Episode 295: Opportunities in Public Markets: Finding Relative Value in Fixed Income

 

Stewart: My name's Stewart Foley, I'll be your host. Hey, welcome back. It's great to have you and thanks for listening. We hear a lot of really nice comments from folks about what we're doing and our podcast and whatnot, and we really appreciate that. Right? So we've got folks on the LP side, the GP side, and then some folks in between. But I just wanted to say a big shout out and thank you to everybody who listens. And if you like us, tell your friends. It's a small audience, small group of people. Money's huge, but the number of people, the community is relatively small. So it's interesting that the idea for our podcast originally came out of someone at Invesco, and we're joined by someone from Invesco today and we're going to be talking about something that hasn't gotten nearly as much attention as it used to, which is opportunities in public markets, finding relative value in fixed income. And we're joined by Matt Brill, who's the Head of North America Investment Grade Credit at Invesco. Matt, thanks for taking the time. Thanks for being on. I look forward to hearing what you have to say today.

Matt: Thanks for having me. Happy to be here.

Stewart: We always started off with a little get to know you. We'd love to know where you grew up and what was your first job, not the fancy one.

Matt: I grew up in Norcross, Georgia, which is just outside of Atlanta, suburb of Atlanta. So I grew up here pretty much my whole life. I did go to school, but in Virginia, Washington, Lee University in Lexington, Virginia. And then I graduated in 2002, so it was right after September 11th in 2001, and the economy had a recession. Things were a little harder in the job market right then, and I had a few offers on the table and they all kind of got postponed. And so I came back home and took a job working actually in the mail room of a company. So I worked in the mail room for several months, and if you've ever seen the Michael J. Fox movie Secret of my Success, I kind of pulled a little bit of that, of working out of the mail room right into the finance department and then other areas from there. So yeah, that's how it all began.

Stewart: That's interesting. I worked in a mail room too, for a minute, and here's a really weird reference, but I think there's a really interesting BMW motorcycle dealer in Norcross that deals in old race bikes and stuff like that. They're like a specialty BMW dealer. And when you said Norcross, it reminded me of that. So can you talk to us a little bit about how you got from the mail room into the job that you're in today? And the reason I ask is that there's people out here that are earlier in their career and sometimes when you're early in your career, it's hard to figure out a path to getting to be someone as senior and successful as you are. So what was the path?

Matt: I always had an interest in finance and wanted to take classes in it, and obviously I got a finance degree, got out of college, and then you realize that a lot of other people have similar things to you, so you have to start separating yourself and how can you do that? Studied for the CFA, took the CFA, eventually got the CFA designation that I know you have. That's a great way to separate yourself. But then I also just went to individuals within the company I was in. Once I got my foot in the door, I said, “Hey, can you give me a project to work on? I'd love to do something for you. I'll do it for free. I'll work extra time learning this.” And they see somebody's willing to do that, trying to get their hands dirty, if you will, in the finance department. And they realized that they can trust in you and start giving you extra things and they say, actually this guy's pretty good. Maybe we'll hire him full time. So just asking for more and then trying to get any kind of credential that can separate you versus the rest of the competition.

Stewart: Yeah, that's a great point. I mean it's a little bit like Matt Damon in Goodwill Hunting, right? It's like, Hey, wait a minute, this guy's really smart. I want to switch over to Invesco's platform. We've had a number of your colleagues on before. Invesco clearly brings a deep bench across public and private markets. Can you give us a sense of where you and your investment grade team sit within that broader Invesco ecosystem?

Matt: Invesco, talking big picture, has a little less than $2 trillion of total assets under management. Within fixed income, we have about $500 billion, so almost a quarter of the company's assets. My team, which is the investment grade credit team, has about a $100 billion dollars in total assets. We manage money in core strategies, core plus, corporate bonds. We also manage short-term strategies. We manage institutional as well as retail. Within the institutional space, we'll manage for pension plans, banks, sovereign wealth funds, and last but not least, insurance. So we can kind of do a little bit of everything. I think what we really try to do is focus on customizing for the client because, at the end of the day, the foundation of what we're going to do is the same, but then each client's going to need different things, different parts of the curve, different asset classes, different risk tolerance, and then also different accounting metrics for each client that we work for, which can somewhat drive what we're going to invest in for them.

Stewart: Yeah, you've got a great distribution team led by Chris Mechem over there and I think he just joined, I think Blake Mock just joined over there. So obviously making a big commitment into the insurance space. Let's talk macro for a second. There seems to be a tariff a day announced or taken away. It has certainly created some volatility. What's changed in your outlook recently and how has that influencing how you're positioning your portfolios today?

