MASTERCLASS: Fixed Income February 2023

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  • 52 mins 20 secs
Three experts look back on the unprecedented year that was 2022, so that they can look forward to new opportunities in 2023. They cover various topics and outlooks within fixed income, including high yield vs. low yield bonds, updating investment strategies, and where they're seeing the best opportunities in the space.
  • Brian Kennedy, VP, Portfolio Manager - Loomis, Sayles & Company
  • Jim Robinson, CEO - Robinson Capital Management
  • Tom Carney, CFA®, Co-head of Fixed Income & Portfolio Manager - Weitz Investments


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Jonathan: The traditional relationship between fixed income assets and equities went off kilter in 2022, as central banks raised interest rates globally in an effort to curb runaway inflation. Instead of acting as a portfolio ballast with a negative correlation to more volatile investment types like equities, fixed income became known for its volatility and positive correlation to equities in 2022.

Unfortunately, that positive correlation went in a negative direction as almost all asset classes took a hit. The Bloomberg Global aggregate bond index was down 16% last year, and the Financial Times reported that a broad gauge of fixed income assets around the world lost 15% of value in 2022.

Investors fled fixed income, but now the tides have turned and fixed income has become one of the areas of greatest interest for investors in the new year. Joining me to discuss the state of the fixed income market are Brian Kennedy, Vice President and Portfolio Manager at Loomis, Sayles & Company, Jim Robinson, CEO of Robinson Capital, and Tom Carney, co-head of Fixed Income and Portfolio Manager at White's Investment.

Gentlemen, thank you for joining us. Brian, persistent inflation and Central Bank's reaction to it were key drivers behind much of the market malaise in 2022. From your team's perspective, what is the likely path of US inflation from this point forward?

Brian Kennedy: Inflation in the US has peaked for this cycle. As many things are, we think inflation's cyclical. All five forces that drove inflation recently are in retreat: rents, margin expansion, food prices, energy, and wages. Wages being really the last one to start to come down most recently.

The market continues to want to price in a soft landing for the US economy and a return to the 2% inflation years that we experienced pre-COVID. According to inflation break-evens, if you look at where they're priced right now, we're not of the opinion that that's the path we're headed down. We never bought into the transient inflation story.

They're secular headwinds, two below 2% inflation narrative. We think inflation's going to remain in the two and a half to three and a half percent area this year thinking about C P I. That's above the Fed's target, which could put them in a tricky spot later this year if growth slows substantially and inflation's still above their mandate.

And finally, I would just keep an eye on commodity prices with China emerging from their zero COVID policies and European growth, given what's been a warm winter so far and really the Europeans avoiding the worst of the energy situations. So recent PMI readings in China are back in expansionary territory and economic activity in Europe may be better than forecasted and both could be inflationary in the second half of this year.

Jonathan: Jim, coming out of the carnage of 2022, is it safe to get back into fixed income right now?

Jim Robinson:Well, it's certainly safer. If Brian's forecast is accurate with regard to inflation, rates may continue to stay elevated or perhaps even return to levels they were back in October.

But if you go back to the beginning of last year, yields were so low across all fixed income indices that a 20 to 30 basis point increase in rates, would essentially wipe out an entire year's worth of income. And now rates have come up considerably since then where bond indices can withstand 60 to 70 basis points of rate increases and still generate positive income.

So, it's definitely safer. It remains to be seen if it's safe.

Jonathan: Tom, do you expect the US to enter into a recession in 2023? And if so, how is that influencing your portfolio allocation, particularly in high-yield?

Tom Carney: Thanks, Jonathan.

Well, recessions are always inevitable. It's the timing that's always unknown, at least with certainty. One often can't be sure a recession is even occurring until you're already in it. Given the textbook definition of recessions of two consecutive quarterly declines of GDP, it might have already had it back in Q1 and Q2 of '22.

As to 2023 recessionary possibilities, our investment process is enlightened but not predicated on near term predictions. Those of us who live through 2020, it certainly provided, thus with a front row seat, on the use, fullness or not, of predictions because that unprecedented time in market history re-reminded us at least that our job as stewards of capital for our investors and for ourselves as co-investors is the importance of being aware of where we might be in a cycle.

Certainly Brian and Jim alluded to some of those comments just recently. We try to take the market's temperature, if you will, borrowing from Howard Marks at Oak Tree as he often suggests. But we need to be prepared to react always to changing inputs that drive market pricing, and therefore investment opportunities.

