Junk ETFs Are Favorite Trading Partner to Exploit: John McClain

a number of years. This year, however, it has been out performing. Our next guest joins us to talk about that, John McClean, portfolio manager at Diamond Hill. John, I want to start with that because there's been a lot of concern about riskier assets this year, certainly volatility picking up, and yet the high old market has been significantly outperforming

higher rated debt. What do you make of that? Well, I think it's uh, the credit spread that you have in in high yield is uh still reasonably attractive for the default rate expectations going forward. Uh, So you have UM you know with this case, you also have less interest rate sensitivity UM with with high yield, and so I think if people are worried about the markets, I'd first be a little bit more worried about equities as

as opposed to high yield. When we talk about high yield, should we get specific and talk about some of the energy areas like oil, natural gas? I mean, because weren't they really the big focus of high you lending? Uh? Yeah, I mean that was definitely the story in sixteen. Um, I think the market has sharpened its pencil and understands where good assets are and where weaker assets are. And uh, from our viewpoint, you want to be concentrated in the

Permian basin. And uh, you know, at this point, companies have right size their balance sheets. Uh. You know, I think we've seen all the distress kind of moved through. And uh, with the commodity environment where it is, particularly in oil, uh you know, around sixty bocks. Uh, that's pretty constructive for for a lot of the high yield issuers right now, all right, I want to talk a little bit about some of the sinkholes that we're seeing.

For example, Community Health. Uh, yesterday it was rumored that it is going to hire advisors to restructure its debt and its bonds sunk. This sort of feeds on an ongoing slump in healthcare related junk bonds. Is this scenario where you see opportunity or that you want to avoid like a plague? Yeah, I'd probably see the latter. Uh. We are certainly underweight healthcare in general, and UH community specifically has a very tough path on a go forward basis.

We don't really like the assets and we think that it has an untenable debt load. So I do believe a restructuring could occur U and could occur it seemingly faster than and the market has anticipated. Another name that caught my eye Valiant. This is a company with twenty seven billion dollars of debt. It just sold more bonds and there were plenty of buyers. Evidently were you among them? And do you view this as a sign that the pendulum has swung back to issuers in the high bond market. Well,

we were not. And the coupon that they had to pay at nine and a quarter was pretty expensive relative to the market, yielding a little north of six percent. So uh, you know, they're in a position right now again with a with a very weakend. Uh, they have to continue to kick the can down the road and their interest costs continue to move higher. I don't think a deal is traded particularly well. Um, So you know, I think that one is certainly a wait and see story.

Tell me about Sprint and they're going back to the market for more money and they using spectrum as collateral. You're kind of laughing a little bit here. Why we kind of put that in the too hard pile. It's it's very hard to you know, set a set a true valuation around what that spectrum is worth. So if we can't analyze and understand it, we're not going to

commit capital to it. What about the e t F involvement in the high old bond market, there has been a sort of bifurcation between bonds that are included in the high yield bond e t f s and those that have not. How much do you sort of play that space and try to focus on bonds that are either in the e t F s or out of them. Yeah, I mean the e t f s are favorite trading counterparty Lisa UM. What does that mean? You have a technical buyer or seller, and they're typically buyers into strengthen

sellers into weakness. UM. So for us, that is certainly an opportunity that we can exploit in the market, um by providing them the liquidity that they provide to their customers. So I think the E t f s and high yield are kind of a victim of their own success. Uh. They've been sold as liquidity, not as alpha. And uh, you know, I would say that if you look at their performance over any reasonable period of time, their bottom

quartile performers. And uh. You know, with equity markets, you have cheap beta, and if you look at the expense ratios on the on these relative to true active management, you're not really getting a big break there. Tell me about private equity companies in their role in buying up how yield debt? What have you seen right now? Ah, there continues to be a swath of capital in in private equity, So uh, you know, I would continue to

think that we will see more on the LBO front. Um. It's just how much leverage you can put on companies. So I'm wondering you said initially you expect the default rate to remain low, John, what are you looking at in particular to signal that the tide is turning? Because this is sort of the key question that everybody turns to when they talk about strength and risk your assets. I mean, we're looking at underlying economic data and growth

seems to be here. Unemployment rates continue to be very low. You know, it is a strong labor force right now. So uh, you know, again, we we remained pretty constructive on the fundamentals of the US economy and with high yield, roughly of revenues are generated domestically. Netflix interested in buying Netflix debt? They've certainly got a lot of it at a certain price, absolutely a price. Uh you know, I would say with Netflix, Um, you know, we would look

to where they were issuing that several years ago. Um, you know, if you could get a high fives uh six percent kind of coupon on a name, I think that would be very attractive. Now, what will we see that? I don't believe so. Um, but you look at the content library itself covers the debt there, so it's a company you can believe in the equity market capitalization. That's a that's a huge margin of safety for US. Which companies in this sort of triple B sphere, the lowest

