ETF Edge - Staying fixated on fixed income 3/18/25

Episode Date: March 18, 2025

With volatility up and yields down, what should you be doing with the fixed income portion of your portfolio now? We dive into that. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ. Let's rethink possibility. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you are looking to learn the latest insights in all things, exchange, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors.

I am your host, Bob Pisani. Extended volatility is the word here, and we have the discussions for you today. This is the fixed income portion. of ETF Edge and the fixed income portion of your portfolio coming up here. We've got Jeffrey Katz with us and of course he is with TCW and the manager director over there and Alex Moore, CEO of FM Investments. Jeff, you can know the drill here, heightened volatility we've seen, heightened concerns about

inflation and tariffs. Are bonds a safe haven from all of this craziness? Yeah, Bob, thank you for having me. Yeah, actually they are. And so you think about where we've come from 2022 prior to that. rates were very low, wasn't much protection in terms of income. We now have a much, much, much more comfortable buffer and bonds are acting as they should in the context of a 60-40 portfolio. Yeah. So Alex, we have flows into fixed income ETFs. I was just looking at an ETF action.

They've picked up. I mean, really it's impressive in the last month or so. They're almost rivaling flows into equity ETFs this year. That's kind of unusual. What should investors be doing? Should they be increasing their allocation to bonds at this point? We think so. I mean, particularly on the short end of the curve, shorter duration. There's a lot of safe haven to be had there. And if you look at where the equity market's going, if you didn't like the wipeout of a couple of weeks ago, there's some more banana skins ahead of us. Tariff risks are high. Inflation risks are real. I know folks say, well, inflation is the scourge of fixed income. Why should I get in now? Well, there are also the antidote to uncertainty, right? Inflation's a generational concern.

Recession is a short-term one. What's a central banker to do? Not very much is the answer. And if policy stays where it is, short end of the curve is going to be a great place to be. It's amazing how sticky, at least the CMBC viewers are, with the short end of the curb. They love their money market funds. That is the stickiest thing I've seen in your, what is there, $6 trillion sitting in money market funds right now? And they don't seem to want to move. They're getting 4%. They seem to be, it's a positive return overall.

Is there reasons they should add to it, detract from it? What should those people be doing? You can even extend out a little bit. You look at our flexible income fund, flexer. A lot of our duration is in the front end of the curve, as Alex mentioned, kind of two and five-year part of the curve. If we get something outside of the miraculous soft landing, you can expect the Fed to maybe cut a little bit further than what the market's predicting.

You can get a benefit from duration there. So maybe you can extend that a little bit, kind of two-and-five-year part of the front-end of the curve. Well, people get confused about this. So let me try to get a little specific with you. You run a very broad, active bond fund, invest in all sorts of things. treasuries, mortgage-backed securities, corporates, asset-backed securities. What parts of the credit markets do you like? What parts are you overweight, enthusiastic amounts about, and what parts are you not enthusiastic? That's a great question, Bob. Yeah, great question. You know,

the beauty of our fund is it's a go anywhere fund, and so we can do things outside the scope of traditional index, like the Bloomberg Ag. So, you know, credit to us looks fully priced or rich with respect to the spread you get compensated. You're talking about corporate bonds, corporate bonds, corporate credit. So what we've done in the fund is we've leaned into securitized. So you're underway corporate credit. You've got to handhold that people's hands. Explain what you're doing here. You're underway corporate credit. Okay, because we think valuations don't reflect the potential for anything outside a soft landing. Okay. And you were talking about overweighting? Asset back securities? Asset back securities. Explain that. So there's a couple

parts of what we call the securitized market. So the residential, single-family residential market. We like mortgage credit, and so we think that there's a lot of equity in the housing stock today, so very little incentive to actually default on your mortgage. If you can, the undersupplied housing market, you can easily sell your home. The commercial mortgage market, particularly Class A office, I think Park Avenue, call back to office. We've seen a really strong rebound in the course of the last year. We've leaned into that, so basically you think Class A office space in New New York City. And then you referred to the asset-backed securities market.

