Inside The Curve with Dan Ivascyn

Greg Dowling (00:05):

Welcome to the FEG Insight Bridge. This is Greg Dowling, head of research and CIO at FEG. This show spans global markets and institutional investments through conversations with some of the world's leading investments, economic and philanthropic minds, to provide insight on how institutional investors can survive and even thrive in the world of markets and finance. On this episode of the Insight Bridge, we go inside the curve with Dan, CIO of PIMCO, one of the world's largest asset managers. Dan is a legend in the world of fixed income. Today we discuss his career journey, how PIMCO has evolved since he started, and how the industry has changed from the era of high interest rates in the 1980s to the zero interest rate environment post Covid to now. We also discuss Fed policy and answer the question of whether the Fed is behind the curve. Finally, we finish with a discussion of the impact of private credit and the current macro environment. Get the inside scoop. Do not miss a second. Dan, welcome to the FEG Insight Bridge.

Dan Ivascyn (01:14):

Thanks, Greg. Great to be here.

Greg Dowling (01:16):

Alright, Dan, would you introduce yourself to our listeners and maybe give your background?

Dan Ivascyn (01:21):

Sure. So, my name's Dan Ivascyn. Been at PIMCO about 26 years. I think my anniversary date is right around today, give or take, been here for a long time. Of course, came from Massachusetts, originally, got hired as part of the PIMCO MBA recruiting process and spent a lot of time at the firm, you know, trading structured products, asset-based finance type assets. Then took on more and more responsibilities over the years and spent a lot of time today, not only on our alternatives products, but also, you know, a lot of our income strategies, including closed-end funds, you know, for just about a decade. Have been responsible for overseeing the PIMCO portfolio management team. So it's been a lot of fun, a lot of different market environments. A great ride so far and still super excited to do what I do here with a really, really good team.

Greg Dowling (02:07):

You know, it's funny, you know, people and you know what they do and where they work at, but you know, as part of prepping for these, these podcasts, we always get the person's bios together and kind of go through it. And I noticed in your bio that you were elected to the Fixed Income Hall of Fame. Is that like getting, like, do you get a master's jacket or is it like more like going to Cooperstown? What is this?

Dan Ivascyn (02:27):

Well, you go to a banquet in New York. I think what's interesting about Hall of Fame in our industry is that they give you these awards while you're still working and not sure if that's some type of signal or not, but it was several years ago and always great to receive an honor like this one. You know, the key point though is, you know, asset management's the ultimate team sport. So I think these types of awards should probably be given out to the firm or to you know, investment group rather than the individual. But obviously, you know, honored to be recognized in, you know, Bill Gross, Muhammad Arian and many other folks within the fixed income arena. I have been honored over time, so you're always nice, but again, the team deserves all the credit with these types of things.

Greg Dowling (03:04):

So you get to the Hall of Fame and you get some rubber chicken in New York. But, you know, I was thinking maybe you get like one of those golden HP 12 C calculators that everybody used to use back in the day. I'm trying to think what we, you need something right for, for that kind of stuff.

Dan Ivascyn (03:18):

Bond math, yeah, was used to be a, a priority in this business. Now they got the computers doing it, but you know, I guess that's called improvement in overall efficiency. But yeah, talk about my time at PIMCO going back 26 years. You know, first couple of years was literally spent on calculating bond pricing and reverse engineering cash flows and day discounts on mortgages and things. It's a little bit different entering the business today. A lot of that stuff's done for you for better or worse, but it is a little bit different.

Greg Dowling (03:43):

Yeah, I was going to ask you that later, but it is funny, right? Like it's great that we don't have to do those things anymore, but it's good foundational underpinning just because now a computer spits things out, you almost are hesitant to or even have the knowledge to question some of the inputs.

Dan Ivascyn (03:56):

Yeah, I would agree with that. Later today I'm going to meet our intern class. They have, I think, a few more days to go before they return to school. And when people ask me for advice, you know, that stage of their career I tend to tell the young kids to try to do a little bit of this math. You know, you don't have to do it, you know, with, you know, pen and paper necessarily, but trying to create your own spreadsheets and understand the math behind these cash flows will likely serve you well over the long run. Again, the, you know, the kids that do join our firm today though are quite technically proficient. Even, you know, relative to, you know, my class back 26 years ago, I don't think I could necessarily get this job today if I had to go through the process and compete against so many real talented people. So, you know, the industry's changed and you know, I think that new generation, although they may not be as good at old school bond math, they have pretty good technical skill sets. Times change, they evolve.

Greg Dowling (04:42):

Well, that's great. You mentioned earlier that you are just going on your 26th year, and you've also mentioned the Bill Gross and Mohamed era of PIMCO. How has PIMCO changed in your opinion over those 26 years?