Matt: It's obviously been a long month, long year early in April, so a lot going on constantly. I try to listen to the administration with an unbiased approach. I think it's always very difficult with politics, but there are a couple of things that I've heard out of the administration recently that I'm taking some comfort in, but also just trying to position the portfolio potentially around or try to understand if it's accurate or not.

This first one is going to sound a little bit silly. It's simply out of Trump's mouth is “The bond market is beautiful right now,” and that was a true quote by him. What does he mean by that? It basically meant that it was dysfunctional before and now it was acting appropriately. I'm going to get to that in a minute, but that's important because if the bond market is going all over the place, it's really hard to invest. And so the fact that the bond market kind of got Trump to pause on those tariffs rather than the stock market or even I would say versus FX or even the dollar, it was all about bonds. And at the end of the day, if the bond market needs to function in the eyes of the administration, that's very good for us.

Another thing that I've heard out of administration is the quote from Trump that “I'm flexible,” and what does that mean? We heard the narrative that he may be even trying to engineer a recession. We've heard things that he may be wanting a slower economy, and I never really bought into that. But when he was saying that he's flexible, it gave me a little bit of comfort that he's not just purposely going to drive the economy in recession, he's not going to drive the car right off the cliff on purpose.

So the flexibility I think is key because we're going to own things other than treasuries. The treasuries are important from the bonds that are beautiful or the bond market is beautiful, that's treasuries. But credit is going to matter on whether he's flexible or not. Is he going to allow certain exemptions? Is he going to set up an economy that is going to be able to get through this, even with tariffs maybe at a higher level than a lot of people had expected?

So I'm trying to evaluate all this. I'm trying to figure out from a credit standpoint, can we buy things other than treasuries? And then, from a treasury standpoint, is the US economy losing its favorite nation status? The strength of the dollar and the place that everybody can always go to in the worst of times, it's usually been the dollar and right now has been acting very strange. So a lot going on there, but overall it's going to be volatile, we know that, but we'd like to try to glean some things out of the mouth of administration.

Stewart: Yeah, it's interesting. When I taught there was always a lot of focus on equities and my experiences in running money is that when you go into the investment committee, if there's 1% equities, that's what you're going to be talking about. Not the bonds, not the 99% bonds, but when it gets down to it, the bond market is a very, very important market and a very important indicator of economic activity in the way that it forecasts inflation, really. I mean it's just an interesting point that you're making about the importance of watching the bond market and how it's anticipating all of the news coming out. Let's just talk about sector preferences in IG for a second and just zooming in, right, in the corporate investment grade space, are there particular sectors that you're leaning into or steering clear of right now?

Matt: Yeah, so there's been a dispersion of late. Pre-tariffs, everything was pretty bunched together. There really wasn't a large dispersion between sectors within the investment grade world or even within high yield, but that has created some opportunities. Just generically though, let me just state a couple of stats, which I think are interesting. So we were at a period of time where we had high yields but low spreads. So if you were looking at spreads coming into this year, they were basically in the bottom five percentile over the last 10 years. Now you've got yields that are still in the 90th percentile, meaning they've only been cheaper 10% of the time. So we know yields are good, but they've been generally good most of the year. But spreads have kind of gone from that low 5th percentile, they've been cheaper 95% of the time, to now around 40th percentile.

So basically they're in the middle, the median there. So I'd say you're in now an environment where you have high yields, very attractive yields, and you also have semi attractive spreads versus really attractive yields and not attractive spreads at all. So I think a lot of investors, to start the year, were thinking, “Should I just simply be in treasuries and not buy anything and not buy consumer non-cyclical or whatever part of the economy?” Even if we go into recession, it didn't make sense to really buy a lot of credit, in a lot of people's eyes. So now that we've got values that are I think pretty decent everywhere now, we can kind of pick through them and find the best value within that.

So, this situation we're in right now is I think atypical, or normally, when you have a crisis you think, okay, it's going to be the banks. The banks are going to be the ones that are going to have problems. I need to sell the banks first. You saw that in 2023, you saw it a little bit in 2022. Obviously, COVID was really quick, but the banks really got beaten up quickly then and all that stemmed from the great financial crisis. So everybody was always thinking that if there's a problem in the US economy, I need to sell the banks.