So things like CLOs, very high quality, investment grade, floating rate. Collateralized loan obligations. Collateralized loan obligations. And then data centers. So data centers are a new phenomenon, about two years of issuance related to the AI phenomenon we've seen. There's a very big demand for cloud computing and computing power. We're seeing a build out of that infrastructure and they're coming to the ABS market to issue.

And then we have shorter duration of treasury. I know you're overweight that too. Correct. Yes. So we like the front end of the curve. So two-year treasury notes, five-year treasury notes. So extend a little bit outside of money markets and get a little bit of benefit from duration. So your underweight corporate credit, your overweight residential commercial mortgages, overweight, shorter duration treasuries and overweight asset back security. That's correct. That's correct.

Okay. Alex, let me turn to you. You've got a suite, you've been on many times before, of the suite of fixed income ETFs, but particularly Treasury bills. A lot of your assets under management are there. The three-month Treasury bill, ETF, TBIL, which we've talked about before, passively managed, invests in

the most recent on-the-run three-month treasury. Explain what on-the-run Treasury and what you're getting with TBIL. Sure. So, every in the case of the 90-day, every week, other bonds come out every month or every quarter. The Treasury auctions a new version of

So when you look on CNBC and you see the 10-year yield, you see the 90-day yield, that's the most recent issue. Over time, whether it's 90 days or 10 years or 30 years, those will mature, but the government needs to constantly fund itself. So the Treasury is regularly auctioning these off. It's a great way to stay more liquid. The on-the-run, the most recent issue, just has inherently more liquidity in it. More people want to trade it. It's on more desks. It has more flow.

And why, and you too, are also enthusiastic about shorter dated, shorter maturity, sort of duration? Treasury's, why the interest in shorter duration? We like duration to stay short because in times we're uncertain, taking more risk and multiplying it to an even bigger number doesn't really achieve the outcome we want. When folks are looking for that safe haven, particularly a cash alternative, right, there are $7 trillion dollars plus in money market funds. There's another $15 trillion locked away in bank deposits that are sitting there long term. Some CD, some just sitting in your interest bearing account earning 25 basis coin points. We like that short duration to give you that same amount. to give you that same experience.

I'll also say a dirty term for a lot of folks, which is tips. We like ultra-short duration tips, the space that no one has played around in for a long time. We launched a fund our bill, first ultra-short duration tips fund on the market. So this is going to work rather like buying that 90-day

or that six-month, but you're going to have this inflation insurance policy issued by the government. So you mentioned inflation as the, I think you used the word, the scourge of fixed-income investors. tariffs, are they inflationary? Terrace are inherently inflationary until they become depressionary.

I think that's what folks miss is it is true. There is an outcome where tariffs don't create inflation. They just destroy growth in such a way that we don't really want to think about that outcome. In the short term, they're inflationary. And as we're seeing now, even worse, the fear of uncertain tariff policy is creating inflation anticipation of future inflation. So until we get some real clarity there, we like staying short. We also like staying liquid.

So if you want to look at five-year bonds or notes or two-year notes, U-5 or U-2, very liquid, super-blade to play it, you don't have to worry about a security aging out and not trading well. So the Federal Reserve is meeting tomorrow. Alex, your helicopters land. Yeah, they're ready for me. He'll have to leave in a few minutes. The Fed's meeting tomorrow. What's Jerome Powell to do here?

Given these concerns, he sees the same issues with it. Yeah, I think he's in an unenviable place. right? There's a lot of uncertainty from the policy side. I think that they're fortunate that they've given themselves the bandwidth to deal with either a slowing economy where they can cut rates or, you know, hike rates if we do get a bump from inflation on the tariff side. But he's in pretty much a standstill pattern. Very little he can do at this point. And you same way? I think the same way. I think Jerome Powell had his choice. Would cancel this meeting and cancel every meeting until the end of the fourth quarter and cancel all the congressional appearances and just

