Episode 284: Bonds, Benchmarks, and Beyond: An Insider's Perspective on Fixed Income Investing

 

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Hey, welcome back. It's great to have you. We've got a phenomenal podcast for you today. And I say that kind of self-servingly, because as most of you know, I'm a fixed income geek or nerd, whatever you want to call it. I ran core fixed income for a lot of years for insurance companies, worked internally for an insurance company running their fixed income as CIO, and that's the topic of today.

And core fixed income is the biggest allocation of most every insurance company, and it doesn't necessarily get the sunlight that it deserves. And I've spent a whole career kind of halfway apologizing for being a core fixed income person, but I'm thrilled to be on today with Christine Thorpe Institutional Portfolio Manager at Fidelity Investments. Christine, welcome and thanks for taking a few minutes with us today to give us a really good education as professor for a day on fixed income.

Christine: Well, thanks for having me. Always a pleasure to be with a fellow bond geek.

Stewart: Absolutely. And I say that with the greatest amount of pride. I am a bond geek. And I have a really good friend named Dean Shillito who covered me back in the day, back when the earth was cooling, and we had the geekiest conversations ever about this security and that security. So I'm really looking forward to this.

But before we get going too far though, I'd like to know a little bit more about you. So, can you tell us where you grew up and what was your first job, not the fancy one, and how did you go from that not fancy job to the seat that you're in today?

Christine: Yeah, it's funny, I grew up in MetroWest Boston, so I'm not too far outside the city. And I'm not part of a big family, I only have one sibling, but my parents both came from really large families, and so I was always surrounded by cousins and happened to be the oldest, so frequently was sort of camp counselor for everyone.

So I think it wasn't a surprise, baby sitting was really my first calling. So I leaned into that pretty heavily, and then eventually made my way to college. And then I really started out as a government nerd, that was my first focus area in terms of school. So I actually spent a couple of years after graduation working on Capitol Hill down in D.C.

Stewart: Oh wow.

Christine: Yeah, so a totally different world. Then decided I really wanted to move in a different direction, didn't know what, so came back home, went to business school, and then eventually made my way to Fidelity, and basically I've been here for close to 13 years. Time has flown by.

So, started my time at Fidelity working here in fixed income, then spend some time working on large institutional client relationships before I got back to my roots in fixed income. So I've been back here as an institutional portfolio manager for the last three years.

Stewart: Oh, I love that. That's a great story. I think sometimes, at least my experience with students is that they get really locked into, "My major is what I must do." And it's so interesting. I used to have folks come and recruit and they would say, "Well, yeah, I'm looking for a 3.5 in finance or better." Of course, I was a 2.6 in history, but I'm like, "If it worked for you, why wouldn't it work for somebody else?"

So, I love that you've got a diverse background, but I don't know beans about how that politics business works, but I know a fair amount about fixed income. So, Fidelity manages about $2 trillion across your fixed income strategies. Can you talk a little bit about the depth and breadth of all the various places that you're managing money that make up that two trillion?

Christine: Yeah, absolutely. So, it's funny, we're actually based in Merrimack, New Hampshire. This is where I'm sitting today, and this is where all of our money market and investment-grade bond strategies are managed out of. We also work really closely with our high-yield, our leveraged loan, emerging market debt and high-yield real estate teams that are based out of Boston. And then we've also got a global credit team that sits in London. So, I think a pretty broad breadth of exposure across all those different sectors.

Now, here in Merrimack, what I'll say is we manage a number of different types of vehicles. So we're pretty agnostic in terms of any type of wrappers that our clients want. We've got 40 Act products, ETFs, we run separate accounts, and also institutional collective vehicles for different pension plan sponsors or dominance on foundations. But what's interesting, we've also, on top of all that, got pretty broad exposure to the insurance provider.

So for us, we run some core mandates that are used in different annuity products distributed directly by Fidelity, but we also manage some large sub-advised mandates that are used by other insurance firms for their annuity products. And then we've got some separate accounts we run, where we're actually managing balance sheet assets for both domestic and global insurers.

Now, I think obviously across that scale there's different degrees of complexity, where any of the annuity mandates running look pretty similar to their 40 Act counterparts. While anything, we're running really for the balance sheet assets, typically tend to be all customized, and for some we might be matching the liabilities of their cash flows or durations, or we may have gain, loss requirements we're trying to manage against. But even for those, the nuts and bolts of what we do as active fixed income managers doesn't really change. We just look at those elements as being additional constraints we're trying to manage against.

