Harnessing the Best of What Fixed Income Has to Offer

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  • 57 mins 28 secs
The list of market risks seems to be growing, but so is the variety of tools to mitigate them. In this exclusive Masterclass, three experts from Insight Investment discuss income and ballast in portfolios, why clients need fixed income, the broader benefits of the asset class, central bank policy, ESG, and much more. Insight is the largest BNY Mellon affiliate responsible for over $1.1 trillion in assets under management across fixed income, liability driven investing, and absolute return and unconstrained investing.

Jenna Dagenhart: Hello, and thanks for joining us for this exclusive fixed income masterclass with BNY Mellon and Insight, Investment. Insight is the largest BNY Mellon affiliate responsible for over $1.1 trillion in assets under management across fixed income, liability driven investing, and absolute return and unconstrained investing. Joining us now from inside investment to talk about approaching risk. Why clients need fixed income. The broader benefits of the asset class, central bank policy, and much more, we have Gautam Khanna, Senior Portfolio Manager and Head of Multi-Sector Fixed Income. Brendan Murphy, Head of Global Fixed Income, North America, and Dan Rabasco, Head of Municipal Bonds. Everyone, it's great to have you with us. I'd like to begin by going around and giving our viewers a better sense of your investment philosophies. Gautam, why don't you kick us off?

Gautam Khanna: Sure, [inaudible 00:01:00]. So, my focus is in building broad market fixed income portfolios with a dual objective of providing clients with a higher degree of income derived from high quality, predictable sources, and plenty of diversification against risk events. So fixed income acts as a hedge, if you will, to equity volatility. So that diversification benefit or put simply, balanced is one of the key elements that we're looking for. Fixed income markets can be quite challenging and quite complex. And our goal is to build an efficient portfolio. Harness the best of what fixed income has to offer in a solution that clients can invest in.

Jenna Dagenhart: Brendan, could you talk to us more about income and balance as Gautam mentioned?

Brendan Murphy: Yeah. I think obviously, income and balance are like two critical components of what you're looking for at fixed income. I think for all three of us, there's income and balance exists in terms of the products. They're just three sort of different ways to deliver that income and balance. On that front when you think about global, I think you really want to think about diversification and opportunities set as being the two biggest drivers. Diversification in the sense of having broad exposure to different interest rate and credit markets. An opportunity set, meaning expanding that universe as wide as possible to give the manager the most available sources of alpha that they can deliver. So, in a nutshell, I think a global, I think a diversification. I think of opportunities being the compelling drivers of that.

Jenna Dagenhart: Dan, how would you describe your corner of the investment universe?

Dan Rabasco: Well, our corner is investing client assets and municipal bonds, primarily tax exempt munis. And I'd say our approach is, we look at fundamentals. That's a cornerstone of our approach in investing. Credit is so key to that. We look at the technical landscape. Supply and demand, because with municipal bonds, it's primarily a retail driven market and you have these swings in demand. So that's important to have a really good grasp on the technical picture and then valuations.

Dan Rabasco: So we meld the three together and to deliver [inaudible 00:03:40] income with low volatility, excess returns. And I think both Gautam and Brendan talked about diversification. We strive for diversified portfolios within the municipal asset class. And one thing that we've been doing for quite some time for decades is that focus on revenue bonds, because we can really use our credit skills, take advantage of some of the inefficiency in this retail driven market providing yield and also good total return. So that's our approach to investing. It's an active management approach. It's a disciplined approach investing in municipal bonds for our clients.

Jenna Dagenhart: I think geopolitics is top of mind for many investors right now as well. What are some of the top geopolitical issues that fixed income investors should be paying attention to?

Gautam Khanna: Sure. Let me see if I can address that a part of it and then others, please jump in. I think first and foremost from a geopolitical perspective it's about China. The US and China relations are a little bit strained at the moment. These are the number one and number two economies in the world, and also the biggest share of global economic growth. So it has implications for commodity markets for oil, for supply chains, et cetera. So really, the thrust of thinking about geopolitical risk and contrasting that with, let's say central bank policy risk is really about our relations with China. If we can write the ship in terms of how we are interacting with our second largest economy in the world, that's going to be very important for markets, including fixed income markets, particularly on the credit side of things. So that would be for me the number one risk. Yes, there's other areas, Middle East, Afghanistan, et cetera, that would contribute to a geopolitical risk. But I think those are a far second and third. The primary one really is China.

Brendan Murphy: I totally agree with Gautam. I think the US-China relationship is critical and absolutely at the top of the list in terms of geopolitical concerns right now. I think though, it's also interesting if you think about the definition of geopolitical risk and how global politics in of itself has impacted markets over the last few years. I think we're at an interesting point where for example, policy and in particular, the policy in terms of COVID response has become a really important driver of what's happening in global economies as well as in global markets.