rated investment grade tier are you watching for a potential downgrade? Uh? Yeah, that's a difficult one right now. It's not a particular area of the market that that we're really focused on. Um, you know, I think we'll we'll continue to see uh you know some fallen angels like a Teva um you know, where you have large scale M and A that doesn't work out. But there's nobody particularly on my radar right now, toys r Us tell me about any Were you involved

with any of that? No, that was the train wreck we saw coming a mile away. What what what gave you that? I mean a lot of people obviously didn't see that train. They thought it was light at the end of the tunnel. When's the last time you've been to a Toys r Us? Basically, Like it was basically something as basic as that you run it. You talk amongst yourselves at the at the firm, say, we don't even do this ourselves. Yeah, that's certainly a part of it.

And uh, you know they are, they were saddled with too much debt and uh you know, their competitors were taking market share for a long period of time. So it was something that uh, you know, we felt like we could see well in advance. I want to thank you very much for being with us. John McClean is portfolio manager for Diamond Hill Investment Group, helping to manage more than twenty two billion dollars based in Columbus, Ohio. Although Mr McClean hills from the great state of Kentucky,

factory work and the industrialization of the world. It has attracted political pundits, but it also has now attracted a analysis by Joshua Freeman. He is a distinguished Professor of history at Queen's College and the Graduate Center of the City University of New York of Cuney, and his book is entitled Behemoth, a History of the Factory and the Making of the Modern World. And he joins us here in our eleven three oh studios. Professor Freeman, thank you

very much for being here. First, tell us why did you decide to write this book? Well, you know, I was what caught my attention was in two thousand and ten when there was a sudden bursts of attention to Fox con because there was some suicides of its workers jumping off the roofs. And this this got, you know, attention, and what que my make maker of iPhone products, maker of iPhone you know, and biggest and not just iPhone, but Samsung and many, many different things. And what caught

my eye was the size of the factory. It had two hundred and fifty thou workers and as in a story, and this was mind blowing. This company I had barely ever heard of. And I started thinking, you know, are

their precedence for this kind of outsized establishment? And you know, I thought, well, yeah, they kind of are, and that in each era for three hundred years now they have been kind of cunning edge establishments that have been the templates for the future and have captured public attention, you know, because they've become carriers for debates about, you know, what our future should look like, you know, what system should we have. So that's what it got me into this book.

I thought, let me do some case studies that start with the earliest English factories and in with Fox coun One of the brilliant things about the way you framed this was looking at factories as disruptors, not sort of moments of nostalgia that people want to get back to. Can you give us a sense of kind of how you did that, what you were thinking, Well, you know, I think in the States right now, we look at

decline and abandonment so much. But you know, I want to tell the story when these things were sources of wonderment, when these were new things under the sun, that they represented these great breakthroughs in human ingenuity and capacity and also frankly, human misery at the same time. You know,

they're all linked together. Um. And what I found over and over again was the observers saw them this way almost immediately, whether it was in in eighteenth century England, or the people that flooded into tour the Ford Factory in the nineteenth nineteen twenties, UM, or the photographers who celebrateed Soviet factories, that there's a great sense that this was some vision of what the new society was going

to be like. Maybe described for listeners what it would be like if you were to enter a factory that, let's say, operated in the United States, a textile mill, for example, around the turn of the previous century. Well, you know, if you were going into a textile mill in the early days of textile manufacturing, uh, probably you were coming from the country or rural life. And first of all, you've probably rarely ever seen so many people

in one place or such a large building. You know, even just going in a five story building was a new thing. Then it was loud. You know, there's all this machinery, weaving machinery you know has has you know, throws back and forth the shell sixty times a second. You couldn't hear anything. It's stunk because you know, they were this before oil. They were using whale oil and animal grease. UM. And there were all these workers, and

yet it was all being coordinated. It was all in one with them, the whole thing, the people in the machinery was one enterprise. UM. In the best of the factors, you might see pretty nice looking young women mostly you know, we came from New England farms. Uh. In the worst of the factories, you'd see child labor looking pretty darning,

miserable and starved. So, Josh, let's connect this to now, because we hear a lot about bringing manufacturing back to the US, keeping uh some of these assembly line and production jobs in America. And I'm wondering, what moment in time are politicians talking about this looking at what which which era of manufacturing do they want to bring back? And what's that tell us about our moment right now? Uh?

