The CFA Institute just held its 2012 fixed income conference in San Francisco.
Speakers shared a very broad range of perspectives on fixed income issues over the course of about a dozen sessions.
Session notes and observations (in no particular order) include:
Demographics and Deleveraging -- Rick Rieder, Blackrock
The Best Idea in Light of Demographic and Fiscal Challenges -- Scott Simon, PIMCO
Forget about Risk Free Assets -- Michael Hasenstab, Franklin Templeton Investments
Free-Range Interest Rates -- James Grant, Grant’s Interest Rate Observer
Debt Overhang -- Lacy H. Hunt, Hoisington Investment Management Company
All About Incentives -- Thomas Hoenig, Federal Deposit Insurance Corporation (FDIC)
A Rather Disturbing Data Point -- Marie Cavanaugh, Standard & Poor’s
Risk (Uncertainty) Protection is not Cheap -- William L. Nemerever, GMO
What about Growth -- Leo de Bever, Alberta Investment Management Corporation
The High-Yield Market -- Martin S. Fridson, FridsonVision LLC
Fixed Income ETFs -- Matthew Tucker, Blackrock
Searching for Value -- Dana M. Emery, Dodge & Cox
Demographics and Deleveraging -- Rick Rieder, Blackrock
- A profound imbalance between the demand for and supply of income producing assets
- Demographics (aging societies) are driving demand
- At the same time, supply is constrained by the Fed, crowding-out, etc
- High demand and low supply results in low rates
- Lackluster global growth
- Velocity still trending down
- Credit creation (and therefore growth) constrained by lack of quality collateral
- Software is eating the world
- Extreme success at a handful of technology companies not nearly enough to offset the impact on people-heavy companies that are on the wrong side of the efficiency equation
- Monetary policy is of nominal benefit to employment
- Dividend paying stocks have potential to outperform
- Steepening risk-free curve and rising inflation expectations affecting long end of curve
- Interest on excess reserves as the inflation emergency switch
The Best Idea in Light of Demographic and Fiscal Challenges -- Scott Simon, PIMCO
- Offer U.S. citizenship to 1,000 people for $1 million each
- Reduce debt by $1 trillion
- 1,000 new and presumably productive citizens
- Sounds similar to the advice Steve Jobs gave to President Obama
- On a more serious note, U.S. housing is super cheap
- Mortgage finance is still constrained -- banks only lending to people who present no real risk
- Housing could go up a lot if something good happens to open-up mortgage finance
Forget about Risk Free Assets -- Michael Hasenstab, Franklin Templeton Investments
- The notion of a risk free asset (e.g. 10 year) has been upended
- Wealth protection will require taking risk
- Guns and gold time if the landing is hard in China
- Evidence (Chinese migrant workers monthly salary data) indicates that China is no longer exporting deflation to the rest of the world
- Surest way to lose money: keeping $ on deposit or in 10 year treasuries
- Some noticeable QE effects in EM - $30 million for 6,000 square feet of residential space outside of Singapore
Free-Range Interest Rates -- James Grant, Grant’s Interest Rate Observer
- Fiscal cliff is Y2K of 2012
- Signal is unfunded entitlements -- a $115 trillion U.S. fiscal gap compares to $72 trillion in global GDP
- John Cochrane: the real value of debt today must equal future value expectations of government’s ability to run surpluses to honor that debt
- Has the bond market done its math? When might investors lose confidence in government’s ability to pay back debt with good money?
- There are only so many real assets around if and when the panic sets-in
Debt Overhang -- Lacy H. Hunt, Hoisington Investment Management Company
- Too much debt and too much government are key features of the inflation / deflation debate
- Rising percentages of unproductive debt (debt to fund current consumption rather than productive asset development and growth)
- Rising percentages of counter-productive debt with negative (versus no) income stream
- The terminal or end-point of government over-indebtedness can take a very long time (multiple decades potentially). The problem is that interest rates typically do not react until the very end, and the long amount of time in between can consist of generally lousy economic conditions
All About Incentives -- Thomas Hoenig, Federal Deposit Insurance Corporation (FDIC)
- The merger of investment and commercial banking activities under Gramm-Leach-Bliley changed the incentives in the system in a non-favorable manner
- Does not make sense to subsidize higher risk activities such as investment banking and trading
- Institutions that are subsidized will continue to take on more risk--more capital buffers only buy time
- Higher risk trading and i-banking need to be re-separated from the subsidized safety net
- Not much matters unless monetary policy provides some semblance of predictability and stability
- Money market funds are investments--not deposits
A Rather Disturbing Data Point -- Marie Cavanaugh, Standard & Poor’s
- Things happen fast:
- Greece rated A roughly 3 years ago
- Spain’s debt/GDP looked very different 5 years ago
- However, a meaningful time lag (several years) between movement in bond spreads and initial sovereign downgrades
- Balance of payments a fundamental issue in Europe as currencies cannot be used to get the BOP pressures to adjust
- Socialization of risk - private sector contingent liabilities continuing to migrate to sovereign balance sheets an ongoing problem in Europe
Risk (Uncertainty) Protection is not Cheap -- William L. Nemerever, GMO
- Uncertainty is a more appropriate characterization than risk of many challenges in investment management
- Enormous changes in correlations between asset classes over the past 20 years
- Implied volatility (basis for option prices) consistently greater than realized vol
- Relatively high implied vol impacts returns
- The value of tail risk “insurance” is hard to quantify but the expense creates a meaningful potential performance drag--particularly in a low yield world
What about Growth -- Leo de Bever, Alberta Investment Management Corporation
- Weak global growth and mixed results for listed assets (equities low end of historical average and bonds low or negative total returns)
- Improving on this mediocre picture requires seeking investments on the “road less travelled:”
- Markets dislocated by financial sector deleveraging such as life settlements
- Private debt
- Pre-IPO venture funding
- Relationship investing with a long-term perspective
- The pace of innovation is accelerating but the implications for the economy are uncertain
- Employment and labor’s share of GDP
The High-Yield Market -- Martin S. Fridson, FridsonVision LLC
- On the surface yields make it hard to argue that risk is lower in the market (September 1.4 standard deviation)
- However, low treasury rates are a big part of the story
- Option adjusted spreads are not historically high
- Bubble story would be more compelling if the risk basis supported it (default rates do not support it)
- A commonly used high-yield valuation method produces very misleading results over the short-term
- Presented a new methodology for relative value assessment
Fixed Income ETFs -- Matthew Tucker, Blackrock
- Fixed income ETF liquidity is additive to the overall bond market
- FI ETFs as a risk and liquidity management tool--providing efficient exposure to beta and overall asset allocation
- ETFs may reflect changes in investor sentiment more efficiently than individual bonds
- Also may be differences between ETFs and OTC bond market in terms of speed of price discovery
Searching for Value -- Dana M. Emery, Dodge & Cox
- An exceptionally tough time to invest in credit, but corporate balance sheets and fundamentals remain strong
- Opportunities for attractive relative return over the next 3-5 years despite the low rate environment
- Credit investing must focus on downside risks even in good times--valuation assessment is key part of research process
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