Brendan Murphy: And so, you had very much a global shock that impacted virtually everyone. We saw, I should say very similar responses in terms of trying to support economies, but very different responses in terms of the actual health approaches to tackling the COVID problem. And so, as we're in this period where we're 18 months through it, observing the different reaction functions from different governments and different policy makers across the globe is really going to be important in shaping how we think about markets over the next few months and quarters.

Jenna Dagenhart: Dan, what about the issue of tax policy here in the US? I'm sure that's saying you're paying attention to in the muni space.

Dan Rabasco: Well, we're in the middle of the budget reconciliation, but looking more so medium term and long term. Tax policy is a tailwind for the municipal bond market from the demand standpoint. Tax rates probably going to be going up, personal income tax rate, corporate tax rate. And that gives staying power for the municipal bond market. I mean, what are investors looking for? They're looking to shelter income and having that tax exemption where the coupon interest is not taxable at the federal.

Dan Rabasco: And many times the state level is going to continue to be a driver for demand in our marketplace going forward. And we've seen that with historic amounts of flows into funds in the industry, and we expect it to continue. We expect that demand to continue in a constructive environment for munis. But I wanted to take a step towards the global side of things too. Gautam and Brendan were talking about China. They were talking about COVID.

Dan Rabasco: Global geopolitics does touch munis in a fundamental sense because there's credits out there in the municipal bond market that are tied to the global scene. Port authorities, for instance, airports, in terms of travel, and healthcare too with the COVID situation ban that's being placed on many healthcare providers. So, you know what? Munis indirectly impacted by the geopolitical scene also on a globe from the global sense.

Gautam Khanna: Yeah. I would just add that look, policy is beta and it always is, and it's perhaps even more relevant now where you're in the midst of a pandemic you're in the midst of central bank policy adjustments, perhaps. You're in the midst of tax policy changes. So, policy is very much beta here. So, it's front and center for investors.

Brendan Murphy: It's been a huge driver over the last 18 months, right? I mean, you'd argue that what we've seen in a lot of these markets has been driven by a lot of really extraordinary policy measures. And so, when we think going forward about how long those extraordinary policies remain in place, or they get removed or whatever happens, right? That's likely to be very impactful for markets.

Jenna Dagenhart: Yeah. The Fed's been buying 120 billion of bonds every month. Anyone else want to weigh in on central bank policy? We've been in a low rate environment for so long and now tapering seems to be looming on the horizon.

Brendan Murphy: Yeah. I mean, I can weigh in a little bit. I mean, I think, as I mentioned earlier, seeing tremendous amount of monetary using tremendous amount of fiscal using across the globe. We're at a very interesting juncture right now because as a lot of economies, most economies really stabilize. A lot of them are left in very different places when you look at the growth picture, the inflation picture. The monetary policy stands.

Brendan Murphy: And so, if you look at a place like the US, for example, inflation is running high, probably higher than it normally would. And the labor market, while it's improved a fair amount, still has a fair amount of slack in it. So how the Fed itself handles that situation going forward, how quickly they remove the accommodation is going to be a huge driver, potentially of returns for things like fixed income and equities and things like that.

Brendan Murphy:When you look at broader markets though, and you expand the lens out to places like Europe and Japan, they're not necessarily seeing those same inflationary pressures that you see in the US. So, those central banks might react more slowly, potentially. Other places like the UK, you are seeing extremely elevated levels of inflation right now, and how that the bank of England handles that will be important as well. Some of the emerging markets have already started to tighten policy. So, in places like Russia and places like Mexico, you're seeing rates have already risen and some rate hikes are already coming through. So again, that sort of the differentiated policy response I think is going to be a critical driver.

Gautam Khanna: Yeah. I might add that, look, when you look across the developed world, whether it's Japan or Europe with 0% interest rate policies, the longer we stay at zero bound, the harder it is to get off of zero bound, because there's a little bit of anchoring that occurs. And frankly, the market is a junkie. The market is, it wants more and more and more, whether it needs it or not. And frankly, with the level of strength in the US economy, it sort of begs the question, whether you need emergency level monetary policy and is it not the case that the real economy can handle modestly higher rates from here? And I think the answer to that is probably yes. The market may not like it, but I think the real economy. Is equipped to handle

Dan Rabasco: It in terms of the muni market. Gautam talked about the economy handling it. Market, maybe not. I feel it's market expectations that are important in that, if the Fed becomes a bit more hawkish in their talk and their timing of tapering, they provide a lot of liquidity to the market. There's a lot of cash out there chasing bonds. If that turns out around in a negative way, but the demand isn't there, what happens to the muni market?

Dan Rabasco: We remember the taper tantrum and I'm not saying anything like that would happen. But I just remember the retrenchment of folks getting out of the market. Negative flows. Our curves steepened significantly. If there's even a little width of that to our market, it's something to watch out for, especially in view of the fact, our curve is flat twos to '30s. It's not even 150 basis points, which is flat on a historical basis.