Dan Ivascyn (04:58):

Yes, I don't think we've changed that much. We've evolved with the marketplace and over the last 10 years, of course, we had a period of very, very low interest rates, negative real interest rates, outright negative yields in many parts of the fixed income opportunity set. So clients have looked for alternatives to more traditional fixed income. We've been part of that process evolving into some of the alternative areas of the market, private segments of the market. We've also, you know, increase the flexibility, that we provide end investors focusing a lot of times on solutions rather than more traditional and, and better defined mandates. And then again, the markets have become more global. Other areas outside the United States have grown at a more rapid rate, at least when you're looking at emerging markets. China, Asia as a region, as just one example, and marks have become much more tactical and much more complex.

Dan Ivascyn (05:50):

The machines have mattered more. So we've had to focus more over the last decade on implementation, more specialization than we would've had in the past. But a lot of the key themes have stayed the same, and I'm sure we'll talk about this later, but Bill Gross left us with, you know, a really good investment framework. A lot of good time tested approaches to running money, especially from a risk management perspective. So in the areas that really matter, the high level themes, a lot has stayed the same. And my job's been fairly, you know, easy being left with such a again, a great team and great processes that were put in place by Bill and to some degree Mohammed as well.

Greg Dowling (06:29):

So humble, right? My job is easy because of my predecessors. So what I'm hearing you say is that, you know, the world is more global, it's more complex. You have to have more flexibility and also more offerings to address this. Maybe this is my view, but I'd love to kind of hear you respond to it. It also feels like PIMCO is a little bit more from a cultural standpoint, kind of team driven versus just having kind of bill at the helm. It seems like it's kind of broadened out a little bit. Is that, is that a fair comment?

Dan Ivascyn (06:58):

Maybe to a degree. And again, it goes back to the point around market complexity. Global opportunity sets rapidly developing capital markets. That requires a keen focus on implementation coordination. But Bill, although he had such a big, you know, personality, he wrote the monthly iOS, which of course, you know, came from his desk where he had his own unique style. He was a huge believer in team, a good portion of the return he generated over time was tied to repeatable sources of alpha structural and inefficiencies in markets out resourcing the competition and having, you know, teams in some of the more complex areas of the market. So he, you know, again, having a big personality at times was viewed as having perhaps a bit more individual input into decision making, but he was the master at building out teams processes and then, you know, leveraging the collective insights of this team that he put together.

Dan Ivascyn (07:49):

And I think, you know, one example of that would just be our forum process. I went to my first forum before I ever joined the firm officially. It was in the summer in between my years at business school. And we were a lot smaller, uh, firm at the time, but I had a microphone thrown in front of my face. They're asking me what I thought. I didn't officially join the firm yet. The true answer, by the way, is I really didn't know what to think, I was just thrilled to be in the room. But it's an example of Bill always tried to harness the collective wisdom of the group. And you know, even in today's environment, when you see all this tech innovation and you know, LM models and AI and other very, very important areas of development that are going to impact investment management, it's the young folks that are going to have a much better perspective there than old timers like myself. So, you know, bill unlocks something I think very important with this team driven process. Again, we're just trying to leverage that in the context of today's, you know, market realities. So very much a team driven approach. Again, it makes it a lot more exciting, you know, to be, you know, working with such talented people, you know, regardless of experience or seniority levels.

Greg Dowling (08:47):

So I want to pull on a few strings, a couple comments that you made. You talked first about how the fixed income industry has changed a lot, just the environment from kind of the higher interest rates of kind of the 1980s to a point in time where, you know, you go to the GFC and Covid and you've got, you know, negative interest rates. Gosh, it must've been nice to be, start fixed income with this, you know, wind at your back and rates dropping, but like the environment has changed. Can you kind of explain how different the industry is now versus when you started?

Dan Ivascyn (09:19):

It's different in some respects, and it's feeling a bit more like the old days. More recently, we went through a major shock during the global financial crisis, which, you know, we think set the stage for a significant regulatory response that changed the industry. And it set the stage for a decade plus period of very, very low interest rates, a lot of involvement from policymakers, a lot of volatility suffocation. And that led to a shift even in investor preferences. When you have negative real yields or outright negative nominal yields, you know, you got to look for alternatives. A lot of people shifted their asset allocation towards equities, towards credit, even deep, lower rated, quite risky credit. And it's been a long time since we've had a recession. Those decisions have been quite rewarding. As I mentioned earlier, you've seen expansion of capital markets around the globe as well.

Dan Ivascyn (10:12):

So things have become, you know, much more global. But you know, for much of the last 10 or 15 year period people were looking forward and seeking out alternatives to more traditional fixed income. We've been part of that process for end investors and some of these alternative strategies that I mentioned. Today though after the significant bout of inflation, again, bringing us back to seventies, eighties type periods, at least in terms of the overall level of inflation, we finally have really, really good value back in fixed income markets. So we don't quite have the yields that we were able to ride as a firm, you know, the late seventies, early eighties, down to these exceptionally low yields post GFC. But we do have the highest nominal or real yields that we've seen in 15 plus years. And when you look at real interest rates today relative to equity valuations, very, very attractive value in this market.