In humanity? Well, I think the nostalgia, if you want to call that, uh, the the the make America great again. I think people are thinking really about the fifties and the sixties. Uh. And this was an era when you had the height of American manufacturing industry and unionization, which meant that the the tremendous uh productivity lead to profits

that were widely shared. So it's sustained a way of life of upward mobility for people who came out of high school, got a job in the local plant, did better than their parents, and knew the kids were going to do better than them. And I think that's the moment people look back to. You know, I'm not so sure of bringing a fox con plant as they operate in modern China is going to sustain that way of life. You know, Wisconsin just uh said it would spend three

billion dollars to do that. It will be interesting to see what actually happens. You were not only uh analyzing historical precedent, but as Lisa brought up, current factories, factories in China, just give us a sense of the scale. Uh. And and there again, if we can draw us a picture their mind box, they're absolutely mindboggling you know fox KNT City, which was their big ascendion center, which is still operating, although there are many other plants. Uh. It

takes an hour to walk across the complex. Um there are you know, something like two hundred three hundred thousand people there. Uh, seventy or eighty thousand of them live in dormitories. These are young Chinese people, mostly coming from the rural areas. Um. There's the factories themselves, which combine both very sophisticated production techniques and just very old fashioned assembly with people doing very fine putting together of small things to go into your phone or the mother boarder

of your laptop. But it's surrounded by whole world. You know, there's everything from soccer fields to cyber cafes to wedding dress shops. You know. Uh. I think for a lot of young Chinese people this who are leaving behind, you know, less developed rural areas, this is an interlude that that that's difficult. The work itself is tough and boring, but also it was a glimpse into a more urban, cosmopolitan world before they go back to where they came from,

which is what happens with most of these workers. What about pay well, it depends on what you measure it by. By U s stands, of course, it's very low. But pay in Southern china's gone up. There's been actually a big wave of strikes, which doesn't get much publicity in this country. That's pushed up wages and in fact, UH some companies, like there's a company that makes UH shoes for of Anka Trump's line, have begun building factors in Africa because pay rates in Southern China are now going

up pretty quickly. So um, you know, UH, it's a very fluid situation and the cycle that we saw in the United States and elsewhere of you know, you build a new factory, it's innovative, but but at some point it gets eclipsed by by the newer version of it, and labor course another course go up, and then it closes. That cycle seems to be happening ever faster. It's it's just a fascinating issue. Thank you so much for joining us,

really truly pleasure. Josh Freeman Distinguished Professor of History and author of Behemoth, History of the Factory and the Making of the Modern World. He is at Queen's College and the Graduate Center of the City University of New York, And it raises this question of, you know, can you ever focus on just recreating that one moment where it all works together and wages are rising and the jobs

are still innovative going forward. The United Kingdom's Prime Minister, Theresa May expelling twenty three Russian diplomats to talk about this and other possible points of contention between the European Union, the UK, the United States and Russia. We want to bring in Toby Harshall, Bloomberg U national Security Editor. Tobe how much of a big deal is this? Um, It's both a big deal and not a big deal. UM. It's going to depend on exactly who the diplomats are.

I think Theresa May is in front of Parliament right now. It may or may not come up. She's going to give a statement later in the day sort of with more details. I mean, this is this is all part of the game that they play. Um. We suspended, you know, under the Obama administration, we suspended Russian diplomats and we took over their their lovely shore house in Maryland. UM. And I don't think anyone truly it's more of a

statement than it is actually messing up their their their embassy. Okay, so there was this nerve agent attack of a former Russian citizen. He was killed in the UK. Interest, Yes, hanging on, but they're hanging on. But they're both hanging on. Okay, great died overnight. But okay, um, Okay. How important is it that President Trump respond to this in support of

the United Kingdom? Um? It's only important because it's President Trump. Um, because of you know, his statements during the campaign that led a lot of people to think he was going to be squishy on Russia. Um. He actually hasn't been. Um. They've been pretty tough on on Putin. Um since they have, since they've taken office, they upped sanctions, they've they're rhetoric has been pretty good. Um. But yeah, it would be nice to see him just add moral support. Toby, is

this more about the optics and the headlines? Because I can't imagine, as horrible as it is, that this is a security threat to let's say, either the United Kingdom or to the United States. And I'm wondering whether this is in a sense of diversion of attention away from issues having to do with challenging air power in the Baltic sale of military hardware to Turkey and perhaps even undermining NATO. That's always a possibility. I'm gonna I'm gonna be the skunk at the garden party for a moment,

for we don't actually have proof that Rushes behind this. UM. We strongly suspect for good reason that they were, so I don't want to get into their motivations behind it. UM. I don't think that anyone would would think this is gonna going to keep the attention off of their other nefarious doings for very long. In fact, I think it'll only add to the image of of of the Russians as as you know, being a huge problem. Okay, so

let's say, okay, it hasn't been proven. Both individuals who are attacked with a nerve agent are are still hanging on, although they are critically ill. Uh. At the same time, Rex Tillerson came out in strong support the now former Secretary of State for the U S came out in strong support of Theresa May and the United Kingdom in

