00:00I want to get your take on what Carson Block was saying. He's bearish obviously on these corporate credits ETFs,
00:07HYG and LQD specifically because of concerns tied to job losses from the AI revolution.
00:12How are you thinking about corporate credit? Yeah. So first, thank you for having me, Scarlett and Eric.
00:16If we take a step back, think about what's going on right now with the conflict in the Middle East,
00:20right?
00:20The initial impulse by everyone is pricing higher inflation, causing higher rates across the curve, pontificating that some central bankers
00:27are actually have to hike in here.
00:28We actually have been talking to clients about the fact that be careful with the growth impacts of that, meaning
00:33that, yes, the near-term impact is inflation,
00:36but that will be a self-fulfilling prophecy and probably impact growth. What I mean by that is the consumer
00:41will feel higher prices to fill up their car,
00:44to go on trips to the jet fuel. That will crowd out other discretionary spending. That will hurt GDP.
00:48You've already seen financial conditions with credit spreads widening and rates going higher significantly tightened. That hurts GDP.
00:55And then finally, the soft data, business confidence, consumer confidence is getting really weak right now. That will impact GDP.
01:03So we actually think that while everyone was fearful of inflation and higher rates, the real boogeyman here might be
01:09the growth and labor market impact of this,
01:11throwing the AI dynamics that was just spoke about there. And that leads us to be also very cautious on
01:17public credit.
01:19I'm not necessarily saying it's going to be like GFC-type levels of carnage, like I think I heard in
01:23that interview, but it's pretty much price to perfection.
01:26We're barely wider since the start of the Iran conflict on investment-grade and high-yield public credit.
01:32So there was a tremendous amount of complacency in the markets to start the year.
01:34And we had a little bit of softness, but not commensurate with the risks ahead.
01:39And we put a paper out on our website about how historically supply-side shocks to oil is usually not
01:46long-term good for credit.
01:47So the longer it persists, the greater the magnitude of it, the more you need to be careful.
01:52That's why if you look at our funds, whether it's BUND or P-Yield, any of our funds, we're very
01:57light in corporate credit,
01:59more focused on securitized product like agency mortgages, simple Fannie, Freddie, Ginny mortgage, we think are much more attractively priced
02:05than corporates.
02:07And this is not a market where you need to be bottom-feeding and trafficking in lower-quality assets.
02:11The yields on offer and high-quality liquid assets are very attractive.
02:15Let's talk about what the trade he just recommended or he's doing.
02:19HYG, first of all, during COVID, HYG's discount was 1% at the most.
02:23And that was during – so you get a little extra, but it's not like it was back in the
02:27day.
02:28They're better at doing that.
02:29The arbitrage bands are tighter, number one.
02:31Number two, this feels – I've got to say, people overthink things so much.
02:37It almost feels like he's overthinking it.
02:38Like, it seems like there's the Trump put to a lot of this stuff.
02:41And then you've got this Fed chair coming in.
02:44They're probably going to lower rates, and that would make the bonds out now worth more.
02:49So isn't it just that simple?
02:51Like, why cloud it with all this thought?
02:54Yeah, and if you look at the underlying liquidity in public corporate bonds right now, it's the best since pre
03:00-GFC.
03:00I mean, we went through the dark years after the GFC with all the regulation where the banks were holding
03:05inventory.
03:05But now with things like portfolio trading and the in-kind create redeem baskets and ETFs, you're seeing liquidity in
03:11public corporates better than ever.
03:13So we would tend to agree with you that some of these fears might not be founded.
03:18So this idea that the underlying assets for HYG or LQD becoming illiquid because of an AI scare, that's –
03:24you don't see any basis for that at all?
03:27Well, look, that said, we are being very cautious on our exposures there.
03:31If you look at bond, it's running 1% high yield.
03:33So it's not because we're doing that because we're afraid of some liquidity crunch on high yield.
03:38It's just the valuations aren't commensurate with the risks and the uncertain outlook.
03:42And certainly, you want to be the one who has dry powder should that theory come to fruition and people
03:49be purging these bonds into an illiquid market, which is not our base case.
03:53But I'd much rather have dry powder and enter that with clean initial conditions than chock full of credit risk.
03:58Let me ask you, bond is the ETF.
04:00This is famously launched by Bill Gross.
04:02We were just talking about that.
04:04It's beaten AGG.
04:05It's gotten good success.
04:06Great.
04:07But on the mutual fund side, what's interesting about bond managers, they have had way better luck than stock pickers.
04:13Like, active bond mutual funds tend to see inflow still.
04:15They don't crush it, but they're above water.
04:18Active stock picking mutual funds, it's just like outflows every month all the time.
04:22What do you make of that?
04:24I mean, I know you're happy to be on the bond side, but why are people doing that versus coming
04:28over to, say, the ETF structure more?
04:30Yeah, so a couple of things.
04:31I think you hit it, that if you look at the history in bonds, you can't beat the passive benchmarks
04:37net of your fee.
04:38I mean, our data, looking at all the core, core plus managers that have an ETF or mutual fund in
04:42the last 10 years, over 80% of them have beaten their passive peers net of fee.
04:45That's not the case in equities.
04:48So, first of all, we're staunch believers in active management and fixed income.
04:51The data proves it works.
04:52And we're vehicle agnostic, right?
04:54We think we have a best-in-class fixed income investment engine, and we don't think it's our role to
04:59say you should get that on a mutual fund, an ETF, an SMA, or latter.
05:02That's the advisor or the client's tax planner to help them figure out what the most optimal vehicle is.
05:06But I think you're right, Eric.
05:07If you look at the ETF bond universe, I don't know, you guys had me on here six, seven years
05:13ago, and I was bullish on active fixed income.
05:15I was probably five years too early on that.
05:17If you look at the core, core plus ETFs right now, I think about 75% of the stock of
05:22assets is still in passive.
05:23But the rate of change is in favor of actives.
05:26Last year, 45% of flows were inactive.
05:28This year, it's 55%.
05:29So, I think there's the natural evolution of the ETF market, which started off primarily as a lower fee, passive
05:36alternative, and now people are waking up to the value of active management and fixed income.
05:40We also are one of the few shops out there that's trying to equally grow our ETF franchise and our
05:44mutual fund.
05:45Again, vehicle agnostic, not our job to tell people what vehicle is.
05:48Just deliver our investment process to whoever wants to partner with us in whatever vehicle they want.
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