Dan Rabasco: So, there is some risk to the muni market if market expectations don't line up what the Fed actually does. So, I put that out there and that's something we think about. The fundamentals are strong. The technicals have been strong. Valuations are somewhat rich in terms of that flat curve and spreads if there's some sort of disappointment that causes an outflow cycle because of a more aggressive tapering. That's something that we have in the back of our minds.

Brendan Murphy: Yeah. And I would agree with that. I think across all markets, I think the story's the same where valuations are pretty expensive, but on the flip side, the fundamental picture as well as the technical picture is really quite strong. There's a lot of demand for fixing come across all different flavors. Credit quality is generally good. Economies are generally doing well. Central banks are generally airing on the side of being accommodated.

Brendan Murphy: So that's all very supportive, but when the value part's not there, I think it becomes really tricky as a fixed income manager because it depends on your timeframe, right? That those valuations can stay expensive for a really long time potentially, or if the environment changes, you can see the valuation has changed to reflect that. So, I think that's what a lot of fixed income managers myself included are struggle with right now is how long can these valuations remain at these really expensive levels?

Jenna Dagenhart: On the fiscal spending side, we're seeing a lot of headlines around infrastructure. Obviously, this is a tremendous opportunity for the muni landscape. What's your approach to muni investing as you look to the medium long term, Dan?

Dan Rabasco: Well, it's the same approach we've been using for quite some time that I alluded to earlier. We look at the fundamentals. What sectors we feel are stable to positive in terms of their track going forward. We stay away from those obviously that we don't think are on a good track. We look at the technical picture that we keep talking about. What's the demand situation? What's the supply situation?

Dan Rabasco: One interesting thing about infrastructure is this, two thirds of our country's infrastructure has been financed with municipal bonds and partly two trillion dollars over the last decade or so. And munis will continue to be a main source of infrastructure spending. More infrastructure spending, more projects, more economic activity, better delivery of goods and services, more money in the tax coffers and more revenue generate by power utilities and water and sewer utilities.

Dan Rabasco: So, that's kind of like how we look at things. What's a fundamental picture? What's going to change? The technical picture in terms of supply and demand. And Brendan and I are talking about valuations, rich are cheap. And I think what's important to all this, Brendan talked about in this environment, it's tough for a money manager in fixed income where valuations are rich, but at the same time, the fundamental pictures certainty out there.

Dan Rabasco: I think one thing in terms of our investing approach, fundamentals, the foundation, technical's valuations. I repeat ad nauseum. But I think what's really key too is the appropriateness of the risk budget based on all the information you have and the way we approach it is, when volatility's low and spreads are tight like they are now, we don't push the credit envelope. We don't reach for yield. Because when the market turns the other way, whether it was merit Whitney situation or the tapering tantrum, or the Trump trade when munis widened out, that yield that you've reached for dissipates with spread widening.

Dan Rabasco: So basically, in the environment that we're in now, we're not pushing the credit envelope. It's low wall, tight spreads. When the market dislocates, that's when we allocate to your A and triple B rated bonds to build in future earnings potential for the strategies and the potential for price appreciation or spread tightening. So, that's it in terms of our philosophy. Fundamentals, technicals, valuations, and risk budgeting. The appropriateness of it based on the client objectives and where we are in the market and our view going forward. So right now, we're constructive on the market, but we're not reaching for the yield because we don't feel as if our clients are compensated.

Gautam Khanna: I just wanted to make a point as well that even for our broad market portfolios, yes, we don't want to reach for yield, but at the same time, yields are very hard to come by. And our focus is to emphasize the areas of the market where we see strong, fundamental strength, and that could be potential rising stars. So, selectively and high yield as an example, or companies that are very stable almost regardless of what the backdrop is. Perhaps in the cable space, as an example.

Gautam Khanna: Asset backs. Again, capturing a little bit of a complexity premium. So, capturing a higher degree of spread and yield upper unit of risk or a volatility of that particular instrument. So those are areas that we're looking to allocate to. And again, with that view of income and balance, we don't want to mirror the benchmarks because they are very concentrated. Concentrated in government risk. And I think you've heard from the three of us that we think rates could go a little bit higher.

Gautam Khanna: So, we want to have shock absorbers in the portfolio where we are capturing a higher degree of income, and let's not forget the rising stars. So, where do you have potential for price compression and price performance? I should say. So that's all critical, and I would agree that from a philosophy point of view, we think of it as precision and diversification. Be very precise about the risks you're taking. Are they appropriate for the client? Are they appropriate for the alpha target? Are they appropriate given the underlying volatility of the asset? Are you adjusting sizing for the underlying volatility? That's the precision component.