Dan Ivascyn (11:01):

So it does feel a lot more like the old days by early years at PIMCO and we're super excited about that. And then another key point about today's environment, at least for the time being, is a lot less influence from policymakers. Central banks are tightening policy. Yes, you know, we, we probably have rate cuts around the corner, but with debt levels around the globe quite elevated. The likelihood of fiscal or monetary policy related falsification look like there'll be less impactful going forward. So we may not be back to the old fashioned bond vigilante days where sort of everyone fends for themselves if you have a lot of extreme volatility. But you've certainly seen a market much more reminiscent of the old days. And of course it's quite exciting to be back in that environment. Because it's a great environment for active fixed income.

Greg Dowling (11:51):

It's hard, right? Like for, there was a period of time where if you're an active fixed income manager and you're charging a fee, in some cases that fee might have been more than the yield offered. That's a tough business. That's a tough business. You had mentioned that during that period of time, the world needs yield, it needs income. And so people kind of drifted more to the kind of junkier side of credit and really into private credit. PIMCO was a part of that. I mean, I think people would be surprised to hear how big some of these businesses are for you, but can you put the genie back in the bottle? Is it, do you still need that? I mean, or can you get that again in traditional fixed income? So maybe compare and contrast what you can get on the private side versus what you can get on the traditional side these days?

Dan Ivascyn (12:38):

Sure. So the answer is, it depends, but to answer your specific question, no, you don't need it any longer. With real interest rates at the highest levels we've seen in 15 years with key segments of the investment opportunities set looking quite attractive, you can put together a high quality portfolio, quite resilient, even in the face of significant economic weakening and generate yields, in the high single digits. If you, you know, expand into higher quality strategies that are a little bit riskier, that may use, you know, a little bit of leverage, you can quickly get up into the very, very low double digits. So no, you don't need to take the same type of economic sensitivity that you did a few years ago to generate attractive returns or attractive yields. Now, again, it's been a while since we've had a recession. We should have had a significant recession, you know, during the covid period, at least fundamentally.

Dan Ivascyn (13:29):

But policymakers didn't let that happen. So, you know, when you have that type of dynamic where you avoid either an earnings recession or an outright recession, you know, weaker credit will mature. It reminds me a lot of those, you know, subprime lending days, oh 4, 0 5, 0 6, really bad underwriting, really bad bonds. But until you actually had the economic shock partially due to higher rates, the steps continued to mature. So in the higher quality areas of the opportunity set, we are quite excited about what we're doing in the alternative space. But we think that investors need to be much more cautious about, sensitivity to economic deterioration, especially with public equities at these types of levels, the type of optimism embedded in current economic thinking. But there are areas where you could be defensive, where you can pair a more traditional fixed income strategy with an alternative strategy that allows you to go down the liquidity spectrum, up the complexity spectrum and generate very, very attractive returns.

Dan Ivascyn (14:27):

So you want to be cautious, you know, anytime valuations are stretched and there's excess optimism in the market, you want to be very, very leery about strategies that have grown significantly relative to historical trends, especially if money may be pouring into those areas for the wrong reasons. A wrong reason would be the fact that prices just don't move a lot and that feels good coming off of 2022 period of extreme volatility and be willing to say no and be willing to, you know, avoid that excess. But we're excited about alternative opportunities as well. But again, the compensation necessary to go down the liquidity spectrum or up the complexity spectrum isn't always there at the moment, given that you have a lot of firms fighting for, you know, what appears to be market share more than focusing on end client value, at least at the moment. But our industry goes through these periods and you just want to be, you know, patient careful, defensive resilient, you know, add, you know, good value to the end investor.

Greg Dowling (15:21):

Well said, well said for sure. You mentioned the PIMCO secular forums. I think that's one of the coolest things that PIMCO does. Could you maybe give a little background to listeners who don't know what this is and who's involved? I mean, it's pretty amazing the participants that you have.

Dan Ivascyn (15:37):

Well, it's fun and you know, our secular forum is a meeting we hold once a year. It could be viewed almost as an internal, you know, PIMCO conference. We've been doing it for many, many years. This was the meeting I referenced earlier where I showed up to observe and they threw a microphone in front of my face back, you know, before I even joined the firm. And the whole idea here is to bring the firm together, not just portfolio managers, but all investment professionals. So people that spend the bulk of their day focusing on client interaction, client servicing other folks in non-investment areas of the firm or direct investment areas of the firm come, they listen, but they're also expected to participate and offer up their insights. So it's again, a set of meetings that forces us to get away from the noise. And there's a heck of a lot more information noise today than there was 26 years ago, and I'm sure a lot more noise than 40, 50 years ago when the firm was first founded.