But we look at the banking space and it actually seems really, really solid. We think there's going to be some deregulation that's going to occur that will help in some capacity. We think companies or banks specifically have been preparing for a recession for a number of years. You go back to 2022, Jamie Dimon was talking about a recession. It never happened, but the bank balance sheets are in really good shape because they thought this recession could occur. So overall, we would, in a normal crisis, be fleeing from banks, but we actually think they're a bit of a safe haven within it right now. And post SVB, you saw another round of increase of capital and defensive mechanisms out of banks. So overall we love the banks. We think there's a great value there. They've all backed up 30 to 50 basis points, so that's a pretty good spot.

We do also like the utilities. You think about the AI revolution, which maybe a little bit slowed down with what's going on with tariffs. We're talking today, there's some news around Nvidia and them not being able to sell into China, but in general, you still are going to see a huge AI revolution out of the United States and one of the things that's going to fuel that is power and power from utilities. So we like the utility space. We think if you go into recession, utilities are firing. We think if you have an AI revolution, utilities are going to do even better. So we like that.

An area that I would've told you or that I've kind of generally been negative on for a while here has been energy. A lot of people think that energy is a Trump trade and you hear things like “Drill, baby drill,” that's going to be great for energy. Well, not necessarily in our opinion because if companies are drilling more, exploring more, bringing more out of the ground and you've got, with that, more supply, you're going to potentially have lower prices, which may not be good for those credits. So we're not necessarily thinking that that is an immediate get-behind-it-type trade because the administration is going to be all for it. We think it actually could have negative effects, especially if you go into recession, energy may be hurt.

Now all that being said, one of the things we've been seeing recently is because energy has underperformed, we're seeing some dollar prices that are really interesting on bonds. I think that that's a different dynamic than we could normally have. There's some energy bonds that are trading in $60 - $70 range that are investment grade rated, and their spreads are still 250 over. So they're not distressed, but they have lower coupons. They have coupons of call it 4% and given where long end yields are on the 30 year treasury, that has created a dynamic where you can buy 30-year energy at between 65 and 80 cents on the dollar for high quality investment grade companies that even if oil prices get beaten up, we think that will actually do okay. So, I've been negative on energy, but now we're getting to the point where we're finding specific value and that's why fixed income is interesting. It's not just one company. It's not just one part of the curve. It's all the thousands of different bonds that are out there, and we can find interesting ways to play every sector or even individual companies.

Stewart: That's super helpful and it reminds me of discussions that we would've had running fixed income. It feels very comfortable to me to have that conversation. Let's talk a little bit about credit quality trends and we've seen a couple of high profile downgrades. Are these isolated events or do you think we could be on the front end a broader trend in investment grade credit?

Matt: When you hit COVID, the rating agencies kind of, I don't want to say panicked, but they definitely got very negative very quickly. And you saw downgrades of companies like Ford and Delta, Occidental Petroleum. I think you even saw Continental Resources. So there's a slew of downgrades that occurred and then when you got in 2021, which is a little bit of recovery, and then 2022, even with the inflationary aspects, we had to go along with the Fed hiking, we're seeing a huge ratio of upgrades versus downgrades and that's what we often try to take advantage of in our funds is finding those BB credits. They're going to get upgraded to investment grade. You can usually can predict them, especially if you have good analysts, you can predict them. But when the tide is rising and you have the wind at your back, like you did the last several years, we actually saw a ratio of around four to one.

So four times the amount of upgrades, rising stars, versus downgrades, what we call fallen angels. So those are great opportunities for us to add alpha to the portfolio because there's a lot of investors, whether they're on the pension side, sometimes insurance side, even a lot of the banks, they can only buy investment grade and so they can't even buy it. Even if they were 100% certain that something's going to be upgraded within the next six months, they can't go buy it. Usually the bigger buyers are going to be your institutional investors. So the broader base that you have of buyers and the bigger the pool that you have that can buy investment grade bonds, that's going to drive prices up and spreads down. So we can pick these high yield companies that come and then once they get more eligible for a large buyer base, it's very, very good for them.

So the wind was at your back, you had four to one, but recently you've had names like Celanese and Nissan. Celanese is a chemical company. Everybody obviously knows Nissan, and the auto space and interesting enough, Nissan was kind of having troubles pre the tariff situation, so it wasn't really a tariff thing there, but they were a little bit idiosyncratic. I would call it basically poorly managed at both of those companies. So that was not indicative of the market. Now the next legs forward are really going to be what we're worried about. Autos is in the crosshairs, you've got chemicals now in the crosshairs. Consumer cyclicals certainly will be in the crosshairs of tariffs. So that has me concerned that there is going to be, this four to one is certainly not happening anymore. We've kind of gravitated closer to one to one and we might actually probably, we're not predicting this yet, but I would say 2026 will very likely have more downgrades than upgrades.