Gautam Khanna: And then the diversification. Acknowledging that we live in a world of uncertainty. And certainly, all three of us have talked about the magnitude of uncertainty that we're living in right now with all of the policy agendas, potentially at a crossroad. So when you put all of that together with a deliberate process that's managed by a team of experts and specialists, what you should see is steady performance. [inaudible 00:21:03] and Europe. That's how we're trying to manage our portfolios.

Brendan Murphy: Yeah. I just add got brought up rising stars, which is, I think a huge opportunity in markets. And as much as I said before, the spreads are tight. The thing, the beauty of a rising star is the spreads can be tight for high yield, right? But as the credit quality improves as the ratings improve, it moves up and credit quality. And so like it rides that credit curve, if you will. And so despite the fact that it looks tight historically as a high yield credit, if it's improving to investment grade, you're going to get a lot of price performance potentially out of that, as it moves up into the new grading category.

Brendan Murphy: So the fundamental analysis, identifying rising stars, the names that you own and being comfortable that you can own them through some volatility, those are all critical components, as well as a really strong, robust risk management process to make sure that, to the extent that if you've missed something or that certain names experience volatility that you don't forecast, that your exposure to those names is limited. So risk management fundamentals. That's I think what's going to drive performance over the next few years.

Dan Rabasco: And couple things I'd add to what Brendan and Gautam just said, as it relates to like muni high yield as the economy is growing rates go up. That's good for high yield muni credit. And to Brendan's point, there could be strong credits out there. Credits that get stronger and add value. So from a high yield contact, yes, that also applies to munis.

Dan Rabasco: The other thing I'd say is this or [inaudible 00:22:46] risk budget that we've touched upon you up, and yep, you know what? Our clients want us to mitigate risk, portfolio risk, market risk, credit risk, trading risk, but as it relates to the portfolio, you have to know where your allocations of risk are. Is it sector, is it security? Is it curve and duration? And those are things that we constantly look at relative to the market environment and where we think the market is going.

Dan Rabasco: And I think the last thing I'd say about this in this environment, that we're in, where there's some uncertainty, okay, rates going up. What's the Fed going to do? Spreads are tight. Security selection is so key and from a fundamentals standpoint, and from the standpoint of being able withstand some of the pressures that might happen in the market. So, it's interesting when we talk about these things, you see the common themes across different areas of fixed income, which is pretty neat, but I just want to add those things in too.

Brendan Murphy: Do you see Dan, when you look at the high yield muni universe, is there much scope for many of those credits to improve in terms of credit quality, or are they kind of permanently in that high yield bucket? Or do you see a lot of ratings migration happen on the munis side?

Jenna Dagenhart: Great question. Yeah.

Dan Rabasco: Yeah. That's a really good question. In terms of ratings migration, you do see some in maybe the CCR space, continuing care retirement center space, where you might have a strong double B. And let's say the independent living units and assisted living units are filled and the fees are strong and there's a good track record. You could see migration to triple B, for instance, in that sector. I think some of the others are pretty speculative out there like the [inaudible 00:24:46]. And again, you have to see the development come through for those to get into triple B. I think what's dominated the high yield space has been Puerto Rico, and we haven't seen much of a migration yet there in terms of rating, but they are working out of their problems.

Dan Rabasco: So I see on the margin. You do see some ratings migration. I think one thing that we're seeing right now, when we're talking about this the other day is such a weakening in [inaudible 00:25:17] and security provision features in the high yield space, and as this demand for yield kind of blinds itself to those important security features and the issues are taking advantage of that. So again, security selection is so key in the muni high yield space. But getting back to your original question, there's some ratings migration, but it's at the margin, but I'd say, somewhat static. But as this economy grows, it could be a little bit more.

Gautam Khanna: Yeah. I would say the punchline is beta is not cheap, but that doesn't mean there aren't things to do. And yeah, bottom up security selection is going to be critical.

Jenna Dagenhart: Yeah. And more and more people are factoring in ESG as they approach security selection. How are you thinking about ESG, Dan in the muni space specifically?

Dan Rabasco: Well, I think municipal bonds are inherently ESG in many ways. The sustainability aspect of it. If you think of this way, E, environmental, right? Water and sewer bonds, water treatment plants, mass transit. Power utilities that are moving more to renewable resources. I mean, that's like environmental right there. Right? So muni bonds are pretty well positioned there from a social standpoint, higher education healthcare. Those are really, really key social aspects to municipal bond finance that fall under the social.

Dan Rabasco: And then from a governance standpoint, how is a municipality handling its pension situation? Are they susceptible to cyber attacks? So I think munis really align well with ESG and getting back to environmental climate change. I mean, that's a growing risk to municipalities. I mean, they're on the front line, whether it's Louisiana or Florida or California with the wildfires or drug conditions in the bread basket. That impacts municipal credits, and are they taking sustainability resiliency efforts more importantly? So ESG lines up with munis. And then from a demand standpoint, there's more investor focus on ESG. And there's mandates out there where investors are looking for ESG focus, type investing. And I think municipal finance is really lined up well in meeting that demand.