And an essential part of that preparedness is always having true liquidity to take advantage of market dislocations. Today, there's few canaries in the coal mine, if you will, that would point toward recessionary problems or issues. The three month to 10 year inversion has certainly been pretty predictive in the past. That would certainly be one.

But given where employment is currently, 50 plus year lows, it really doesn't seem to suggest that recession is imminent, although that's definitely a lagging indicator. Credit spreads, another canary oftentimes to recessionary warning signs, aren't necessarily forecasting that either. Because as Jim said, yields were so low a year ago, but so were spreads as well. Investment grade and high-yield.

And while spreads rose pretty meaningfully throughout '22, they've really retraced a lot of those levels since the summer, third quarter of last year. As to portfolio allocation for us, it always comes down to a competition for capital across multiple asset classes, whether that's higher or lower quality.

Last year's historic pace of monetary policy action that resulted in the steepest, shortest increase in short-term interest rates since the Fed started targeting the fed funds rate in the 1980s, definitely presented investors with all kinds of opportunities that weren't there over a year ago.

And this certainly led to meaningful increase in volatility, wider credit spreads. And while high-yield spreads peaked in the second quarter sometime around July of '22, doubling from a low over around 300 option adjusted spreads to base rate treasuries to around 600, the length of time that those spreads remained at elevated levels didn't last very long. And it's now closer to 425 spread.

Last year, we certainly acted more meaningfully in higher quality assets as investment grade spreads rose so materially, coupled with that increase in the base rates, underlying treasury rates, which we believe presented a more favorable risk/reward opportunity for us in the portfolios that we manage.

Today, given the retracement in high-yield spreads from their '22 peak and a Fed still intent on slowing the economy down, hopefully not to a screeching halt or thrown it in reverse via recession, we intend to be even more selective in our exposure to high-yield focusing on companies with pricing power and lower leverage given the current overall levels of credit spreads broadly.

Jonathan: Brian, how are you and your team assessing the fixed income markets today versus a year ago?

Brian Kennedy: Yeah, the list of things that are the same are a lot smaller than the list of things that are different from a year ago. That's for sure. I guess I would sum it up by saying there's yield in the fixed income markets again, and I know Tom and Jim have both referenced that. And that does provide you with a cushion, which is great. And it does provide you with income and an attractive asset class when you're comparing to other areas of the market.

If I think about the corporate markets, spreads are wider than they were a year ago, both on the investment grade side and the high-yield side, although they are off the wides, as Tom mentioned, of last fall. We're also much closer to the end of the rate hiking cycle in the developed world than we were at this time last year.

The potential for growth surprises exists, and I think that that could be good for emerging markets and also for potentially some other areas as well. So if I think about the opportunity set that's out there today, there are some opportunities for sure in there.

I think about cyclical areas like energy, commodities, non-dollar denominated securities that could be ideas this year. The securitized space continues to hold potential in our minds, as well. Traditional high quality CLO buyers are missing from the market. That offers an opportunity to add to very high quality tranches at attractive levels.

But the one thing to remember here is that all of this is being done in the backdrop of liquidity being taken out of the global markets in the form of interest rate rises and also QT. And so while there are opportunities, they're not without the potential for misstep this year.

So this is a year of transition, for sure. I do think that yield advantage plays a critical role in the performance this year, but you do have a cushion against either higher rates, wider spreads this time. I think the large negative returns that we saw last year would be really hard to repeat at this point for the next 12 months.

Jonathan: Tom, the bond market seems to be changing at unprecedented speeds. Investors pulled $216 billion from taxable bond funds, 119 billion from muni-bond funds, and 529 billion from active bond funds last year.

But we've just seen three consecutive weeks of inflows to bond funds. What are some of the paths forward you could see happening for 2023 and beyond?

Tom Carney: Yeah, I think Brian just really highlighted some of the of those key attributes, but I'd liken it to thinking about the volatility that really shocked people into inactivity last year. Whether you used the move index, which tends to measure the volatility around the fixed income markets or VIX, on the equity side really spiking so meaningfully that there was a number of investors, a number of classes of investors, that seemed to have been based on fun flows and activity frozen.

And certainly Jonathan, you highlighted some who just decided to take a powder, to take a pause for a while. But I would think the path going forward is a function of a little bit what we've already talked about. That for the first time in seemingly forever, and no, that's not a Frozen sing along. But for the first time in 10 years almost, we've had the opportunity to present investors with actual returns, cash flow returns, largely due to what's happened to the fed funds rate that we went from zero and maybe hopefully forever away from that acronym ZIRP, zero interest rate, policy and above 4%.

