00:00John, I want to pick up right where Eric left off, the idea that these bond mutual funds are showing
00:04an outflow for the latest week.
00:06What does that signal to you? Do you see signs of forced selling in the bond market?
00:11And does it risk triggering a doom loop, as Eric proposed?
00:15Well, yeah, doom loop seems a little aggressive, but there's no doubt.
00:21When people open up their statements at the end of September, a lot of bond funds are going to have
00:27negative returns.
00:28And people don't like negative returns.
00:30And so what you're going to hear a lot in the next couple of days is with a 10-year
00:35well above 5%, don't give up on bonds.
00:38What we're telling people is if you're worried about higher rates, and there are reasons to be worried about that,
00:46invest in CLOs, right?
00:48They're floating rate.
00:50Obviously, we have large CLO ETFs.
00:52And as rates go up, the actual coupon or income you're getting from CLOs just gets better.
01:01Our AAA CLO ETF is up 3.5% so far this year, and our BBB1 is up almost 4%.
01:09Let's talk about the CLO ETF.
01:11JAAAA.
01:12I call it JA, but I'll give you that.
01:15JAAAA.
01:16Anyway, this thing, if you look at the chart, I think we have a chart, it looks like a 45
01:20-degree angle.
01:21It's like this perfect non-volatile pathway upwards.
01:25It almost looks fake.
01:27Now, I know, yeah, there it is.
01:28Look at that.
01:29Is that like?
01:29That's because of rising yields.
01:30That's an institution's dream right there.
01:33Like, it's like basically no volatility upward return.
01:36So what's the catch, John?
01:38If rates going up isn't going to mess with this thing, what would?
01:42Look, we tell investors the one case where you don't necessarily want a floating rate, high-quality, high-yielding ETF
01:53like this would be a severe recession or something like COVID, right?
01:57And that would cause interest rates to go way down, and you're better off in a longer-duration fund or
02:04ETF like our JMBS mortgage fund.
02:06But, you know, think about the beginning of this year when everybody thought Warsh was going to come in, he
02:12was going to cut rates, the yield curve was going to steepen, and duration was going to be your friend.
02:17It just hasn't happened.
02:19So what we tell people, don't try to time the market.
02:22At least part of your portfolio should be in something high-quality, high-yielding floating rate like JAAA just in
02:29case rates do keep going up.
02:32Okay, so rates have been going up, and that's why we see that incredible performance there for JAAA, and investors
02:38obviously love that.
02:39But at some point, won't the companies struggle to pay back those floating rate loans?
02:44I mean, they will need to refi, and when they do that, the borrowing costs are pretty high.
02:49That's going to cause some kind of – I mean, it's not going to be smooth for them, is it?
02:54That's a great question, Scarlett.
02:56And I was just in Europe for three weeks, I think every meeting I had, I got this question, what
03:01about AI, what about software, what about higher rates?
03:05That's going to cause defaults to go up in leveraged loan land, which are what collateralized loan obligations are made
03:12up of, corporate loans, floating rate corporate loans.
03:15If defaults go up, will it affect CLOs?
03:18The nice thing about CLOs is it's a very diversified portfolio.
03:23100 to 200 different leveraged loans make up a CLO.
03:27Our ETF have hundreds of different CLOs within them.
03:30So right now, leveraged loans' average defaults are below 3%.
03:35Yes, they might go up to 3% or 4%, maybe even 5%, but particularly at the AAA level, it
03:41will not impact that.
03:43We have seen this time and time again, where a AAA CLO just shrugs that off.
03:50It would have to be multiple times worse than the GFC when defaults got up to 14% to impact
03:57the AAA.
03:58So you're right, defaults will go up, but it will not impact or very unlikely to impact our JAAA CLO.
04:06John, I want to go back to just generally the bond market and that chart I showed of bond mutual
04:11funds.
04:12If we go to 2022, they saw $320 billion of outflows.
04:16That bar I showed earlier was only $5 billion, right?
04:19It's the very beginning of what could be nasty.
04:22Does the Treasury let it get that bad?
04:24You know, bond mutual funds, the problem is, again, unlike ETFs, they don't trade in exchange.
04:29So they have to sell those bonds to meet those redemptions.
04:32Because they're fighting inflation, it's not like the Treasury can just start throwing money at it because that would make
04:37it worse.
04:38So how does this play out if we do keep seeing rising rates?
04:42Could we see one of these funds halt redemptions?
04:45I mean, that's what I'm worried about ultimately.
04:46But in 2022, to be fair, $327 billion, it did survive that without halting any redemptions.
04:52But, like, just play this out for us a little bit if it doesn't get any better.
04:56Yeah, no, it's, you know, we think about this a lot, Eric, and look, a couple of things.
05:02One, we're nowhere near the inflation we saw in 2022, where we got up to 8% or 9%.
05:09We're just over 3%.
05:11And there are basically three things causing that, right?
05:14It's the conflict in the Middle East, it's AI, and it's tariffs.
05:18And all those three things will probably mitigate a bit over the next few months.
05:25Maybe it'll take 12 months.
05:27So we don't see it getting that bad.
05:29But you're right, like, there will be probably some withdrawals from mutual funds.
05:34But when the Treasury looks at this, I don't think there's much they can do.
05:38Besant's already been on the tape saying that, you know, he will try to keep down rates.
05:44But the bond fund's going to do what it's going to do.
05:46It's very strong and powerful.
05:48There's trillions of dollars behind it.
05:51But bottom line, don't think of this as bad as 2022.
05:55We think maybe rates will go up a bit from here.
05:58But real rates, that's what you're getting after you take out inflation, are close to 3%.
06:04And historically, that's been a very good time to buy bonds.
06:08So don't ignore the technicals.
06:10But we don't see this as being another 2022, quite frankly.
06:13And just real quick, like 30 seconds, we have a great chart showing the percent of all ETF assets that
06:19bond ETFs make up.
06:21It's only 15%.
06:22That's down from 30, right?
06:24So it seems like the 60-40 is now the 80-20 or even the 85-15.
06:30Is it going to bottom here?
06:32It sounds like you're saying it will.
06:33Where do you see that in a year?
06:36I do see fixed income going up.
06:38Look, it's hard to compete with all the high returns that people have seen in their equity portfolios.
06:46But bond yields and real yields, like I mentioned, look very attractive.
06:50Once interest rates start leveling off, and we think that will happen probably after the next two Fed meetings, call
06:57it near the end of the year,
06:58I think coming into 2027, people will reallocate towards bonds, and that percent will go up in 2027.
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