Jenna Dagenhart: Yeah. Such a growing list of risks out there. I mean, Dan mentioned cybersecurity, something we didn't have to worry about many years ago. And there's also a growing list of tools to help mitigate some of these risks, but on the topic of risk management, Brendan, let's talk about currency hedging. How are you thinking about that?

Brendan Murphy: Yeah, so we run a couple different strategies. Some that are largely currency hedged, some that are not. When you think about that decision, it's hugely important, right? In terms of the risk profile of what you're investing. So, as I mentioned earlier in the discussion, you want to buy global because of the diversification, because of the opportunity set that's available to you. When you currency hedge though, you reduce some of the risks associated with that, particularly in the currency side.

Brendan Murphy: And so if you look at a currency hedge global fixed income portfolio, you get a risk and return profile that's more similar to a traditional US domestic fixed income type portfolio. If you make a decision that you want to take the currency risk associated with those investments, you're going to get something that's more volatile quite frankly. And that can be a good thing in periods where the US dollar is weak. We could go against you a bit in the periods where the dollar is strong. That can be something that fits in very nicely in an individual investor's opportunity set, depending on what they're trying to accomplish. It could also be an instrument that performs really, really well if we're in a period of sustained dollar weakness.

Brendan Murphy: So, from my perspective, we use currency as an alpha driver. We use a small amount of currency based on our fundamental views of things that we want to be overweight, underweight to try to add value to portfolios. But I like to try to leave the decision to the investor themselves in terms of what they're trying to achieve. If they want a large currency hedge product or one that's unhedged. To do that, essentially what we're doing is we're using things like currency forwards to hedge out the currency risk associated with individual bonds.

Brendan Murphy: So we'll buy global bonds, denominate in euros, yen and Australian dollar, Canadian dollar, whatever it may be, but then use currency forwards to try to hedge out that currency risk that's associated with. And like I said before, when you do that, you get a return stream that's going to look more like a traditional US fixed income return stream [inaudible 00:32:15] in its nature.

Jenna Dagenhart: And a lot has changed within the past 18 months as we've been discussing today. How has that changed your approach, Gautam?

Gautam Khanna: So, just from a philosophical perspective, no changes. Obviously, the pandemic was something that came out of left wheel, if you will. It wasn't an economic item until it became one and forced our hand. But it's the same process. It's all about understanding from a top down perspective, what are the forces that are impacting economic growth? What does that mean for the various sectors and sub sectors of the market, the economy? And then that translates into a view on where we see value from a bottom up perspective.

Gautam Khanna: I will add that we at Insight have a very large investment team, but when you look at the resources, how they're allocated, we're allocating heavily into the less efficient parts of the market. Because we want to be adding value and we can do that in the areas of the market that are less efficient. So that emphasis has only gone up. We talked about geopolitics earlier in China. So, as that policy risk is evaluated, what does that imply for commodity companies? Metals and mining as an example. The property sector, of course, front and center these day in China.

Gautam Khanna: So, it's even more of the same if that makes sense. We already had a very durable and a deliberate investment process and we're leaning even more so on. It is to try to take the emotion out, try to be as objective as we can be and try to do the right thing in terms of delivering that balance of income and balance. And not chase yield just for the heck of chasing yield. Of course, you can go out and buy and load up on EM and maximize the yield, but that comes with a cost. And that cost is a heightened level of volatility. So we try to manage using tracking error of all as a metric for how much risk we allocate to the different parts of the market. And that's really it. Nothing has changed. It's just reemphasizing the philosophy, reemphasizing the process.

Dan Rabasco: I like what you said Gautam about taking the emotion out. When COVID hit in the spring of 20, our market dislocated significantly. Folks worried about muni credit. There was a lack of conviction out there. And we said, "Okay. Let's take a step back. What is happening?" We're seeing more federal support. We have seen, for instance, the airport sector was already flush with cash. That could be a bridge to get over a period where we were fishing for attempts to combat COVID vaccination, et cetera.

Dan Rabasco: But we said, you know what? These are fundamentally strong credits. We're surveying the landscape. There's going to be some support on the way. They were already in good shape already. I mean, municipalities had good reserves set up. So we didn't panic, and we showed that fundamental conviction and maintained our holdings of these bonds and it turned out well for the investors. So yeah, that whole part about the emotion. I mean, being in a retail driven inefficient market like ours, there's a fair amount of motion when people run for the exits. We want to be on the other side of the trade. And those people running for the exits and are forced to sell, we want to be the buyers to bring those bonds in at attractive valuations. So that I thought there was a pretty cool way of putting it, taking the emotion out.