And we rarely hit two, post the great financial crisis, so of '08, '09. So now we're above four. You tack on some credit spreads, and this really presents a very interesting environment for coupon return, which hasn't been present for such a long time. So that certainly is an attractive point to highlight regarding '23 and hopefully beyond.

But naturally, too, given the over-leveraged global marketplace, certainly the US, the path unfortunately, hopefully, doesn't lead back to where we were before. We should just probably enjoy, in the meantime, this opportunity to earn returns that potentially could become a bit more real as inflation comes down from obviously very high levels to maybe more sustainable around the three, hopefully sub 5%.

And so, I think that we're going to see, again, more volatility but less likely than we certainly experienced in 2022.

Jonathan: Jim, given their use of leverage, how did closed-end funds hold up in 2022?

Jim Robinson: Well, in a word, they got crushed. Tax-exempt closed-end funds were down 24%. Taxable fixed income closed-end funds were down 20%. It was, as they say, the perfect storm. For taxable funds, their cost of leverage went up one for one with the fed rate hike, so up 425 basis points last year.

For tax-exempt funds, they went up about 60% of that rate, so one minus the tax rate. So they went up about 260 basis points in terms of their cost of leverage. On top of that, the underlying funds that are now levered 50% went down roughly one and a half times what the underlying market did, which was, as we all know, historic last year.

And then on top of that, because of the retail nature... Tom, alluded to this, certain asset classes where investors seem to be on strike, retail investors in the closed-end fund space fall into that category.

Discounts widened out roughly seven and a half percent across all closed end funds last year. So as you know, we managed two mutual funds, one that Arbitrages tax-exempt closed-end funds, the other that Arbitrages taxable closed-end funds. Both of those strategies struggled last year.

We're never happy about losing money in any period, but we do take some comfort in knowing that, because of the interest rate risk hedges that we utilize, some of the credit hedges that we utilize, and the fact that we started last year with closed-end fund discounts pretty much being non-existent, we spent the first six months of the year about 50% underweight closed-end funds.

So we avoided a fair amount of the discount widening. So all in, because of our hedges and because of the active management, our investors in our tax-exempt fund performed about 15% better than they would have, had they been in unhedged unmanaged closed-funds.

And our taxable investors were about 12 and a half percent better than the unhedged unmanaged closed-end funds.

Jonathan: Brian, what is your current strategy around portfolio duration?

And your team security selection process focuses on six pillars. Can you briefly describe your team security selection process, and which of those pillars are most relevant today?

Brian Kennedy: We spent the last year really short on a duration standpoint. I think about the flexibility that our strategies allow us and really the low interest rate environment and really the extension of duration on some of the indices. And so, being more of a benchmark agnostic type of manager, we were really able to take advantage of that.

We spent the better part of the portion of last year significantly short, our benchmarks in some cases three plus years short, if you think about the gov credit and the ag. We've recently added duration to get back to flat. We've been adding duration over the last year to help us get back to flat duration versus our benchmarks.

In essence, we think the majority of the move in rates is over. We think the 10 year is likely to trade in a range somewhere between three and 4% this year. And certainly that's a long way from where we were a year ago, again when we were three plus years short.

I look back to last year, returns and fixed income across the board were terrible. From our standpoint, if I could take one thing away from it, it was that the yield curve positioning generated some excess return and saved some principle loss in that standpoint. Typically, security selection, sector selection, drive most of our alpha generation. In 2023, we expect that yield advantage associated with security and sector selection will be the primary drivers of our alpha again.

And when I think about that alpha, it really does come from the security selection that comes off of what we call our six pillars of bottom-up security selection. And if I think about some of those pillars today, and how relevant they are, I'd say four of the six today are really relevant.

First one being upgrade candidates, rising stars. We've seen a tremendous amount of companies crossover from high-yield into investment grade recently. We still think that there are some candidates out there that can do that, whether it's over the next six months or over the next couple of years. So that's an area that we continue to focus on with our high-yield allocations.

As we come into the end of this credit cycle, and really the later stages of this expansion, we want to be careful about avoiding the losers and that's another one of the pillars in here. And sometimes you can win by not losing in these portfolios. And so we want to be careful about security selection as we get closer to an economic slowdown.