Dan Ivascyn (16:27):

So I think there's some benefits there just to put down your cell phones, you know, get off your X feed or you know, the constant Bloomberg newsfeed and talk about trends impacting economies and markets over a multi-year horizon. Part of this process, as well as you mentioned, is to bring outside guests, including members of our global advisory board as well as outside speakers each year. And the way we select those speakers is we look for very credible senior people across industries that we think will matter in terms of generating returns over the long term that have views different than our own. So there's an important contrarian element or behavioral element here in bringing in people that will challenge our existing thinking. So it again helps us find key market turning points. Some years may be more routine where we just get together and really helps with the overall firm culture and, you know, forces us to think about some of these long-term trends.

Dan Ivascyn (17:21):

But I think some of the greatest successes I could think of at the firm in terms of positioning ourselves to generate client value has at least indirectly, it's sometimes quite directly come out of these forums. The most obvious example of that would've been us beginning to get quite cautious about mortgage and consumer credit. Some of the issues around underwriting in that space back in oh 4, 0 5, 0 6, we were early, but better to be early than late. Again, I think that's probably the example that jumps out of the direct positive impact of our forums. Sometimes it's more subtle than that, but a very, very important piece of our investment process. Something, you know, that I've tried to further reinforce and emphasize on an ongoing basis, given again, the tendency now to be, you know, so fixated on the short term within our industry.

Greg Dowling (18:05):

So at the last forum, what were the major topics and were there any areas of disagreement?

Dan Ivascyn (18:11):

Well, there's always areas of disagreement, but topics, you know, one, you know, more enthusiasm about value and fixed income. And that may sound, you know, a little self-serving being, you know, mostly an active fixed income manager. But we weren't super optimistic a few years earlier when rates were near zero or even negative. A lot of discussion about less synchronized growth cycles, deglobalization trends that are going to lead to more micro cycles around the globe than we grew accustomed to, you know, in the post GFC type years, a focus on global debt levels with an eye towards the United States where debt levels and deficits look quite unsustainable, at least over the longer term tech innovation and how this tech innovation's going to impact economies, you know, from a productivity perspective, a real interest rate perspective, but also the ways in which this productivity may disrupt certain sectors or certain industries, including our own.

Dan Ivascyn (18:59):

And then of course, politics and geopolitics, a quite consequential election coming up here in this country that are going to have a significant impact on economic geopolitical themes over a multi-year period. And then again, lot of discussion around, you know, growing tensions in the world, conflict in combat in the Middle East across Europe in significant tensions in Asia. So that's a list of the topics and there was significant disagreement in literally every area. We invite disagreement, we almost structure these conferences to ensure that there will be multiple sides discussed. We coalesce around a few themes, you know, that we put out with our research piece, but plenty of room for disagreement even on things less interesting to the audience here, like the neutral real interest rate. We even had a presentation updating some of our research there. Not the most exciting part of the forum. I think it's pretty important to sort of know where interest rates lead, but even a little bit more of that technical type stuff that we've worked on and talked about for years.

Greg Dowling (19:51):

Yeah, I'm sure, our star is a very exciting topic. Internally, but maybe not as externally, but broaden that out a little bit, just knowing who some of the members are of your advisory council and who participate. You do get some former Fed officials there. I'd be curious to kind of hear views on, you know, whether the Fed is behind the curve and then also potential fed cutting during an election cycle of, you know, how political that may seem. So maybe just thoughts on that from the forum.

Dan Ivascyn (20:23):

We had a lot of economists join us as a reminder, we have Dr. Bernanke, who's been a advisor of ours now for several years, and Rich Clardia has rejoined us, the recent Vice Chair of the Fed, you know, Ben and Rich, think the feds doing a good job. Maybe they're a bit more biased than, than some of us, but we talk to them, you know, both at our secular forum, but we also speak to Ben and Rich, of course, very, very frequently at the investment committee, including after every Fed meeting and every Fed Press conference. But maybe I'll share my views or the collective views of the firm from those of us that weren't sitting members of the Fed or chairs or vice chairs of the Fed. And we think that this central bank's done a really good job. Now our role is not assessing whether they're doing a good or bad job, it's anticipating what they're going to do and trying to make money from, you know, both fundamental economics and policy.

Dan Ivascyn (21:08):

But I think those that are critical of the Fed have to remember that degree of difficulty should matter, try to conduct central bank policy in the midst of a global pandemic of the degree that none of us have ever experienced in our lifetime. And then stimulus on the order of 25% of GDP, other strains of this virus, omicron and other related uncertainty that was going on during this inflation scare were really tough. So yeah, the Fed was late, but the Fed course corrected. And when you look at where we are today thus far, it's not over yet. We have seen inflation come down significantly towards central bank targets. Employment has held up, risk markets have held up in terms of overall performance. And when you look at market indicators of confidence around central banks, they get very, very high marks as well. For example, in the United States, the only meaningful uptick you saw in breakeven inflation rates happened a couple of weeks after the Russian invasion of Ukraine, when you had this temporary but significant spike in commodity prices.