Stewart: And we had your colleague David Gaito on about, honest to Pete, about 50 episodes ago now, which has been a minute. But one of the things that he mentioned was the culture at Fidelity. And I've been at this for a minute too, and I've often heard about the culture at Fidelity. Can you talk a little bit about how that culture and your team-based approach gets put into play in fixed income?

Christine: Yeah. Well, I'm so glad you asked that 'cause I think you really hit the nail on the head. Now, across our fixed income group, we all specialize by either strategy or sector. So, I'm part of our core, core plus and tactical team that manages about turn $50 billion in assets. And we've had really strong performance consistently, not only relative to the benchmark, but also relative to our peers.

And I think there's a couple parts that's really responsible for that, including the team-based approach. And what I'd say is, this is consistent across any of the fixed income teams. It's really just embedded in our DNA. So, for that team-based approach, on this specific team, we've got a group of five portfolio managers who really work as a team. And I mean that in every sense of the word. There's a ton of different debate and challenge and review that goes on every day.

And for us in Merrimack, we actually have an open floor plan. And we really want it to be a flat culture, so the teams of portfolio managers all sit out really in the middle of the trading floor. They're sitting right next to our traders and our quant and right around our fundamental analysts. We want everyone to have access to the PMs. We think good ideas can come from anywhere and we want everyone to feel comfortable sharing their latest thinking.

And I think that also goes both ways. So, the other part of being in the team is we want to make sure all these different groups, again, the traders, the analysts, they have an understanding of what the PMs are looking to achieve, what their views. So I think everyone's really ultimately rowing in the same direction. 
The last part about the team is because we have a group of portfolio managers, you really take away having any type of key person risk, where you're really relying on one person, but we've also got the ability to be really flexible when we need to be and can make decisions quickly when the market calls for it.

Stewart: That's super helpful. And it's interesting too, because insurance companies, running insurance money, particularly core fixed income is rarefied air. Insurance companies, they're a multifaceted portfolio that has to not only meet a whole slew of regulatory requirements and risk-based capital considerations, but they've also got to fund a set of liabilities which doesn't lend itself... Some fixed income managers have a very active duration approach. And that sort of thing, and I've said this before, I think that trust is the most important in the insurance investment community, because the business that the clients are in, trust is a big deal, and running core fixed income for them is a really important job. What can you tell us about your core strategy and how it dovetails into the scenario I described?

Christine: Yeah. Well, I think from our perspective, we know that clients are using our core strategies as either building blocks or they really wanted to fill a distinct role within an overall portfolio. So for us, we really want to deliver a core-like volatility profile. We think that's really important. So, for a strategy that's benchmark against the ag, that's typically what our clients should expect from how we're running the strategy.

So for us, we typically are not taking big duration bets. We think that's really hard to do consistently, and can introduce a lot of swings into the performance of a portfolio. So, while we may have some small tilts within duration, it's typically pretty close to the benchmark. We tend to keep it in a very tight band relative to the ag. And that's really, again, I think a key tenet for us across all the strategies we manage.

Another strategy that we manage across this team is actually core plus. And it's funny, we apply the same thought process around the volatility of that strategy as well. So, for something like that, where we've got a global credit allocation, we're actually hedging all of that exposure back to USD, just given how much higher currency vol can be relative to bond vol.

All of this also means across, again, any of these strategies that we're taking a pretty similar approach for duration. So, instead of making big duration bets, where we really try to lean into in terms of generating alphas, making really good sector allocation and security selection decisions, that's where we feel like we've got a really big edge, just given all of the sector expertise we have in-house, plus all of the fundamental research we have access to as well. So, I think we tend to think of ourselves as maybe being a bit more plain vanilla, but I do think that approach typically resonates pretty significantly with our client base.

Stewart: The one thing I wanted to add was, when you were talking about managing fixed income and managing to the aggregate benchmark, I wanted to make sure that folks knew that Fidelity can also do bespoke portfolios to unique guidelines and investment constraints and so forth, like so often happens in our space. And, we didn’t cover it on the podcast and I wanted to give you the chance to address that here.

Christine: Yeah Stewart, I’m so glad you came back to that. I think it's a great point When we talk about our strategies that are run against the Bloomberg aggregate bond index, those are just our standard off the shelf, but certainly have a lot of ability to customize to different client guidelines, different benchmarks, different requirements, whether it's from a gain or loss perspective. So that definitely exists within our fixed income organization, so happy to make that available as needed.

Stewart: Thanks so much. Yeah, I think that's right. And one of the things that my notes have is the preference for rates over spreads. Can you unpack that for our audience? Because a lot of times, folks dramatically under weigh treasuries in favor of spread product, and that seems like maybe there's a point of differentiation there.

