Episode 77

JANUARY 18, 2023

Steve Weiss on why, for the first time in decades, bonds are front and center for fixed income investors

Steve Weiss, Senior Managing Director, Head of U.S. Business Development at SLC Management, discusses why bond markets are presenting clients with a unique array of investment opportunities in 2023.  

Steve Peacher: Hi, everybody, it's Steve Peacher, president of SLC Management, thanks for dialing in. Today I'm with Steve Weiss, who's head of business development for SLC Management focused on fixed income. So, Steve, thanks for taking a few minutes

Steve Weiss: My pleasure. Couldn’t more happy to be talking about bonds, now.

Steve Peacher: Right? Well, that's, that's the Intro. We're talking about bonds today, and fixed income. You've got a lot of experience and in fixed income. So, you know, this will be interesting. We're in an incredible time in the fixed income markets that we haven't seen for a long time. It's actually an attractive asset class again. Yields are up. That's been a bit painful. If you've been a bond investor up until now. But it could be a very interesting time, so that's what we want to talk about. There’s a phrase out there that you hear as you look in the press: “bonds are back.” So put that into a historical context for us. What does that mean?

Steve Weiss (he/him): I’m gonna throw a couple of stats out there. I'll say I’m a bond geek, so I'll try my best not to, not to overdo this. But when you look at three parts of the curve, because you know the curve, Fed's only focused on the front end, but it affects yields across the curve, but the market kind of takes care of that. So, if you look at the core index, the aggregate index, broadly speaking, it was down, at the at the peak of this rate hike over the past year, 18%, just over 18%, and that happened in October. The last time, and these are all records. No bond market has never been down as much it has been across the curve this year ever before, the last time it was down almost as much was in 1980, I don't know if anybody on this call is old enough to remember that, but it was, that was a rough time, and the agg was down almost 13% there. So, 18% last year, about 13% then. The long end down 34% last year at the peak. Unreal, right? Last time that happened 2008 and 2020, the pandemic down 20%. And then in the front end. And this is the place where I think the most pain was felt, because people aren't used to losing money in the front end of the curve, was down over the one to three GCC Index, which is mostly governments in some corporates, was down almost 6% at the peak last year. The last time that happened 1980 was down only 3%. So, records across the across the curve, the yields now in the core index, 470. In the long Credit index, 560. And then in the front end - this is where I think the most exciting part is - is almost the same as that is in the core space at 470. So, these yields, the lows in core 1%, the lows in long credit 270, the lows in the front end 21 basis points. Those all happened back in 2020, 2021ish. So these are new rates. Bonds are certainly attractive, and hopefully that puts a little bit in a in context there.

Steve Peacher: So, as you, as you mentioned last year was brutal and you know the calendar's turn but if you look at the Fed you've got some mixed signals coming out. You've got some Fed and you know members of the Board of Governors out in the market talking about ‘maybe it's a time to only be raising by 25 basis points,’ but at the same time the Fed chairman has taken a pretty hawkish tone as he's determined to knock down some frustratingly high inflation levels. So, is it risky? Wouldn't buying into the bond market now, in the face of the fact that we're likely to see more Fed action, be a mistake? Is it too low, is another way to say it?

Steve Weiss (he/him): I think the way to think about that is, again, the Fed controls only the front end and the rest of the bond market is going to react on what they think is going to happen, and the market right now thinks there might be doing too much right. So, you've got the 10-year yielding less. You got people, maybe pricing in for a recession, so you could see the Fed over correct and rates could go plummeting down, and you missed your chance to buy right now. Everyone's been underweight, investment grade bonds, I think primarily in most of the client types, and I don't know that you want to say ‘put everything into bonds’ but dipping in here certainly should be a reason. And one kind of key math, if you, if you'll give me one second to talk about some bond math for a second, it's called the breakeven, right. So, basically, how much can you withstand of rates rising before you lose any money in bonds? And those break evens, two years ago were like nothing. Rates go up a little bit and you have no income to overcome that negative price. Return now the break, even in the front end of the curve, now if you were to go out and buy front end 2-year bonds is 300 basis points. So, you could be wrong, you could be a little early on the Fed on where the peak of rates is going to be. But you have 300, you have 3% of rates movements before you lose money in the front end of the curve. And that could be spreads or yields. So, there's a lot of protection and timing, as we all know, if I could time or you could time or anybody could time interest rates. We wouldn't be talking on the phone right, now we'd be we'd be done.

Steve Peacher: You spent a lot of time talking to investors in the market, you know, clients of SLC, prospects, pension funds, institutional investors. So, as you have those conversations, what are those big institutional investors thinking about right now? As they think about fixed income, within fixed income, or maybe in an asset allocation context across their portfolio.