Certainly cheap for rating is another pillar that we're always identifying and looking for bonds that we think could possibly be on a fundamentally upward turning trajectory, as far as their ratings are concerned. That's something we continue to look for.

And then finally, new issue premiums. When I look at the new issue market today, are we getting a premium to be in a particular company where they already have existing bonds in the marketplace? And that can ebb and flow depending on the liquidity in the marketplace.

I'd say two more pillars that we think could be of interest in the future. One would be the stressed and distressed sectors of the market. We're not seeing a lot of that right now. We're certainly keeping our eye out for it. And if global economies do slow, we're likely to see a bigger cohort that we can pick from there.

And then finally, fallen angels. I talked about upgrade candidates, I talked about rising stars, but certainly if we do see an economic slowdown, we will start to see some downgrades. And typically, fallen angels can be some of your best performers and so we'll be on the lookout for those as well.

So those are the six pillars. I'd say again, four of them today really are things that we're identifying and using in the portfolios.

Jonathan: Tom, given the inverted yield curve with short maturities, offering high-yields, do you expect higher near term returns for short duration strategies?

Tom Carney: Well, 2023 so far has proven that not to be the case. As we started the year, we certainly had an inverted yield curve and higher short-term yields. And that still is the case where the peak in yields is somewhere just under a year and then inverts and heads downward out the curve.

It's always difficult to speak about near term returns, but certainly getting back to some of the comments that have already been made, that short-term investors, which again have spent so many years in the wilderness, if you will, in the desert of such low returns, can actually expect either a money market or ultra short or a short duration strategy that the coupon return is going to be a meaningful portion of the overall returns for at least probably 2023 and hopefully forward, so long as the Fed is unable to lower interest rates at least in a dramatic fashion over the next 12 months.

So the prospects for solid coupon return in shorter duration strategies is very solid at the moment. Although clearly, total return has played out dramatically as we begin 2023. But the prospect for current income for investors hasn't been this strong since '07, well over 10 years.

Jonathan: Jim, you utilize interest rate risk hedges in some of your strategies, which no doubt helped you in 2022. Are you still using them in 2023?

Jim Robinson: So you keep trying to get me to answer this question, is it safe to get back into fixed income? Now you're asking it from the other side. Is it safe to stop hedging interest rate risk? Same answer. Yes, it's definitely safer. Much of our hedging activity is (A) intended to be more to minimize the overall volatility of the portfolio.

So when we look at to hedge or not to hedge, we're we're looking at three metrics. One, our hedges allow us to isolate the discounts on the closed-end funds that we're arbitraging. So if discounts are particularly wide, we were inclined to isolate that.

The other two factors that we look at is the absolute cost of the hedge, which prior to last year was di minimus. For a decade with rates pinned at near zero, the cost of the hedge was arguably the cheapest insurance product we could find.

But now there's actually a meaningful cost to that hedge. And then the last piece is just general market volatility, and I think we've all suggested that we anticipate that market volatility will remain elevated. Maybe not as high as it was last year, but probably elevated.

So if it were just down to the cost of the hedge, we would be lightening up on our hedges. But because discounts are in the closed-end fund space are at the 95th percentile of historic discount levels, we're inclined to isolate that. So the hedges help us do that. And then with market volatility continuing to run high, we're inclined to maintain our hedges a bit longer.

Jonathan: Brian, much has been written about the growth of both the bank loan and private equity markets in recent years. What are your expectations for those sectors in 2023?

Brian Kennedy: So if we think about bank loans, private credit, and high-yield altogether as levered finance, 10 years ago high-yield was better than 50% of levered finance. Today, levered finance is split pretty evenly, a third, a third, a third, if you think about it from a market value standpoint, using some of the more widely followed indices.

Bank loan demand has increased as CLOs have become more of a mainstream instrument. And the low borrowing costs that we experienced in the last couple of years that were available to issuers, we saw a lot of issuers going into the bank loan space as opposed to the high-yield market. But the bank loan space has really changed over the last five to 10 years. 60% of bank loan capital structures today are bank loan only. 70% of bank loans today are rated B+ or lower by the rating agency.

We think there's the potential for downgrades in the bank loan space in 2023 and beyond, given the aggressive leveraging profile of many of those companies. And so, I think that's something to watch out for when you contrast it with the high-yield market, which is at its all-time highest average quality at this point in time.

As far as private credit is concerned, if I think about what QE and low interest rates did, they really forced investors to go down in quality and really give up liquidity to find yield and return over the last couple of years. And the private credit market provided both. They provided return and they provided yield for people who needed it.

