy” which is now there’s a move out. I haven’t seen the movie yet, but I did read the book. And kind of thinking about the broader issues that exists across our country, why there’s a lot of political issues, racist — racism issues, income inequality issues, very, very impactful, impactful book.
And then on the investment side, this is going back a while but David Draiman’s book on contrarian investing had a — had a pretty significant document on me and his book is a lot about behavioral — behavioral science, behavioral economics, and not always following the trend.
So, being a contrarian investor, most bond investors are, but looking at investing from a different lens than everybody else is — had a pretty big impact on me.
RITHOLTZ: Quite fascinating. What sort of advice would you give to a recent college grad who was interested in a career on the fixed income side of the street?
Well, I would say, first off, just in terms of people entering the capital markets, financial markets, any — any part of finance, the most important thing is not to worry about what you’re doing and it’s more to worry about who you’re doing it with and who you’re around.
And I think in the first 5-10 years of your career, don’t worry about what you’re going to be when you grow up. That doesn’t really matter. What matters more is that you’re around smart people that can teach you and are willing to teach you.
And you will then figure out what direction you want to take your — take your career. So, I really that’s important. And on top of that, you want to be in a diverse environment. And the word diversity, obviously, can mean a lot of different things. It can mean diverse, obviously, racial backgrounds, gender, but it also — you want to be around diverse ideas.
And it’s really important. You don’t want to be in an environment where everybody thinks the same. The way you learn is by being exposed to kind of things that are very, very diverse.
So, I think that’s the most important. Don’t worry about what you want to do when you grow up, be around smart people. You’ll figure it out.
RITHOLTZ: Good advice. And our final question, what do you know about the world of investing in fixed income today that you wish you knew 30 years or so ago when you first got started?
SWELL: Well, I’d, first, maybe like to answer the question around just investing overall, giving younger people some advice around investing. I think that the most important thing, develop a plan, stick to the plan and don’t look at it.
And that is true for people who are non-investors but, it’s also true for people who are investors.
We often get scared out of our shorts when we see events occurring and we’ll go to cash because we think we can be smarter than the market. Don’t do that. Develop a plan. Develop a diversified — diversified plan for your investing, and don’t look at it and stay very consistent in terms of — doing terms of investing.
In terms of the fixed-income portion of that, I would say probably the same thing goes by the same token that I thought that rates at eight percent or nine percent, when I started my career, looked pretty expensive because rates, two years or three years prior were 11 or 12 percent, don’t think that you’re smarter than the market.
Think about your client. Think about the type of portfolio and type of risk you want to take and be very thoughtful about asset allocation and diversification. And I think that that is the most important lesson and I think it’s true with regard to an individual and in multi-asset investing and I think it’s also true as a fixed income investor.
RITHOLTZ: Thanks, Mike, for being so generous with your time. We have been speaking with Mike Swell who runs Fixed Income Portfolio Management for Goldman Sachs.
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