But what's interesting is the market adjusts, right? The market is out in front of this to a reasonable extent. The pick as we call it, or the additional yield you get to buy BBs versus BBB-, which is the lowest portion of the investment grade space, was around 50 to 60 basis points just a couple months ago. And now today as I speak to you, it's around 125 to 130 basis points. So you are now getting paid a lot more to go buy a BB versus a BBB- than you were to start the year because the market is expecting there to be more downgrades because the market is expecting more volatility.

So, in my space as an active manager, that's great. It gives me more opportunity, bigger sandbox with more opportunities to do something with. But I'll go back to the comment I made about the banks earlier because I think it's important for the rest of these companies. Because companies have been expecting a recession in 2022, 2023, they kind of paused a little bit in 2024 and thought maybe it's all clear, but they didn't go out and lever their balance sheet. They were in much better shape; they've got great liquidity profiles. They were in very, very good shape for a recession that is likely to come. It's 30%, 40%, it's a decent chance we're going to get a recession. But if it comes, I don't think these companies are going to be hit nearly as hard as they would've been in the past because they've been waiting for it and the proverbial winter is coming. It hasn't come yet, but they're prepared for it.

Stewart: Yeah, it's super helpful. So just changing over to timing risk versus being defensive and you mentioned spreads being wider. For insurance CIOs and portfolio managers, and some folks run fixed inside, some folks outsource, it just depends, but they're watching the spreads widen the same as you are, and the natural question is when do you go risk on versus staying defensive? How are you thinking about that trade-off in today's market? And essentially, are the spreads reflective of a recession and that this is a good opportunity?

Matt: The way I’d phrase that is spreads have widened from very tight levels out to median levels as I stated earlier. So you've got about 35 basis points wider, call it from mid 70’s to 110. Now normally – this is spread over treasuries – normally investment grade bonds in a recession would have at least a spread of 150 basis points. So, we are not pricing in a recession. We have widened considerably, but we're not pricing a recession. I'll say there are other things, there's lower dollar price than normal. If you go back to 2022, the adjustment of 400 or 500 basis points caused a lot of bonds to be worth a lot less to par. Less dollars put in, you should have to get paid less spread. So the dollar price of the index is lower, which should be adjusted for. The liquidity of the market is much better. Portfolio trades are being able to be used, using ETFs to offset risk at the banks. Liquidity is better than ever. Your quality within this space, so investment grade as well as high yield, there is a much greater percentage of higher quality rated credits within IG. And then even within high yield, you've got more BBs than ever before or for a very, very long time at least. So there's a lot of mitigants to why spreads maybe shouldn't be all the way to 150. But again, if we do go in recession, you are probably going to have to go wider.

The one thing I'll point out to people is that it's very obvious, and it's very easy to avoid risk, and it doesn't necessarily make it the right call. So historically the market will bottom about nine months before earnings bottom. And so, if you were to sit here today and say, well Matt, I know that these companies are going to miss their earnings over the next 6 months and we're obviously going to go into recession, then why would I buy anything? Why would I buy stocks? Why would I buy credit? I can obviously buy them cheaper later.

But you go back to 2020, the market bottomed 9+ months before any earnings did and GDP did. You go back to pretty much every historical recession, the market bottoms before the market looks through. So that's the hard part about adding risk. It's hard to convince yourself. It's also hard to convince your boss and your shareholders that you should be adding risk, or your risk management committee. Because you have to say, well, I know things are bad and they're probably going to get worse, but guess what? We have to do this before everybody else does because the market's going to start to price it in. So if I look out to 2026 and I say, I think all this is going to be over by 2026. We're going to have tariffs, but maybe they're not going to be at the extremes. I think the economy might've hit a recession.

This is 2021. If I think that that's too early, if the market will identify this well advanced of 2021, and I think you actually start to have to invest now, which sounds crazy because you know you're going to go through some volatility over the period of time, but you cannot wait until the river card is played. You cannot wait until the earnings start to show up and they've improved. And so that's the balance, and that's why it's really hard to have this job because you going to kind of look like an idiot for a little bit and it's impossible to be exactly right, but you have to have this idea where there's value and then trying to look through and realize the world will not end. So there's going to be dislocations and try to keep enough liquidity to take advantage of those.

Stewart: It's interesting too that when I managed money back when the earth was cooling, there was something called core plus, but I don't think it means the same thing today. And you manage both core and core plus mandates. Can you unpack what plus means today? What's in scope for that sleeve and where are you seeing the most compelling relative value right now?