And what was a $750 million market in 2000 is now about a $1.4 trillion market in there. So huge growth in that space, as well. And I would just watch that. As the public markets start to offer yield again, and investors want access to daily liquidity, let's watch for the withdrawal spaces in private credit.

We've all read the headlines, what would happen in BCRED in December and the gates that went up. And so, how orderly is the withdrawal of liquidity from the private credit space?

And the other issue that I would point out to in the private credit space is that as the economies start to slow, our valuation's eventually going to be reset in this space as well. A lot of money got put to work in here really quickly. How aggressive was the underwriting? And so will we start to see valuations really reset and come down lower if economies slow in the private credit space as well.

So we've seen really, really strong growth in both of those areas. We just have to be careful that... History tells us when you see this type of growth, there is sometimes some fallout with that. So, two spots to really watch going forward in the future.

Jonathan: And Brian, what are your expectations for high-yield defaults in 2023?

Brian Kennedy: We still expect defaults, and I specifically mentioned downgrades in bank loans because I don't know that we're going to see a cascade of defaults in that space, but I do think we're going to see some downgrades. But certainly, when I think about the high-yield market, we do expect high-yield defaults to remain below long-term averages, which are about a little over 4%.

There's just not a lot of debt coming due in the high-yield space this coming year in 2023. And even next year, quite frankly. Corporate balance sheets are coming into this slowdown, this potential slowdown, really strong at this point in time. Now longer term, if interest rates remain at these levels and lower rated companies in the high-yield space need to refinance interest expense could rise significantly.

And that's really where we would watch to see a rise in leverage and then a possibility of an increase in probability of default over time. That's a couple years down the road. Certainly we look at high-yield right now and think it's good carry. If you look at it from an index perspective, it's eight plus percent with, we think, below average default. So we still think it's an attractive area, but again, it's about security selection.

And to go back to those pillars of security selection, rising stars are really important to us right now, as are avoiding the losers. So this is about security selection. It always is in high-yield.

Jonathan: Tom, you've described your investment process as bottom up research centric, focusing first on underlying investment fundamentals and then looking at macro factors. Could you elaborate on your strategy?

Tom Carney: Yeah, thanks Jonathan.

And a number of my comments are going to probably make it seem like Brian and I are singing from the same hymnal. There'll be a lot of rhyming that goes on with what I'll be saying. But at the core of our strategy, we remind ourselves, like Brian's team does, that the key to winning and fixed income is not losing.

And we define risk maybe differently than some others. But risk to us is permanent loss of capital and not simply price volatility. So appropriate return for the risk we assume and downside risk management are keys to our strategy. And with this as an intro, our process overlays an informative macroeconomic framework, or tapestry if you will, such as fiscal, regulatory, monetary policies, inflation expectations, nominal interest rates globally, consumer corporate debt loads, investor sentiment, with an actual actionable list of fundamental factors like credit spreads versus long-term trends, yields, yield spreads versus base rates.

What do you get to pick up over and above the so-called risk-free rate? And relative value opportunities across sectors, whether that's corporates, mortgages, structured products, et cetera.

And we grade all these variables that leads to a traffic light analogy, if you will, for a conclusion. Green, yellow, red, which really helps inform our overall bottom up idea generation, credit underwriting, risk adjusted return framework, leading ultimately to actionable ideas, which are always followed up with ongoing monitoring and maintenance.

Jonathan: Tom, where did you and your team find the best opportunities to drive performance over the last year and is that opportunity set changing now?

Tom Carney: Well, a key attribute, first of all of our strategy, we think, is our flexible mandate. At a very high level we are index aware, but broadly index agnostic, similar to what Brian mentioned.

And while many strategies either mimic or hug pretty closely to index weightings like the 25 or so trillion US aggregate index, we cast a pretty wide net across a broad sector of asset classes, investment grade, high-yield. But just taking the aggregate index as one example, of course it has no high-yield exposure, but it lacks exposure to almost over 50% of the US bond market, which is missing from the ag.

And that, as Brian mentioned a little bit ago too, is asset backed securities broadly. That it's a tremendous part of the marketplace that we have really found opportunities in over the last number of years and continue to do so. Why? I think it's certainly the fact that it is not... Many of these strategies are not index eligible. Some of them are floating rate.

Brian mentioned CLOs, that area. But floating rate, whether it's commercial real estate, corporate CLOs, but asset backs broadly provide what we think is a wonderful income and spread pickup to what we could otherwise get in index eligible places. And so, we find that that opportunity is something that really allows us to, over time, out coupon the index for sure with much less interest rate risk.