Gautam Khanna: Yeah. You raise a good point. Thinking back to late first quarter or early second quarter, we were in the midst of an economic shutdown and it was unclear as to when the economy would reopen. So some of the who's who of corporate America were issuing debt to shore up balance sheets and bolster liquidity because, and good management teams tend to do that. And they were issuing at spreads that just a few weeks prior to the pandemic hitting was where high yield companies were issuing.

Gautam Khanna: So it was an incredible opportunity. And indeed having taken the emotion out and thought about what was the nature of these businesses and what the policy response was likely to look like, we added significantly in the corporate credit area. Certainly starting with some of the higher quality investment grade names, and then very quickly transitioned away from that because what we were hoping for price performance from a spread compression perspective played out very quickly. So, that was that opportunity was short lived but we did take full advantage with that.

Brendan Murphy: Yeah. We did the same thing, and I think one of the things that we had to adjust a little bit in terms of the philosophy, if you will at that time, was just thinking about sort of the expected timeframe for the investment, right? In the sense that typically we operate on a six month time horizon thinking about if we can achieve value. At that point, there was such so many big opportunities in the markets, but it was hard to know if that six months was enough time to realize value in it. Right?

Brendan Murphy: So for us, we focused on super high quality credits where we're certain even if the pandemic and the COVID situation lasted longer than... It was a high degree of uncertainty, right? About how long it was going to last. So you had to focus on the really highest quality parts of the market where you knew even if the situation lasted longer than you thought that you were going to be okay from a creditor standpoint.

Brendan Murphy: And so, that meant in some cases thinking a little bit on longer term time horizon, right? Knowing that, well, this might not work over the next couple months, but I guarantee you that over the next year or two, that we're going to be glad that we bought it. So, being flexible in terms of your time horizon, I think is important as well.

Gautam Khanna: Yeah. That's spot on.

Jenna Dagenhart: Yeah. These are all great points and really interesting how Brendan mentions all the uncertainties out there and it feels like everything's changed in the past 18 months. And yet at the same time, as Gautam mentioned, nothing has changed with your philosophy. I think this kind of begs the question. Do clients need fixed income regardless of the market climate?

Gautam Khanna: Yeah. Let me address that and I can start there. Absolutely. Because fixed income, certainly as you approach your retirement years, you want contractual cash flow in your portfolio. In fact, what is the difference between fixed income and equities? It's that contractual cash flow. And of course we all want more of it, not less. Now, yields are where they are, but when you look across the globe, at least in the develop world, the US is still quite attractive in as far as fixed income is concerned relative to other parts of the world. And it does provide that balance that, that diversification.

Gautam Khanna: So, you better believe if a risk event were to occur China or otherwise, and equities are tumbling that the number one flight to quality asset class is going to be the 10 year bond. And if you own zero of that, you don't have that natural diversification benefit in a portfolio that might include equities and commodities and other things.

Gautam Khanna: So, fixed income is always relevant, but to varying degrees depending on what is happening from a macro perspective. But I would say it's critical. I mean, look at where the German bond trades cross the curve it's negative. So, you know if something catastrophic were to occur, we have a long way to go in US yields.

Brendan Murphy: I feel like for my entire investment career, people have been telling me that bond yields are too low. We've done nothing but either stay low or go lower, essentially in the 20 odd years that I've been doing this. The times of severe market stress, 2008, for example, every few years there's severe market stress where people are very happy that they had fixed income to provide that balance in their portfolio. And you're not always going to need that, right?

Brendan Murphy: But I'd argue that we are at a point in time where equities markets have had a tremendous run for a very long period of time. And my suspicion is that the ballast element is going to come more into play over coming years. The income element is there the time, right? That's always a nice carry component that you have to fall back on even when the balance part is not working. But I think going forward people will be happy that they had some fixed income exposure.

Dan Rabasco: I got a kick out of what you said, Brendan, about how you've been hearing this story in terms of yields being too low for quite some time. I was reflecting on that yesterday. And when muni yields were at 5%, they were saying yields are too low, but to the point of diversification, I think it's totally spot on to get risk adjusted returns over time. You need to have a fixed income component. And of course I'm partial to munis, and municipal bonds are negatively correlated to the S&P 500. And low correlations, of course, relative to EM and corporate bonds, not to step on your toes there.

Dan Rabasco: But I think fixed income always has a place for that reason. Not only the income stream but the diversification aspect. So I agree with what Brendan and Gotham are saying that it should play a part. I think it should play a part before retirement as you build that nest egg to get those swings of the risk assets not having an order to impact. So I totally agree.

Jenna Dagenhart: Yeah. To quickly follow up on that point about retirement. Why do you think some people only attribute fixed income to retirement planning? Do you think they should reconsider this opinion?