sit on his hands and tell everyone don't say anything. And it's tough because they're trying to provide guidance. They've worked very hard for a number of years to retain credibility, rebuild credibility. The Fed is usually late to do things, which is kind of the right move often and they get criticized for it. But they've done all the right things. And now political and policy uncertainty comes in and just bashes them over the head. And if you're Jerome Powell, you're looking at this experiment as we're driving our car into walls just to prove that our airbags work. Yeah. So I want to go back to this inflation and tips because if inflation is really an issue, how do you get inflation protections? You've got this TIPS product. You mentioned RBIL. It's ultra-short tips. Tips means treasury

inflation protected securities. Can you just explain how these products work? Sure. They're treasury securities just like the two-year, the five-year, the 10-year. Full-faith and credit the United States government. They are linked to CPI, so they're reset every month, and the government increases your principal. So you're not going to get $100 back. You're going to get $100 back plus all of your accrued inflation. Your coupon grows with inflation as that principle grows. And if something were to happen where there's a lot of deflation, the government guarantees you par value. Where a lot of folks get burned in the tips market is they buy them when they see inflation coming. Well, what happens when inflation comes? The Fed hikes rates.

Hiking rates drives duration assets down. So folks who bought even shorter term tips funds with two or three years of duration in it got absolutely smoked in 21 and 22. is a good time to buy tips then well so tips a good time is when you think inflation is going to be stable or as we've learning with our bill it's almost always a good time to buy ultra short tips the only time when it's not is when real rates are negative which just is so if you think inflation is very real this is not a good time to buy tips then it's a good time to buy ultra short tips there's no duration in them so you're getting just headline CPI a lot of folks see duration they try to fight it with gold gold collapsed in 21 and 22 equities were highly volatile and commodities were causing the

inflation so it was too late to buy them yeah but that ultra short tips market had been just over, they'd been missed. No one was offering a fund, and we came out and the results versus even 90-day treasuries are really great. I think you do bring up an important part, though, because there is duration in those assets, and I think the market underestimates that or doesn't understand that. They think it's a pure play on inflation, and there's a duration component to those assets. And duration, of course, is sensitivity to interest rates. The viewers get confused about duration, you know, versus the term, the maturity, and that's a common problem. I don't want to go into that right now, but the important thing here is you guys are

active, but you particularly are active. And I want to bring up that component because being an old Jack Bogle disciple, Bogle being the founder of Vanguard, his point was basically stay long, understand your risk profile and stay long and don't try to pick stocks or even bonds. Are you going to make an argument that active bond management in this environment would outperform, like your bench is AGG. This is the main benchmark for bonds. It's widely used with the old Lehman Brothers. And of course, the argument Bogle made for decades was holding the S&P 500, you're not going to outperform that. Holding the ag, are you going to outperform it? Under what circumstances would you outperform? So I think there's a really strong argument for being an active manager in fixed

income. And so one of our... Over equity? Well, relative to the index. And so in fixed income. And I think the rationale behind that is if you look at the composition of the ag, so the Bloomberg Ag, the old Lehman Brothers Aggregate Index, it's 45% treasuries, 25, 26% residential mortgages, government guaranteed, and then 25, 26% corporate credit. That's great corporate credit. The very small weighting to Asset Back Securities in CNBS, but less than 2% in aggregate. That's about $29 trillion in investable securities, but there's about $26 trillion in investable securities outside of the ag in the U.S. That would be mortgage credit.

It is a zero weighting in the aggregate index. Almost all of the CNBS market sits outside the ag. Almost all of the ABS market sits outside the ag. Money market securities, emerging markets, high yield. All of these assets sit outside the ag. So there's a really strong argument for diversification, lower correlations. But your argument is there's a bigger sandbox than the ag represents,

but that doesn't mean you're going to outperform the ag still. So what's the argument that active management particularly in a bond space, you're making a very particular claim here, that active managers in a bond space could do better than active managers in an equity space. Why? So you look at the TCW as a whole, right? We have very deep credit teams, research teams, and so our ability, you look at our historical alpha. We've driven over 80% of our alpha between sector rotation and issue selection. So having our teams go through those commercial buildings that surround us, apartments, office spaces, residential mortgages, things like data centers, our ability to pick assets that outperform that will not be represented in the index is something that shines through.