And while we have also modestly increased duration across portfolios, which has been difficult to do in today's environment because as interest rates rise, the ability to increase duration is challenged just by the nature of the math. But nevertheless, the ability to out coupon because of being able to have a flexible mandate that allows us to look beyond what's just essentially in an ag and not necessarily care about the waitings per se, but look for the best risk adjusted returns, we think is a winning strategy long term and has certainly helped us over the last number of years.

Jonathan: Jim, are you favoring traditional fixed income or alternative income strategies right now? And what areas of the traditional fixed income and alternative income markets do you think offer the best opportunities right now?

Jim Robinson: Well, given that most of my firm's focus is on alternative, liquid alternative fixed income strategies, we tend to favor liquid alternative fixed income strategies. In our minds, they offer a little more flexibility. But where do we see value in the traditional fixed income markets? One of the things that we've seen over the last year, which we would expect is in a fed rate hike cycle, yield curves have flattened out. In the case of treasuries, it's actually inverted.

But both treasuries and investment grade corporate bonds have seen their yield curves, and we're measuring it from intermediate maturities to longer term maturities. So one to 10 year index versus the 10 plus year index. Those yield spreads have flattened about a hundred basis points.

Not so in the municipal bond market. We've actually seen about a 50 basis point steepening of the municipal bond market curve. There is zero fundamental reason for that to happen. It certainly isn't a credit related issue. The overall credit quality of the muni-market is much stronger than it is for investment grade corporate bonds.

The historic default rate of munis is practically di minimus. And then on top of all of that, the last COVID Recovery Act that Congress passed earmarked $350 billion for state and local municipalities. That may not seem like a lot, except when one considers that the overall muni-market is about one and a half trillion. That 350 billion is 20 plus percent of the entire market.

These guys are a wash in cash. Municipal balance sheets have not been stronger than this in my nearly 40 years of doing this. We think that part of the market is particularly attractive on a relative basis. The problem is the long duration of 10 plus year municipal maturities. That's where we can offer an alternative solution.

The closed-end funds that we invest in predominantly invest at the longer end of the muni-market. We can hedge out some of that interest rate risk. On the front end of the yield curve, an area that we haven't discussed up to now, we've been a big player for the last three years in pre-merger SPACs. I know SPAC in many markets has become a dirty four letter word. If you listen to the financial media, SPACs are dead.

The structure is not dead. The financial media never quite understood that a SPAC has two lives, a pre-merger and a post-merger life. The pre-merger life of a SPAC, it is for all intents and purposes a bond. It has a redemption value, it has a redemption date, and it's fully collateralized with a portfolio of either T-bills or treasury money market funds.

So for the last couple of years we've been able to buy pre-merger SPACs. We, in fact, have an ETF in the marketplace that is exclusively focused on pre-merger SPACs. We're buying pre-merger SPACs at a discount to the current trust value of three to 4%. A year ago, we didn't really discuss what was being earned in the trust, because T-bills weren't really yielding anything. But today they're yielding four and a half percent, so we're buying it a 4% discount. And on top of that, we're earning another four and a half percent within the trust.

So we're getting eight and a half percent annualized yields for something that has the credit and interest rate risk of T-bills. We like that as an alternative solution on the front end of the yield curve.

Jonathan: And with SPACs drying up, do you think that we'll stick around? Is there an opportunity for you and your clients?

Jim Robinson: Yeah, so we had a number that tried to redeem out and did, in fact, redeem out before the end of the year. There's still over 300 in the marketplace. We've actually had some new issues come to market, both in the fourth quarter of last year and so far this year. Certainly not at the pace that we saw a couple years ago, but we're not seeing IPOs like we saw at the pace a couple years ago either.

Much of this is a function of challenged equity markets that may, in fact, get more challenged as earnings come out. So when the IPO market returns, we believe the SPAC structure will return as well. Bear in mind, the SPAC structure has been around for 20 years. It became quite popular back in 2020 for a variety of reasons.

A couple of poster children were draft kings and Virgin Galactic and then Trump's social media is trying to go public that way, although we'll see where that ends up. But the structure hasn't gone away. The merits of going public using a SPAC structure as opposed to the traditional IPO structure hasn't really changed.

So yeah, we think it has legs, just maybe not at the bubble level it was at three years ago.