Christine: Yeah, so let me caveat this by saying we don't have a house view at Fidelity, so any comments I make are really reflective of how I and the team are thinking about the opportunity and the risks before us. So you're right, I think within our core portfolios we do have a preference for rates over spreads. And really, that's just based on this thought that while the economy feels pretty benign, we're just extremely cautious, given where valuations are. So again, I mentioned we don't take big interest rate bets, but right now we do have a small overweight to duration. Really, rates are the one place in fixed income where we've seen volatility. Just look at the 10-year treasury, that's sold off about 70 to 80 basis points since the Fed actually started to cut rates in mid-September to where we are today. So, that's one area where we can be a little bit more tactical, again in a very small way, just to take advantage of some of those moves.

I'll also say we have been more bulleted on the curve, just given our expectation that the curve's going to continue to normalize and steepen over time. That piece might be more measured, just dependent on how quickly the Fed continues to ease. But of course, we all know that the curve can move pretty quickly, just look at the 2s, 10s curve going back to March of 2023. Back then, we were inverted by close to 110 basis points, and then a week or so later we had steepened by 65. So, a pretty large move in a short amount of time. And again, I think that timing's hard to predict. So, from a portfolio perspective, we're overweight US treasuries by contribution to duration perspective. Yields today in fixed income are in the 80th percentile relative to the last two decades, and most of that yield is coming from rates.

And the other thing we like about having treasuries in the portfolio is it gives us a lot of flexibility when we do want to add risk back. So, we have been neutral investment grade corporates, we've actually been taking down some of that exposure. From our perspective, spreads are pretty priced for perfection, and really, essentially all time, tight. So, I think it's easy to see a scenario where any excess return advantage is really wiped out as spreads move wider. We've really been leaning into short and intermediate corporates. They tend to be a little bit more efficient from a risk perspective, and we're really just trying to generate as much return from really good security selection as we can.

The other piece just on securitized, we have been underweight agency mortgages. There, we've sort of opportunistically added or reduced, depending on spread moves, but right now with spreads at around 40 basis points and we see very limited security selection opportunities, we just don't think there's much excess returns to be generated there. Instead, we've really have had a preference for targeted areas of the commercial mortgage backed security market. So, leaning into property types away from traditional office, which have struggled as of the last couple of years, and really focusing on things like distribution and warehouse centers, and life science buildings in really top locations.

And then the other sector within securitized, we've liked to been AAA CLOs. Again, I really think of those two areas as where research can play a bigger role. So, long story short, if I had to sum it up, I'd say that the theme in the portfolio for us is all about patience and diversification. We think we're getting paid to wait. We've got a lot of flexibility. We've brought risk down towards the lower end, relative to the last decade or so, but we're still risk-on, we've still got to carry advantage, and we're just going to wait for a better entry point before we add more risk.

Stewart: That's super helpful and really insightful. You're just listening keenly of a good sense of how you see things. And I think that first and foremost, for the insurance investors, that they want to understand how you see the world and how you add alpha, and is it repeatable, is it consistent and so forth. So, kudos to that explanation. I really appreciate that.

Can you talk a little bit about your view on fixed income, kind of where yields are, and just for... I'm sorry, but this is the professor in me, so for folks who are not steeped in the tea for fixed income, the spread between the two-year treasury and the 10-year treasury, the difference in those two yields is a measure of curve steepness or in other words, how much higher the long end is than the short end. And you were explaining earlier that we were actually inverted, meaning that the 2-year was higher than the 10-year by 100 basis points, which is, as we all know, 1%. So now we have what we typically would refer to as a normally shaped yield curve, where the back end is higher than the short end. What are you thinking about in terms of curve shape and just your outlook on the fixed income market in general?

Christine: Yeah. I think first on the curve, the expectation is that the curve is likely mean reverting over time, but I come back to what I said earlier. I think the speed at which we return to more of a normal spread, again, using the 2s and 10s curve as an example, the speed to which we get back to that more normal shape probably depends on how quickly the Fed is ultimately going to cut rates. And if they move in a more measured way, similar to what we've seen so far over the last few meetings, it may take even longer. But in the reverse scenario, if the Fed really has to cut to stimulate the economy, they can be aggressive in cutting rates. That's where you could see I think a bigger move, where again, the 2-year part of the yield curve is falling a lot faster than what we're seeing in the 10-year, and that's where you get back to perhaps more of a normal yield curve shape.