Well, Alex, are you of the opinion that active bond managers? So you know the argument of the active managers. Well, wait till we may not outperform generally, but in a real crisis we can move quicker. And generally, even that is not proven to be true in equity. Is there any evidence that active bond management in a crisis being able to move will provide some kind of alpha? I think there is some historical precedent for some active management, mainly because the indices are old and don't really represent how we trade today. So fixing the indices might be a better solution than going fully active. That's an interesting argument. Fixing the indices may be a bigger sandbox like you're talking about.

It's been three decades. I think the last thing I'd like to point out on, though, you look at Flexer last year. Flexer outperformed the ag by over 500 basis points. So that is an active expression given a short data set. but the fund is one of the few funds that's been around greater than three years in the space. We've outperformed since inception, about a 7% return. So, I mean, I think the proofs in the pudding. You see it in the returns of the fund. Did you want to finish your point?

Sure. And that's what we've done with our funds. They're passive funds. We often had to work with someone to create an index that was more investable, simpler. Bond indices get bloated with tens of thousands of issuances. The ag is so big, it's uninvestable. We know that because they created a version called the investable ag. That's also so big that the average person can't even think of investing it.

if they wanted to. So we thought about how do we fix up the fixed income index world. So we've always focused on liquidity, which is great for ETS. ETSs price well when the underlying securities are fewer and more liquid. And we think that's probably the way this needs to go.

We don't want you to think all the magic is us behind the screens, picking the right securities, because it doesn't always work. But if we show you a better index that we follow, more folks can have some comfort in the fact this is a repeatable process. You're not looking at our numbers anymore.

You're looking at Bloomberg's. You're looking at some of the number someone else's and it's a more consistent experience. I know you're not bond market prognosticators, but the viewers want to know your opinion on where, for example, the 10 year is going to go. You know how they love their products. We've got 10-year hovering in the 4% range,

even money market is in the 4% range. A year from now, where is the one year going to be in the 10 years? Sure. So on the front end, we think that the economy, again, is going to slow potentially more than what the market's pricing in. So we think that the Fed's ultimately going to, when they do cut, when the economy slows, they'll have to cut further and faster.

So we're talking about a Fed funds rate somewhere sub three. For the 10 year, again, we think that growth is going to moderate. So we're looking at a tenure someone that three and a half, like mid-high threes. That's pretty close. The spread's not that far. Yeah, so it's a relative, I mean, two and a half, three percent on Fed funds and three and a half on the tenure. Okay.

Alex? We see Fed funds coming down much less. I think we'll see it maybe quarter basis point in November. maybe a second in December, but that's it. So we won't see much movement there. I think we're going to see a lot of range on the tenure over the next 12 months, though. Where it is today closer to four, it's going to bounce back up and look at flirting with five again based on tariffs, based on policy changes. But then hopefully, we hope moderates because the tenure has this great quality when it hits five, it reminds everyone it is the haven asset to go to.

So money flies in and the yield comes back down. So people who are expecting, like, who are holding on to their 3% mortgages hoping the mortgage rates go back to 3%. it's a bit of a fantasy, right? That's not going to pay that mortgage and keep paying it. Yeah, I always tell people that 3% is an anomaly historically, that a 6% or 7% is much more normal. Exactly. That's correct. And in fact, it's healthier to be this way, isn't it? I mean, do you want 1% 10-year yields? Who's going to give the government 1% for 10 years that we had a few years ago? That doesn't make sense. I think we fell into this belief that 0% interest rates were some badge of honor. They are no badge of honor. That was a strange time where we threw away all the historical precedents, but because things were cheap and asset values were going up,

we all became pretty happy with it. But they are unusual. They're untested. And long term, it's sort of unhealthy to have this unnatural asset appreciation mechanism. Yeah. So for people who keep messaging me about more mortgage rates going to come, expect 6% to 7% mortgages. You don't expect any dramatic drops. Yeah, I mean, I think we see something maybe slightly lower, but there's a pretty material spread between treasuries and mortgages today, given that there's less volume origination. So with that spread could, compressed, but yeah, somewhere maybe just shy. Years ago, I was the real estate correspondent in the 90s.