Jonathan: Brian, where's your team currently seeing the best opportunities in fixed income markets?

Brian Kennedy: Yes, I think if I looked at the markets today, again, corporate spreads are wider than they were a year ago. You have yield. Security selection at the end of a cycle is always very important, so we continue to think that there are select opportunities in the corporate space.

But I think the driver, again, of return this year is likely going to be from yield advantage and from carry. As we go further into the year, some of the opportunities that I think are going to be more interesting are going to be the ones that play off, again, the reopening in China.

So emerging markets could be interesting, some non-dollar denominated securities, whether they're sovereign or corporate as well in there. And then things that are related to commodities. Certainly the energy space is still an area we think you could see some upgrades. And then I would look at the securitized space, as well.

And again, a good amount of carry in that space for not a lot of duration, particularly in the CLO market. But there's other areas there, both on the consumer and the corporate ABS side in addition to some of the non-agency RMBS markets as well. And I think about single family rentals, non-performing loan tranches.

So I think again, the flexibility of your strategy is really going to allow you to get away from that ag type of investing and try to collect additional premiums this year. There are some select opportunities. The last one I'd mentioned is banks, both in the US and in Europe. Again, Europe's avoided the worst of what we think was going to be a real significant energy crisis. It looks like their banks are trading really cheap.

US banks, very well capitalized. Jim mentioned the municipalities. I would say the banks have never been better capitalized than they are today in the US right now. And there's been a ton of issuance at the banks over the last year, so they're still trading at a fairly generous premium as well.

So I think there's some opportunity out there. It's selective. This is not just raise your beta type of market. It's about security selection. And I think with the way we do things here, that kind of plays right into our process.

Jonathan: Brian, Jim, Tom, thank you for joining us today and thank you for sharing your fixed income expertise with us.

Jim Robinson: Thank you.

Tom Carney: Thank you, Jonathan.

Brian Kennedy: All right. Thanks for hosting, Jonathan.

One of the tenants of our strategy has always been yield advantage. And so when you think about our products, what you will almost always see is a yield advantage against the benchmark, thinking about multi-sector products that we manage. There are different stages of cycles. And in each cycle, each credit cycle, you have different opportunities in different sectors of the market.

But across all of those different cycles, there are opportunities to build in a yield advantage over the benchmark. In our case right now, a couple of the areas that we're focusing on would be Triple B (BBB) rated bonds in the investment grade corporate sector. Higher quality CLOs in the securitized area, thinking about Double A (AA) and Triple A (AAA). We've seen a real pullback in the traditional bank buyers of CLOs and that's created a significant opportunity for us in a shorter duration asset that does offer a good amount of yield.

Dollar pay emerging markets, and that's some of, I would say, our highest conviction opportunities, thinking about two or three different names in that space that are creating opportunities to build in good total return opportunity, but also yield advantage as well.

And then certainly in the crossover space in high-yield, thinking about names that are still upgrade candidates and we talked about upgrades a little bit earlier and trying to identify those still at this later stages of the economic cycle that we're in right now. And certainly that's that Double B (BB) cohort does give you the opportunity to build in yield advantage as well.

So to recap, a lot of what I said earlier, there is yield in the fixed income markets again, and that's a good thing. It does provide investors with income, it provides investors with a cushion against any kind of a downside that we may see. And that's something that, if I go back to the end of 2021, we didn't have. We had more duration in portfolios than we did yield.

Even though we had taken a much lower duration exposure in the portfolios, there just was a real tough spot in fixed income. Today, a much different story as we have a fair amount of yield in here. As I said earlier, we think that inflation is going to continue to be sticky on the way down. We think that markets are starting to realize that, although we did see a push towards a pivot type of market pricing for a period of time.

But we do think that this is likely to be a transition year 2023, where we're going from really very aggressive rate hiking into maybe a more level set period of time where we have interest rates that are a little bit more consistent over a longer period of time.

So we are creating, again, yield advantage in our portfolios. And again, I would say that while inflation is coming down and we've likely seen the peak, it is likely to stay sticky and above the Fed's target and that could create a problem for the fed later on in the year if we do see a significant drop-off in economic activity.

We are starting to see some signs that economic activity is slowing in some spaces in the US. We may be buffered by what's going on in both the reopening in China, as well as the warmer weather in Europe. And certainly the avoiding of the worst case scenarios for economic activity over there from energy rationing that really hasn't had to take place to the extreme levels that some people thought it would have to.