Dan Ivascyn (22:11):

And of course significant uncertainty. I guess you could add that to the list Kentucky monetary policy, while there's a war going on in Europe. So when you look at break even inflation rates, when you look at credit spreads, when you look at, until I guess the last couple of weeks, you know, relatively low credit spread or equity volatility, the markets are very confident and give central banks very, very high marks. Now, with that said, and I know you didn't ask this question directly, are investors a bit optimistic about central banks being able to engineer positive economic or financial market outcomes? Probably because they've done pretty well so far. So we do think in general, this is a world that we live in today where there's still a bit too much blind faith in central banks and that investors should be looking at stress scenarios that don't involve neat and clean solutions to problems provided by either central bank policy makers or fiscal agents. But with that said, you know, given the incredibly high degree of difficulty, we think central banks, including this federal reserve, have done a really, really good job with, again, a very, very challenging environment.

Greg Dowling (23:13):

I would agree. You know, it seems like, Jerome Powell's also kind of grown into the role and has been better behind the podium with some of his language and words. And I think you stumbled a little bit early on, you know, continue on this topic. Do you think the markets are a little ahead of themselves in terms of how many rate cuts that they're projecting and how quickly it seems a little unlikely, but you know, I hate to go against the markets.

Dan Ivascyn (23:36):

So yes, we do. And this has been an exciting time for active asset management. This is an example of why we've been very, very excited about this environment in terms of, you know, know, return generation. You've had these big shifts in optimism and pessimism towards central bank policy, while the economic fundamentals have shifted on a much more measured or slow moving basis. And I think even the reaction to a little bit of surprise weakness in the employment report and some technical factors in markets, more recently you ended up, you know, repricing in more rate cuts than are likely to happen now, go all the way back to October of last year. There's a lot of pessimism in markets. A lot of people thought central banks may need to take policy rates comfortably above where they were. Then you had the rally into year end. So we looked at the new year at the end of December and we saw lots of optimism regarding central bank cuts.

Dan Ivascyn (24:25):

And now we think we're back not to the same level of extreme optimism we saw at the beginning of this year, but we do think that the data is more mixed than what the markets have suggested. More recently, what have we been doing about that? We've been reducing a little bit of our front end exposure. We've been allowing our duration to drift lower to the point now where we're a little bit underweight interest rate risk relative to our benchmarks. Now, great long-term value if you're an investor looking at the market over a three or five year period, but we have taken off some of our exposure to the extreme front end of yield curves. Then looking back over several quarters, we've been much more active in our duration and curve positioning across nearly every PIMCO strategy than we typically are because it has been quite, target rich environment. And then when you add other countries outside the United States to the opportunity set even more extreme local boats of optimism, pessimism that can be traded as well. But yeah, we do think there's a little bit too much optimism at the moment in terms of central bank cuts and we'll probably see some of that normalization over the course of the next few weeks.

Greg Dowling (25:26):

You had mentioned the election and we're big fans of Libby at PIMCO. She does a great job of political analysis. So I wanted to ask maybe two questions here is how much does politics impact your thoughts when investing and then also just Harris or Trump presidency? What does that mean in terms of the economy inflation and then just the kind of the overall rate environment?

Dan Ivascyn (25:46):

Yeah, well yeah, Libby does a great job. You see it in terms of her discussions around policy. The way I see it is she's always telling me, hey, here are my views. Here are how my views are going to change. Here are how my views are going to impact the markets, but be careful not overtrading based on these views. And what Libby will say is that, you know, even now is still very, very early in this election process. The Democrats haven't even had their convention, things haven't even gotten going yet, but we think it's going to be a very close election and it will matter to a degree, but it typically matters less than people think. And it can matter in a way that may be counterintuitive. And we saw this with the Trump election when he first got elected, you had a market reaction that lasted a couple of days, then a very, very powerful reversal.

Dan Ivascyn (26:26):

We think this is that type of election. So Trump getting back into the White House will have significant ramifications for global relationships, global policy, but it doesn't necessarily need to. There'll be more uncertainty of course, and uncertainty, you know, means, you know, potentially higher volatility, but it doesn't necessarily mean more or less conflict. Things we think would be the case. You know, if you got, you know, either a Harris or Trump presidency would be things tied to regulation. Trump will be less focused on regulating the energy sector, much less focused on regulating the financial sector. Harris is going to focus much more on regulation in those two key areas. Consumer protection, antitrust will be issues to think about more within a Harris administration. Neither party is focused on deficit reduction, but they won't be able to move the needle significantly in terms of further deterioration in government finances unless they gain control of both chambers of Congress, something we're watching very, very closely.