Dan Rabasco: I think they should reconsider it. I mean, like Gautam was saying, folks are looking for that dependable income stream and when we're all at that retirement age, that's what we want. Right? Even though maybe equities play a part and help your portfolio grow a tad because life expectancies, thank goodness are pretty long. But I think that's the reason people want dependable income stream in their retirement years. But I think before that, fixed income should play a part. It definitely should in terms of risk adjusted returns, but...

Gautam Khanna: Yeah. I was going to say, you want to look at it in a portfolio context, so, if you don't own any fixed income, then perhaps your equity portfolio may own less grow. It may have some more utilities and telecom and other things, but somehow you need to manage the totality of the risk and volatility of your portfolio. So if you have a fixed income asset allocation that you know is going to provide balance, and it's going to pay to edge during periods of stress volatility, then you can go for small cap growth. You can have some of that high tech asset allocation, because, you know you have something else in the portfolio that's going to help dampen that volatility when it arises, and we know it does it. It inevitably does. So that's why it makes sense.

Brendan Murphy: And I also important as a source of liquidity, right? The sense of, I think people typically think in a retirement sense because that's when you're drawing on your money from liquidity standpoint, so you don't want big adverse price shocks at the time you need to withdraw your money. But as we all know throughout life, there's different periods where you need liquidity for different things, right?

Brendan Murphy: And so having some portion, even at a younger age of your portfolio in fixed income which is going to have a more stable return stream means that when you need to access that money for the down payment on the house then the equity market just fell 15%, that you don't necessarily need to go into the equity market to get that money. Right? You can draw that from the more stable fixed income source. So I do think it's important obviously likely to be a lower part of your asset allocation at a younger age than is higher age, but it certainly should be some meaningful part of your allocation [inaudible 00:46:31] age.

Dan Rabasco: Yeah. Look it as an anchor, right? Anchor to the portfolio from liquidity stance and also a diversification aspect. It's there. If you're saving for college educations, you have a portion in fixed income and then another portion in equities, but that's the anchor that you can tap like Brendan's talking about, so.

Jenna Dagenhart: Also, any unexpected expenses that arise. Sometimes the only certainties are that there will be uncertainties in life at various points in time. Now, going back to your specific corners of the fixed income, why is it important to look beyond the US for opportunities in fixed income, Brendan?

Brendan Murphy: So I think particularly right now, the most important reason is to think about where your interest rate risk is coming from, right? So, there's a number of risks with fixed income. Two of the biggest are inflation and duration, right? So, to the extent that inflation moves higher than people expect that [inaudible 00:47:41] negative and central banks respond by tightening policy. The fact that fixed income has duration means that that's going to be a headwind for fixed income returns in that environment.

Brendan Murphy: So when you think about global fixed income, the biggest benefit in my mind is that you're diversifying that interest rate risk, right? So, most products that are US-focused, most of that interest rate risk is going to lie in the US and be dependent on the Fed. With a global fixed income product, you're diversifying that much more broadly. So you do have exposure to the US and the Fed, but you also have exposure to Europe, to Japan, to China, to Australia, whatever, whatever the country might be.

Brendan Murphy: And that's important, particularly, potentially over the next few years where central banks might be looking to hybrids to know they're going to do that at varying paces. And some may not even do it. Some may do it more than others. And so having that diversification I think is going to be very important over the next few years, particularly if we're in an environment where the Fed is raising rates. Now, I don't necessarily think the Fed is going to raise rates super aggressively. I think they will raise rates to a certain degree. It might not be to the extent that people foresee, but even in that environment, I think having that global diversification is going to help you.

Gautam Khanna: Can I just add something? So, the US is the largest deepest, broadest capital market in the world. So there's plenty of opportunity here to get diversification. But I agree with Brendan that to the extent that there are assets that are domiciled outside of the US that provide a diversification benefit to a fixed income portfolio, it's definitely a accretive. And we do that as well. It's not that we are tied to just owning US domicile assets. If there's something that is non-US, that is accretive, we will own it. So we are also global in that sense, even though that's not theoretically the direct mandate.

Brendan Murphy: There's other ways too to think about your US fixed income exposure on a sector basis where you can also very much diversify that interest rate risk that's embedded in there, right? So, US treasury yields may be rising a lot. Those prices may be under pressure, but that doesn't necessarily mean that the US corporate bond universe is behaving in the same way. And in fact, it may be behaving much better. So, there's different ways of diversification. Country is one, obviously, sector is another one. And so, you really got to be able to incorporate all those into your construction and your portfolio.

Dan Rabasco: I was just going to put myself in the shoes of an overseas investor in terms of diversification and taxable municipal bonds. Smaller subset of our market, maybe half a trillion or there about, but an important part of the market shares a lot of the same characteristics in terms of credit quality. We've seen global demand for taxable munis and why is that the overseas investor is looking for yield? I think one of the participant as Brendan and Gautam talked about bonds being negative across the curve.