So it's an interesting year coming forward here, for sure. We do think that the markets are going to continue to be presenting us with opportunities. We'll take advantage of those as we see fit. And again, different cycles do bring different opportunities in different sectors.

The beauty of a fixed income portfolio with a multi-sector mandate is that you can go anywhere and use that flexibility to build in yield and total return capabilities for your clients.

Jim Robinson: So I've been asked a couple of times now on this broadcast if it's safe to get back into bonds. Obviously with short-term yields four and a half percent higher and long-term yields two and a half percent higher than they were a year ago, it's definitely much safer than it was.

That said, bond market volatility remains high and is particularly prone to violent reactions to the statistic de jour, whether it's inflation or the employment report. The challenges I see it for the market is that the vast majority of today's bond market participants have spent their entire careers with a Fed put.

Unless your career predates 1987 when Alan Greenspan became the Fed chairman, you've been conditioned to expect the Fed to pivot at the first sign of market resistance or adverse market conditions. The Fed pits and goes back to creating an easy money scenario.

The problem is that neither Greenspan nor Bernanke nor Janet Yellen ever had to deal with this kind of inflation challenge. I think Chairman Powell on this particular board of Fed Governors are acutely aware of history, and would much rather be remembered as Paul Volcker than Arthur Burns

Every Fed rate hike cycle going back over the past 50 years, how the fed fund's target rate exceed the peak inflation rate for that cycle. The peak core PCE deflator, the Fed's inflation measure of choice, was 5.4% and core CPI got as high as 6.6%. I think at a minimum that suggests that the Fed's probably going to get rates up to about five and a half percent. That's 75 basis points higher than where we are today.

Likewise, in each of those past rate hike cycles, long-term bond index yields thinking the Bloomberg aggregate index indices of that nature all peaked plus or minus a month around that last fed rate hike. So my guess is that we're probably going to revisit those October highs that we saw.

The historic butt-whooping that we saw in the bond market last year has created a number of dislocations in the marketplace. Most of those dislocation opportunities are best managed in an alternative structure, a structure where one can hedge out some of the undesired risks that might go with those dislocations.

I mentioned earlier, the long end of the muni-market being particularly dislocated right now. Where all other yield curves have flattened since the Fed started raising rates, the muni-market is actually steven 50 basis points. That creates an interesting opportunity at the long end of the muni-market. The problem is you also get the long duration that goes with the long end of the muni-market.

A 40, 50 basis point move-in rates will wipe out a year's worth of income. That's where an alternative structure can be of assistance and an alternative structure. The manager can hedge out some of that interest rate risk can still lock into the opportunity of the dislocated asset class in this case, long-dated munis.

We are clearly closer to the peak-in rates than we are to the trough. I might not jump in with both feet just yet, but I would certainly feel comfortable in a combination of short duration traditional bonds and hedged liquid yield alternative strategies.

Tom Carney: As I mentioned, we're primarily bottoms up investors as we believe that's where we can best add value. However, we'd be silly to ignore macroeconomic variables, which inform our actionable list of fundamental factors.

And the Fed's monetary action certainly impacts markets on a macro basis, both in a prospective and retrospective basis. So with respect to the Fed, we're mindful that despite all the data at their disposal, even the Fed gets things wrong, as they did by repeatedly suggesting that inflationary pressures were transitory.

They arguably fell into the trap or resembled this quote from Mark Twain. "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."

The Fed is clearly working at getting ahead of something that they thought was a sure thing, but just wasn't so. That is inflation being transitory. Highlighting the difficulty of forecasting, the Wall Street Journal, very recently in a heard on the street column, summed up the circular problem facing investors, I believe, namely the market is dependent on the Fed and the Fed is dependent on the economic data which the market and the Fed have found impossible to forecast.

So the only thing we can say with trepid confidence is that the Fed is closer to the end of its tightening cycle than the beginning. Inflation appears to be at least leveling out, but not fully rolling over. Financial conditions which the Fed is trying to tighten do not appear tight by many measures.

For example, credit spreads have largely retraced much of the widening of last year, 2022. And real returns are still deeply negative. So whether the Fed's terminal fed funds rate is plus or minus 5%, for example, it's plausible that they will have to stay at that level longer than many expect to fully reign in inflationary pressures. All of this has led us to incorporate a barbell approach, particularly in our core plus strategy via longer duration investments in US treasuries with credit exposure concentrated in shorter duration exposures like ABS, asset backed securities broadly, and floating rate securities specifically.

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