Steve Weiss (he/him): With yields where they are right now. So, if you think of that kind of that core bond yield of right around 5%, active management is gonna probably add some extra yield over what the index is. So, think about a 5% kind of bond right now. You can, if you're a public plan, you have been chasing yield for years. You have an expected, you have an actuarial assumption, that used to be 8% that's now around 6.9%. You've been trying to earn that 6.9% any way you can, and bonds has not been an option for you. So, you've been avoiding bonds forever. So, what we're seeing now is, we're seeing bond search activity start to pick up. You can do things, this is a really interesting fact, the securitized space. So, the bond market, you know there's treasuries, there's corporates, and there's structured credit. Securitized, structured credit, whatever you want to call it, was what drove the 2008 crisis. Anything that ends in “S” has scared a lot of people since 2008. That even carries through to today. You can sort of see the way spreads are. Corporates have actually rallied over the past like 3 months. Securitized is sill, way out there, really wide. You could right now as a public pension plan buy a short-term bond portfolio of investment grade bonds at your actual assumption, at 6.9%, which means that you could lock in your next 4 or 5 years of payments with bonds, of benefit payments, and then go hog wild with risk on the other side, to really take advantage of depressed, maybe real estate eventually, or equities, or whatever. So, you can do things in the bond market now that were really unheard of in the past 20 years from a yield perspective. So public plans, their funding status is improved, but not nearly as much as corporate pensions. On the other hand, corporate pension plans, the last time they were, 100% funded was back in 2007, and it's basically for the past 15 years they've been trying to recover from that that dip where it came way down and back up. We're now 110% average funding status and Corporate DB. Plans. What's interesting there, a lot of them were already buying long bonds, but their duration has shortened. The opportunity for those plans, what we're talking about there, is intermediate credit. So, they they're chock full of long bonds, and there's still reason to own those long bonds. But there's a lot of concentration risk. They actually might even be over hedged now from a bond perspective. So, the intermediate part of the curve is really interesting as their durations have shortened and as they're kind of like looking to maybe match their liability structure a bit better. One opportunity there that we're seeing from a dislocation perspective, is intermediate private credit. And that's a really great way to sort of fill that bucket with even more yield than you would get in the regular corporate bond market. So, we're talking to them about different ways to basically allocate fixed income across their allocation. And then they the Taft Hartley, of the Union plans, you know the American Rescue Plan Act has finalized what, this is a bunch of money that's going to come from the government to shore up a lot of these Union plans that are very underfunded. There's very specific rules of what they can buy, but they're right in the sweet spot of where all this opportunity is in the front end of the curve. So they, too, can lock down benefit payments using customized capital matching type portfolios to take that money that's going to come to them and lock it in at a really nice yield and then continue to invest aggressively with the other parts of their portfolio. And then, E&Fs, you know, Endowments and Foundations, have historically never invested in investment grade fixed income, they like all the private credit and all the stuff that was, you know, generating double digit yields. Well, they're spending rate’s 5%. Bonds have not been able to hit their spending rate for again, years, investment, grade bonds, and now they can. And do that in the front end with those high breaks. We're having conversations with all these different client types of all the different kind of dislocations, because when you think about the bond market, has done some very weird stuff over the past year. So, when you think about it the entire agency mortgage back market is trading below par. That's really never happened. Bonds, long term bonds, are treating 80, 70, 65 cents on the dollar investment grade bonds. This pull to par is real, right. So, bonds, so you people are saying, oh, there's still risk with what the Fed's going to do. But there's a lot of things working in your favor from owning bonds right now, just from the yield, from the compounding, from all the weirdness that's going on in the bond market. It's a really exciting time to be talking about bonds. Sorry if I get a little too excited.

Steve Peacher: Well, what I think what you highlight is how interesting and nuanced the fixed income markets are, and when yields are hovering somewhere between, around 0, in some cases negative, those nuances aren't that interesting and kind of get dismissed. Then, when you get yield back in the market you realize how many angles there are and how it can be used in portfolios, because you can be on the short end, and you could be on the long end, and you could take floating rate interest. You can take credit spread, you can take structure risk, and you and there are really a lot of ways to customize your exposures given what the fixed income markets offer you in a way that really meets your needs beyond, in a way, the equity market doesn't offer that. You know, correlation between equity, various equity types are very, very high. And over time their returns are higher but there's less a differentiation in terms of how you can use it as building blocks. So fixed income right now is extraordinarily interesting from an asset allocation standpoint. So, let's move from bonds into something totally unrelated. I like to ask a personal question at the end of these. You and I were talking just the other night about music and trends in music and albums, and going back to collecting albums, and now it's a counter trend, and how you were doing more of that. And I know you're a musician that grew up playing drums and probably other things. So, if you think back when, as a kid and all the albums you had, if you had to pick one album, if you’re on a desert island, you got one album and a turntable, what's the album you're taking? What's your favorite?

Steve Weiss (he/him): I will tell you that album is, it is probably, oh, wow! Just from a, from a sentimental perspective, I think my first record was my mom's copy of The Beatles Magical Mystery Tour, which is a, which is a kind of a an obscure Beatles record that not a lot of – people know the songs on it, but they don't really know the album that well, and I still have it. It's, I pulled up, I bought a turntable a year ago, pulled up all my old vinyl, and that's right there, and it's Magical Mystery Tour, and it's the original. It's probably, if I kept, if I kept it in good shape, it'd probably be worth a lot of money right now, but it's not. It's just worth sentimental value to me. Grew up on the Beatles. That would be my, that would be the record.

Steve Peacher: I didn't know where you're going with that when you said your mother gave you an album, I thought it was gonna be like a Carole King album or something. But anyway, that's an interesting answer. So, listen thanks, Steve, for taking the time, fascinating markets in fixed income, and thanks everybody for listening to this episode of “Three in Five.”


All data referenced in this podcast has been sourced from Bloomberg.

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