Dan Rabasco: You've got taxable municipal bonds that are giving you 1.5%, 2% yield with strong credit quality. That's been appealing to the global investor along with the diversification aspects we've talked about in the high quality asset class that is with minuscule default rates. So kind of like flipping it there, but global investors looking for diversification have been buying taxable municipal bonds. So, I wanted to put that out there from a global aspect.

Jenna Dagenhart: Yeah. That's a really interesting point, Dan. And how should everyday investors be using various muni strategies in their portfolios?

Dan Rabasco: Well, I'd say the main thesis is if you're a US taxpayer and you want to avoid taxes, shelter some income, that's the place to be. And I think how you can use the different strategies is the following. If you've got a risk tolerance, you go into the high yields type strategies. You get that yield, you're willing to make a commitment to the manager and that they do a great job at security selection, avoid defaults or a fair amount of defaults.

Dan Rabasco: So I think that can play a part in investors wanting to dabble in the muni market. And then there's other strategies whether it's shorter or intermediate or higher quality. Again, the bottom line is, you're able to shelter income from taxes. So, we've talked about the diversification aspects too. The negative correlations to equities. So from a total return standpoint, getting some tax exempted income, municipals can play a part. And there's various strategies that can appeal to the personal preferences of the investor.

Gautam Khanna: Yeah. I would concede to Dan is saying that that tax is increasingly important. So yeah, I would agree.

Jenna Dagenhart: Yeah. And Gautam, it's pretty [inaudible 00:53:17] named. But why is core plus an important part of an investor's portfolio now in this kind of environment?

Gautam Khanna: Well, it should form the base foundation of your portfolio. It's that part of the portfolio where you are getting your income and balance from. It also provides that diversification benefit during bouts of volatility. Equity markets, I think Brendan said they have had a very long and strong run up post the pandemic and there's uncertainties that are building, policy related uncertainties. So having that base foundation of your broadly diversified portfolio which includes things like core and core plus and global, I would say, should provide a nice offset.

Gautam Khanna: And it goes back to that idea of contractual income. In periods of uncertainty, you want that contractual cash flow that you are going to get year end year out, month in, month out, quarter in quarter out. So that should really form the base of the portfolio, and then you layer on top of that other specialized areas that will be extra kickers. And then a core plus strategy is designed to be efficient. We use the right amount of high yield, the right amount of asset backs based on mathematics. So it's not willy nilly asset allocation. It's based on particular understanding of the underlying volatility. What the value is. I think we talked about that earlier, as well as part of our process. It's combining all of those things and it's a very nice solution for most investors.

Jenna Dagenhart: And of course, Insight has a strong heritage of LDI. How does that fit into your strategies?

Gautam Khanna: Well, it's really about certainty of outcome. So Insight's entire LDI program and success there is delivering on a particular outcome, whatever that outcome may be. It's matching the cash flow to your cash need. And while these strategies are not LDI, that LDI heritage of delivering precision. Delivering certainty of outcome. All of that is part and parcel of the DNA of the firm.

Gautam Khanna: And so, as we are thinking about building an efficient portfolio, I've been known to say the ag is the inefficient frontier. So what does that mean? And what is the efficient frontier? Well, core plus is the efficient frontier. It's a much better risk reward than the plain vanilla benchmark. So that's the LDI heritage that also comes into play.

Brendan Murphy: I would just add. So I have actually just joined Insight fairly recently and cannot say enough how impressive it is. The culture that's in place there around the LDI heritage, the certainty of outcome. The risk management policies that are put in place and the approach to risk management is really quite robust, and really quite well thought out and frankly, just very impressive.

Dan Rabasco: And I'm a new addition to Insight also, relatively new with Brendan. And that certainty of outcome that is a cornerstone for Insight and the approach, I think really resonated with me, because municipal bonds, what are investors looking for? They're looking for tax exempt income and total return, but also preservation of principle.

Dan Rabasco: And it seems like certainty of outcome really lines up with what muni investors are looking for and the risk management side of things also, I think. We just, in terms of our addition to Insight, philosophies lined up well, in terms of fundamentals, technicals valuations, the approach, appropriate risk budgeting. But I really like that certainty of outcome aspect. I think it really defines itself with muni investors too.

Jenna Dagenhart: Well, we could go on and on, but we better leave it there because we're about out of time. Everyone. Thank you so much for joining us.

Gautam Khanna: Thank you.

Brendan Murphy: Thank you.

Dan Rabasco: Thank you.

Jenna Dagenhart: And thank you for watching this exclusive fixed income masterclass with BNY Mellon and Insight Investment. Once again, I was joined by Gautam Khanna, Senior Portfolio Manager and Head of Multi-Sector Fixed Income, Brendan Murphy, Head of Global Fixed Income North America, and Dan Rabasco, Head of Municipal Bonds. And I'm Jenna Dagenhart with Asset TV.




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