It used to be 150 basis points. It's about 250 right now. Yeah, it's huge. And a lot of that covers the cost of origination, but volumes dried down. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast. Alex Morris, CEO of FM Investments, continues with us now.

Alex, thanks for sticking around in beautiful Miami Beach, Florida. It's lovely. every time. 82 degrees and a nice gentle breeze going along. You watch flows in ETFs. I have been very impressed with, we're continuing to get inflows into equity ETFs,

some outflows in technology, but very impressive inflows in bonds this year. What do you make so far of flows? I think a lot of folks are looking for that haven quality in the asset. They're also seeing attractive returns. I mean, we often malign fixed income, but

4% plus, 5% plus, Historically speaking, pretty nice return profile. Folks are seeing that, and it's hard to get on your own. And a lot of folks have looked at some of the more active strategies that are out there that have taken bets on lots of three-letter, four-letter acronyms and grown tired. So they come to more traditional strategies, and we're seeing some pretty impressive flows really across the fixed income space, but in particular, mid- and short-duration treasuries. Yeah, there's a super short end.

You know, people seem to love their three months and even their money market funds. We talked about this on the show. remarkable how sticky that money is. Yeah, we're trying to get some of that out. As we're talking on the show, we like that ultra-short tips. Folks have missed this. Like, why would you not want to take the 90-day, take T-bill rates and get an insurance override from the government for free? It seems like the place to go. You protect your purchasing power. Would that be a better thing than just owning a broad bond fund right now? If you had a broad bond fund, would you say you should put money in an ultra-short-tips fund? We do. We're telling folks take your money market fund and put it there. You're going to get a similar rate, maybe better.

you're going to get that if insurance insurance if inflation does spike you're going to get that ride automatically guaranteed from the government and since you don't have any duration you don't have risks of rates moving around on you like the duration bet works if you think rates are going to come down precipitously very quickly faster than the market thinks I don't think central banks are poised to do that for people yet how about the sort of more exotic aspects of the market there's been huge attempts to get ETFs and do private credit and private equity at all. I mean, I've seen people tie themselves into pretzels to try to do this. It's very difficult to have this in an ETF structure because you need underlying liquidity. Any thoughts on that?

Yeah, we look at things where ETFs are going to be priced hundreds of times a second, and something that is natively priced once a quarter doesn't really seem to fit very well, particularly when you want flows to come in and out of the fund. So appreciate the desire for access to those asset classes, but for as interesting and evolutionary and revolutionary as the the ETF can be. There are just some asset classes that aren't a great fit. I applaud the efforts. I think folks are trying really hard and there is some value to some of it. But when you have to start explaining to me all of the things that it isn't like buying the native asset, and that's how we got to the ETF. I worry. Why can't you just give me the native asset? It is a good thing to worry about.

How about crypto? We saw massive, probably one of the greatest launches of all time with Bitcoin ETFs last year, flows were just massive and now it's a little more moderate. Flows are moderate. Cryptocurrencies came down, right? There was a 25% correction that somehow went unnoticed by most of the crypto fanboys. And that was a very real item. Assets moved out of the coin bases of the world, moved into the ETF space. And some of those managers are learning they can leave just as quickly. Yeah. And it's a it turns out that It's aspects of this are just as much risk on as a couple of years ago investing in Kathy Woods Arc Fund is, for example.

There were people who were really risk on with her a little while ago, and that sort of moved on. Of course, the Bitcoin enthusiasts think it's just a low. And that's the beauty of the market. You get to decide where you are in that risk trade. The beauty of the ETF now is you can come and go without paying three, six, eight percent commissions. So if you're a punter in the space, this is probably,

a safer way to get access. But I don't know that you should be putting all your money market funds into Bitcoin ETFs today. Yeah, good advice. Stick with the tried and true there. Alex, thank you very much. Appreciate your time here. That does it for this week's ETF Edge, the podcast. Thanks for listening. And remember, you can see all of our shows on the website, etfedge.cc.com. How does InvestcoQQQQR rethink possibility? By rethinking access to innovation and the NASDAQ 100. Let's rethink possibility. Investco Distributors Inc.