Matt: In the technical definition of core plus, the plus generally would mean non-investment grade rated securities, having the ability to buy non-investment grade securities, which historically has generally been being able to buy high yield and emerging markets. Now the market has evolved. It has enabled us to buy other areas of the structured credit market. We generally don't buy very low within the stack, within structured credit, we're generally AAAs, but there are opportunities there. There's other things called whole business securitizations. There's things within CLOs. There's a lot of different areas that we can add kind of spice to the portfolio that would not be directly down the middle. When most people think of core, they're thinking of treasuries, agency mortgages and corporate credit, IG corporate credit, to be specific. So we can add different asset classes in small size and they add yield, but they actually will zig when the rest of the market is zagging to a certain extent, so they're not a hundred percent correlated and some might even have negative correlation.

So you can reduce your overall volatility by having a small amount of these different asset classes within the portfolio while getting more yield. That's what we try to do. And so that's what core plus enables us to use these expertise for multiple different asset classes. Again, it's going to look and act like a bond fund at the end of the day. We don't really want to take equity-like risk in a bond fund because I always tell people, if you have enough time, you want to own stocks. Stocks will outperform bonds over 50 years, probably over 10 years and certainly over 100 years. But not everybody does, and not everybody has the willingness to sit through that volatility as we've seen over just the last few weeks. So you need to have something in your portfolio that's going to be that damper of volatility, which is what fixed income is, but we can get you a little bit more yield and a little bit more spice by having the plus components to it.

Stewart: Matt, I can't thank you enough for being professor for a day today. I've learned a lot and I know our audience has too. I've got a couple of fun ones for you on the way out the door. One of the things is when you are adding to your team at Invesco, what characteristics are you looking for when you're hiring folks, not the school they went to or are they skilled at Python or whatever, but what characteristics are you looking for when you're adding members to the team?

Matt: The number one thing that I want to see is do they actually want to do this job? Meaning would you do this job for free? Now we are going to pay them, but at the end of the day, do you like markets? Do you think this is interesting? And so usually the question I'll ask most people that I interview is, can you tell me a book that you've read recently, an article that you've read? Now, podcasts are much more in vogue, so I'll ask podcasts that you've listened to that talked about investments, that you learned something about investments. Because if you're doing this on your own time, this means that it's actually interesting to you and we go through this and I honestly really enjoy coming into work. I don't love when the markets are going crazy, but I do love watching things happen real time. We have a scoreboard at the end of the day, we know we did well or we know we didn't do well. It's very, very easy to know and that's quantitative aspect of it, and I like that people that come in and could just see the markets every day and say, this is really interesting and here's how I could try to make money off of it. That's what I love and that's why we try to hire people that have that mindset.

Stewart: Yeah, that's super interesting. I mean, if you get a chance, you can mention this podcast. We would certainly appreciate that, Matt. And the last one for you is lunch or dinner with up to three guests, you included. Don't have to be three, could be one, two, or three. Who would you most like to have dinner with, alive or dead?

Matt: Yeah, that's a great question. So I'm a pretty simplistic person. I'm sports and markets almost exclusively, and the family, I suppose. So those are kind of the three components of my life. So I'm going to start with sports. My Spanish isn't great, but it's not bad, but I'd have to have Lionel Messi at the table. My wife’s Argentine. He's the GOAT. I definitely would need to have him at my table and possibly have a little Google translator in my ear or something if necessary. But I'm also an investment guy and the greatest, the GOAT there is Warren Buffet. So I have a Warren Buffet at the table as well. And then because I have two daughters, I have a son as well, but because I have two daughters, I'm going to have to have Taylor Swift at the table. And so Taylor Swift is going to be the envy of my children to have had lunch with her would be next level. So that's where I'm going.

Stewart: Yeah, my daughter, I swear to you, would think I was cool for the first time ever if I managed that. That would be very cool. I really appreciate you being on, man. Thanks for taking the time. You did a great job of covering this market and really appreciate you, you stopping by.

Matt: Yeah, thanks for having me.

Stewart: We've been joined today by Matt Brill, who's the Head of North America Investment Grade Credit and a Senior Portfolio Manager at Invesco. Thanks for listening. If you have ideas for podcasts, please shoot me a note at Stewart@insuranceaum.com. Please rate us, like us and review us on Apple Podcast, Spotify, Amazon, or wherever you listen to your favorite shows. My name's Stewart Foley. We are the home of the world's smartest money at InsuranceAUM.com.