Dan Ivascyn (27:26):

It looked for a while, like Trump had a good chance of not only winning the presidency but taking both chambers of Congress along with him. Now with Harris running and a lot of momentum swinging in her direction, you even have to think about that other tail scenario. So, you know, bottom line is that it's something that we watch very closely from more of a micro decision making perspective. It does impact how we allocate our assets across, you know, individual corporates or industries. But for now, no major shifts in positioning other than we think this is a consequential election. It's an election where either side may not respect the outcome initially. So we do think it could be a volatility inducing event. And again, what we're doing about that is we're running a lot more liquidity than we would otherwise. Some of that's tied to just a view on volatility remaining elevated, but also there's been a market structure that's existed over the last few years that have allowed us to maintain strong performance, maintain a desired amount of credit beta or spread exposure while not needing to go down the liquidity spectrum too much.

Dan Ivascyn (28:26):

But again, it's something that is live. We're spending a lot of time here leaning on Libby and our other advisory board members a lot, and we'll have more thoughts for end investors and more thoughts for our own portfolio positioning as we get closer to the actual election day.

Greg Dowling (28:39):

So speaking of volatility, the time of this recording we're about a week or so after BOJ can raise rates and cause a immense amount of volatility and along with a, you know, poor jobs report, maybe some weaker earnings on the tech side. And we saw for a couple of days all of this volatility in equities, but also rates and currency. I guess I'd be remiss if I didn't ask you about BOJ and rate policy and then maybe kind of go into kind of our debts. Does debt matter and when does it matter?

Dan Ivascyn (29:13):

Sure. So maybe I'll start with the ingredients for this type of event. You know, typically stretch valuations are a key feature of these types of events. When you have more extreme valuations, less negative surprise can still have a big impact on pricing or shifts at overall sentiment. So you look at equity markets in general, Japanese equities in particular, very stretch valuations in a period of very, very low volatility. And then when you look at the rate market in Japan, very expensive markets, most expensive market in the world, the most subsidized market in the world. So a very small surprise in more of a momentum driven market where things are expensive and that could include, you know, public equities, here in this country as well, can lead to a very, very sudden reversal in sentiment and reversal in valuation. So we think that that has a lot to explain the more recent events, and we think this is a risk that's going to linger over us in areas where you see stretched valuations and perhaps a little bit of complacency or even irresponsibility in segments of, you know, the public equity space, the private credit space, and markets like Japan that have been beneficiaries of a lot of policy support and volatility suppression over many, many years.

Dan Ivascyn (30:28):

So we think this is a manageable short-term example of how you can have these very, very powerful reversals, when you have a small negative surprise and a big shift in overall sentiment. In fact, this is one of the positive type dynamics in the fixed income market today. People are so influenced by the 2022 events in public fixed income when bonds, you know, not only perform poorly, they didn't provide any hedge against equities. There's just not a lot of inherent negativity there. And you could end up having a positive shift in sentiment, you know, within the fixed income areas, which could be a catalyst for further price performance. By the way, as we know, the events of the last week were accompanied by a very, very powerful rally in shorter maturity, high quality fixed income. So you finally did get that diversification benefit back a week.

Dan Ivascyn (31:10):

Doesn't make a trend just yet. But we do think as inflation gets back down towards central bank targets, you're going to see not only fixed income perform well in an absolute and relative sense, but also begin to have these diversifying characteristics once again, which we all like in our portfolios, no one likes everything moving in the same direction all at once. On the second point around deficits in the fiscal situation, yes, it will matter or it does matter, it will matter over time, you know, as debt builds up. But the Japan experience is an example of how difficult it's to time these factors, you know, the debt situation in Japan has created a significant policy challenge there, both fiscal and monetary. They can get away with running these policies and they can get away with this debt situation. As long as inflation isn't a major problem, and if you do see inflation come down and rate relief elsewhere in the globe, it can take the pressure off Japan, we move in the other direction, or if there could be some type of other unanticipated shock, they don't have the same policy flexibility and these deficit concerns can rear their ugly head.

Dan Ivascyn (32:12):

We saw it in the UK a couple of years ago.

Greg Dowling (32:15):

Yeah, with Liz Trust, right when she recommended some unfunded tax cuts.