I will say, even with all of that, from our perspective, we're still just broadly constructive on fixed income. If I go back to the beginning of last year, that was really our view, and we actually wrote a white paper titled, If You Don't Like Bonds Now, Maybe You Just Don't Like Bonds. And the thesis back then was we did see a higher likelihood of positive returns for the asset class, and could even see the potential for double-digit returns if we hit the right conditions, which of course, ultimately we did. So we had that high starting yield in fixed income, and that was paired with capital appreciation. And then we saw bonds return 12% over the 1-year period if you go back through September of this year.

But the other part of that thesis was, we thought there was the potential for the return of the diversification benefits of bonds. And of course, that was coming on the heels of 2022 with the breakdown of the 60/40 constructs and rates and equities being positively correlated. And so our thesis was, hey, when the Fed becomes less of a driver of volatility in the market, some of that diversification benefit was likely to return. And from my perspective, I think people really care about bonds as being a diversifier when equities are drawing down. If both asset classes are up, I don't think people really care that much. And now, when we look at where we are today, since we wrote that white paper, we've had a few examples. If we go back to the regional banking crisis last year, or even just this past August, where after the nonfarm payroll print where equities were selling off and bonds were rallying, and I think we could really see more of that in the future.

Now, I think for me, I'd be happy if yields just stay this high and we continue to clip this coupon over the next several years. I think broadly, that's more of that modest total return environment for fixing them. My base case is we're probably still going to be in this soft landing environment for a while, and the Fed can likely just continue to gradually cut rates and get less restrictive over time. But again, if they have to move aggressively and they have to stimulate the economy, I think that's the scenario where rates could fall quickly and you potentially could have that higher total return scenario. But all of this said, there's still a lot of unknowns. We've got a lot to unpack and monitor in terms of what gets implemented policy-wise with the next president, what to expect from an inflation standpoint, where growth is going, deficits, you name it. So a lot, I think, to stay tuned for.

Stewart: I'm glad that you mentioned our incoming administration. Is there anything that came out of the election that impacted your view? For example, do you think that you're going to have the same tenor at the Fed going forward? That's a really hard question, by the way, and I'm sorry.

Christine: No, I think it's the right one to be asking. Again, the way I look at it, is I do think the Fed is going to continue to be very data-dependent, as they're trying to make decisions about what makes sense in terms of monetary policy. Chairman Powell was very clear at the November press conference that he does not believe he can be removed from his position, so he anticipates staying in that role until sometime in 2026.

So, I would not expect a deviation from how the Fed has been carrying out policy, but of course, we got a lot of volatility in the numbers that they're going to have to wade through, whether we're looking at inflation, whether we're looking at the labor prints. So again, I don't have a great guess in terms of exactly how many Fed cuts we're going to see, what that pace is going to look like. Again, I think we're all in this wait and see mode. So, nothing has changed in terms of our overall outlook, except I think volatility will continue to be our new normal and we'll see what type of opportunities that presents. But nothing material has changed in terms of how we're positioning portfolios.

Stewart: Fantastic education on fixed income, Christine. Thanks so much for being on. We've got a couple of fun ones for you out the door, if you'll entertain us. The first one is really more about paying it forward. I take you back to when you were earlier in your career. If you were starting out in this business and you were a couple of years out of school or just coming out of school, what advice would you an early-20s Christine Thorpe?

Christine: Well, I would continue to use the best piece of advice I think I got, was don't burn bridges. I think I'm always amazed by the number of people I worked with at one point in my career at Fidelity, that then years later, I start working with again.

And in a place like this, collaboration is everything. Nobody can do anything alone, so I just think it's so important. You got to keep those relationships alive, you got to be a really good partner, and it just sets you up to do a lot of different things.

Stewart: That's great advice. My last fun one is, who would you most like to have lunch or dinner with, alive or dead? You can have up to three guests and then you're the fourth. You don't have to use all three. You can use one, two, or three. But who would those folks be?

Christine: That's a good one. I love that. I think I'd have to look to Omaha, and Warren Buffett and Charlie Munger, brilliant minds, incredibly track record, but man, they had such a great friendship, but I'd love just to sit there and be a part of that dynamic and dynamic. And I think, man, if that's who I'm going out to lunch or dinner with, I think I'd have to bring my dad 'cause I know that'd be a dream table for him. So I got to include him to be a part of that as well.

Stewart: Wow, that's really cool. Well done. I really appreciate you being on, Christine. Thank you so much. We've gotten a great education today, and thanks for sharing all your views and all the information, so great to have you on.

Christine: Thanks for having me.

Stewart: We've been joined today by Christine Thorpe, Institutional Portfolio Manager at Fidelity Investments. Thanks for listening. If you have ideas for podcast, please shoot me a note. It's stewart@insuranceaum.com. We'll see you next time on the InsuranceAUM.com podcast.

 

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