Dan Ivascyn (32:20):

Absolutely. So another example of how these deficits or debt levels can rear their ugly head in, you know, somewhat unpredictable fashion. Now here in the United States, and I remember Paul McCall used to say this all the time, given that we're the global reserve currency, we can afford to be quite irresponsible and not have to pay much in the way of price. And we still think to a degree that's the case and we spent a lot of time in our recent secular forum and can follow up in these areas with a lot more detail. To the extent there's interest, the United States still the global reserve currency, not an obvious alternative benefits from this flight to quality dynamic in markets. We do have a very vibrant economy today, lots of tech innovation that masks some of these fiscal challenges. So yeah, it's probably manageable and when you look through the economic history books, there have been other periods where developed nations have run similar deficits or debt levels and we're able to get them on track, but it's usually required some form of political catalyst.

Dan Ivascyn (33:14):

When you look at the United States as well, we don't tax our society nearly as much as other parts of the world. So we have some room even from that perspective, but no one's talking about this now. And it may require either a strong signal or a subtle multi-year signal that we need to get our fiscal house in order. One way investors may be benefiting from these higher deficits is through higher real interest rates than otherwise would be the case. So it's not all bad, you know, back when deficits and debt levels roll out lower, we had negative real yields, back when inflation was a lot lower, it felt better, things were more stable. You and I, you know, slept better at night, but there was no return. So yeah, we have inflation today, we have higher debt, higher deficits, but you're finally getting paid a decent real rate.

Dan Ivascyn (33:57):

So long-winded way of saying it's a concern. And then again, what are we doing about it? We're keeping all our maturity shorter than they would otherwise be as it relates to our positioning across the United States yield curve. Now, there's other reasons why we like owning shorter or intermediate maturity bonds over longer duration bonds, but that's one consideration. And the second one, and this is an important one, global bond investing is back. Areas like Australia, Canada, even the UK to a degree, are offering similar or even higher yields than the United States, and they're much closer to balancing their books. They also have less dynamic economies. So fiscal responsibility, weaker economic growth dynamic usually are good for high quality bond markets. And there's a lot of markets now that are competing with the United States for capital and they're looking quite attractive. So again, even in our US focused strategies, a key theme of ours over the last several months, even over the last year or so, has been diversification into other higher quality segments of the fixed income markets. Again, not just because they're running a more responsible fiscal policy, but that is one advantage and one reason why we are considering, you know, shifting, you know, some of our duration exposure outside the US into some of these higher quality and very, very reasonable alternatives.

Greg Dowling (35:11):

So maybe what we'll do is we'll kind of close out here with a kind of a, maybe not quite a lightning round, but a kind of a quick, quick round and get your initial thoughts on a few kind of sub-sectors of fixed income. And we've talked a lot about rates. Let's talk a little bit about credit. Is there any value in high yield with these spreads so tight?

Dan Ivascyn (35:30):

Yeah, it's fine. Public high yield, public IG spreads are tight, but fundamentals are good and technical are really, really good as well. Problematic high yield companies that should be hitting a maturity default end up getting a pick deal from the private credit folks. So the positive technical there are keeping the fundamentals strong and high yield, so less risk premium than would like, but when you look at spread versus reasonable loss scenarios, even under harder landing scenarios, it's still a fine asset class. It's just not as interesting as it was certainly year and a half or so ago when we're going through all the regional bank problems.

Greg Dowling (36:00):

All right, let's go to bank loans. A lot of outflows in bank loan AUM here recently, just as a kind of, not a PIMCO thing, but just kind of a global thing. We've seen people pull money from bank loans. What point do rate cuts meaningfully impact the return profile?

Dan Ivascyn (36:16):

Sounds like a simple question. It's quite complicated as you know. So you know, rates coming down mean yields on bank loans are likely going down as well unless spreads widen. So from that perspective, just like cash versus longer term fixed income, we may have hit the peak in terms of returns. So we wouldn't be surprised if you see some rotation out of floating rate credit, particularly lower quality floating rate credit into some other areas of the market that have more resiliency or allow you to lock in those yields for longer. Consumer lending, asset backed lending, all the stuff that was quite regulated coming out of the GFC where you have good transaction documentation where growth has been much more measured. We have hard assets protecting you all look really attractive versus unsecured high yield, certainly bank loans, certainly, you know, mid-market, you know, lower quality, you know, direct leveraged lending.

Dan Ivascyn (37:04):

So that's one fact. The other sort of second order effect of course will be that you've seen deteriorating interest coverage within the bank loan space and the private credit space. It hasn't been reported on as extensively as it probably should, but it is a bit of a little ticking time bomb. So if rates come down enough, it will provide some relief to bank loan borrowers, private credit borrowers. This is true of the commercial real estate market as well.

Greg Dowling (37:51):

You kind of mentioned the structured side, R and BS, any sort of a BS, what do you do there?

Dan Ivascyn (37:56):

This is where I may be a little bit biased. I mentioned earlier I grew up as a structured product trader, PIMCO's, you know, one of the largest players in the especially finance industry, probably the largest under most reasonable measurements. So it's an area where we have a lot of resources and a lot of comfort. But the bottom line is, let me sum it up this way, regulators hate bailing out the same sectors twice. And that's why you saw coming out of the global financial crisis, this massive regulation on consumer lending, mortgage lending, the banks which they had to bail out as well. This has created, you know, what we think is one of the most obvious asset allocation decisions investors can make, just think about this dynamic. When you go out to refinance your mortgage, you got to fill out about this much in the way of forms.

Dan Ivascyn (38:35):

When you look at a bank loan or a private direct lending deal today, the protective covenants are about this thick, they're a pamphlet, never mind, booking documents. And that's because of this regulatory response where if you lend against the house, particularly acquiring a season loan against the house, you have tremendous protections both in terms of the underlying collateral that's gone up a lot and really, really great transaction documentation. If you lend someone against their car or you give them a personal loan and you know they own a house, they're a great credit as well because they can't extract that equity. So they may not have the liquidity, but they have one of the strongest balance sheets they've had in years. So this is a sector that's getting a little bit crowded, we're seeing a lot of entry into this space. So you have to be careful about crowded sectors of the market.

Dan Ivascyn (39:16):

You have to be willing to say no if you don't get the protective covenants that you want or the price is too high, but it represents tremendous value relative to the lower quality areas of the corporate universe. I mentioned earlier, you know this question around interest rates. Well if our rates are going down, going to help or hurt bank loans or direct, you know, leverage lending, I said, I don't know for sure. You don't need to answer those more complicated questions within key areas of the specialty finance arena, especially when lending to the consumer because you have these institutional frictions that are giving you a very, very robust profile. Even if you have a significant economic slowdown, if you don't ever get the slowdown, it doesn't matter. You know, resiliency gets massed by the fact that everything tends to do well. But you can tell by my enthusiasm, this is one of the most exciting areas, the market as you know, we're overweight this risk across the public and the private segment of our business. It's a huge area of focus and it's an area that we've been focusing on now for, you know, quite, quite some time.

Greg Dowling (39:52):

Alright, last market question for you. You talked about the opportunity set for global bonds, but mostly developed countries. Anything to do in EMD?

Dan Ivascyn (40:00):

Yeah, EMD looks good. Long term should be a favorable environment for emerging markets, the need for more physical investment. You're seeing this even, you know, related to energy needs across the tech sector, the global, you know, energy transition, likely benefits, select emerging market countries. Reassuring and diversification away from China will likely benefit emerging markets. And then valuations, whether you're looking at local fixed income or equities looks quite attractive from a long-term perspective. So we like emerging markets in the higher risk segment of an investor's portfolio, you always have the risk overhang from more direct conflict with China. So you need to appreciate and realize this is going to be a more volatile segment of the market. Then finally, even on a shorter term basis, you've seen significant underperformance of certain higher quality areas of the emerging markets. More recently, Mexico, Brazil have been fairly crowded trades, especially Mexico. You look at just, you know, the Mex peso versus the yen. They've moved almost perfectly adversely even over the short term. We think consistent with this overshooting theme we talked about earlier, there's value in emerging markets from more of a short to intermediate term tactical perspective, but longer term, you know, real good value. You just got to remember that there's a lot of risk out there in the world and you want to put that in the higher volatility bucket of one's overall portfolio.

Greg Dowling (41:15):

All right, a couple personal questions for you. You're originally a Massachusetts guy, but you've been on the west coast for a long time. Red Sox or Dodgers?

Dan Ivascyn (41:22):

Oh god, Red Sox. I didn't even like to hear the word Dodgers. I was happy this entire conversation until just now. That's part of the fun of being out here in California's pretending to really dislike California sports teams.

Greg Dowling (41:34):

That's great. So outside of fixed income, do you have any hobbies? What do you like to do?

Dan Ivascyn (41:39):

Love to ski. Used to do it in the old days and then have two, you know, younger children. So it was a dad later in life and just absolutely love, you know, taking them skiing. They'll be passing me real soon on the mountain. But that's, by far my favorite, favorite activity out of work.

Greg Dowling (41:53):

I love it. I love it. Well, thank you Dan. I'm not sure about the Fed, but at least our listeners are not behind the curve.

Dan Ivascyn (41:59):

Thanks, Greg. A pleasure. Really, really appreciate spending time with you today.

Greg Dowling (42:03):

If you are interested in more information on FEG, check out our website@www.feg.com. And don't forget to subscribe to our communications. You don't miss the next episode. Please keep in mind that this information is intended to be general education that needs to be framed with the unique risk and return objectives of each client. Therefore, nobody should consider these to be FG recommendations. This podcast was prepared by FEG. Neither the information nor any opinion expressed in this podcast constitutes an offer or an invitation to make an offer to buy or sell any securities. The views and opinions expressed by guest speakers are solely their own and do not necessarily represent the views or opinions of their firm or of FEG.