their efforts to go after this. Whereas yesterday we heard President Trump waffle on the issue, saying, you know, well, we'll see what happens whether it's Russia or whoever else. I mean, this seems symbolically important. Are we reading too much into that? Um? I think in the US we maybe are. I mean, for the Brits to react like this is very much called for. I mean, this is an attack on their on their sovereign territory. Um. It's also you know, if Russians were behind it. Remember that

some he was part of a prisoner swap. So this is breaking all the rules of the Cold War. Um. Once you're part of a prisoner swap, you're supposed to be clear. I mean, we're not going to go after the people that he was traded for and try and kill them. Um. It it's therefore, it's different than the previous poisoning case, UM, where the person was a defect, not a defector anymore, but had fled the Soviet Union

and was living, you know, in quasi hiding. UM. It's no better to attack people with with nerve agents, UM, no matter their status. UM. But this is it's really strange, Toby. Let's just shift to the US and our own defense budget right now. What's the most important issue that should be before people's attention when it comes to spending over seven hundred and what sixty billion a year. I hate to say it, but it's actually UM pension and healthcare reform for for veterans. I don't think we can do

much about that. For UM the current retirees. I mean, we made a promise to them. They put their lives on the line. UM. But I think we have to be much much tougher on UM. The people in the service and particularly new recruits and with disaffect things like the Veterans Administration. Yeah, that's a separate budget technically, UM, but I think there are a lot of savings to be done there. UM. The disability UM program in the

v A is an absolute disaster. In fact, when they had the huge scandal about the waiting times a few years ago, UM, almost all of those people were not waiting to be admitted to a hospital. They were UM looking to have their disability claims reviewed and a larger monthly checks. So it wasn't it wasn't as horrible as

it seemed. It was bad that there was this huge backlog, But the real problem is UM the people get you know, they're great, they were in the military, they're they're strong and capable people, and they get sort of sucked into this this this disability trap um, where there's not a good system to get them back in the workforce and it's sort of a subsistence living. Toby harsh thank you so much for being with us. As always, we love

having you on. Toby Harshot Bloomberview, National Security editor, talking about the move the Teresa May announced today expelling twenty three Russian diplomats. Where are we in the real estate market? Cycle here to answer that question so that you can rest easy, as Scott Lawler, founder and chief executive officer of Waypoint Residential based in Connecticut, but here in our eleven three oh studios today in New York, Scott, I

want to start with that question. But before we get into the answer, has the market in the US ever been more bifurcated between cities that have seen an explosion of growth and price increases and the sort of smaller and mid tier communities that kind of had been left

behind until recently. Um, well, it's hard to say where whether it's ever been more bifurcated, but it certainly is now right and so what we're experiencing is, um, there's a tremendous influx of capital into major coastal markets, institutional capital, foreign capital and so on. And one of the reasons we try and um playing a little bit different playing field is because of that. So it's the case that capital has now flowed further out, and we used to

be a little bit ahead of the packer. So we hoped and felt um playing in secondary tertiary markets even as recently as three or four years ago. We talk secondary tertiary, we're talking perhaps Baltimore, uh, Pittsburgh, New York. As view of the world is different, but you know, markets as small as half a million million people and so on. UM, there's a point in time when we felt we were you know, we didn't have as many

friends pursuing deals in those markets. And what's going on is because of what we talked about a minute ago, and the tremendous influx of capital into the major coastal markets driving down yells, um capitals spread out in search of yield. So the markets are absolutely bifurcated, but we're seeing a dynamic where the smaller markets are becoming more competitive as well. Tell us about the time, I think it was recently that you broke ground on a new

development in Georgia. This is a senior living facility and it combines a couple of different things. It's what they call memory care community. And maybe just use that as an example of the kinds of new things that you're doing and the demand that you see demographically for this kind of real estate. Yeah, so senior housing, Uh, it's a sector we're very excited about. Um. We've got into

it about a year ago. That was our first investment, and it's it's a good thirty to forty minutes outside Atlanta, okay, um a little bit more than a hundred units noon and Georgia. That's right. And relative to what I was talking about a minute ago, you know, Atlanta, depending how you look at some would consider a major market, tremendous capital inflow and so on. So we have to be thoughtful about where we play from a geographic perspective as

it relates to the product type. So this is a mix of independent living, assisted living in memory care, which is typically how we like to do it, UM and and show it's ground up development and and the idea here is really um like everyone, I should say like everyone, but senior has become much more competitive in a response to sort of you know, the demographic tidal wave that's coming, and we understand that, and for actually many of our

friends do too, and so this space has become more competitive, and so we bring to bear the same philosophy and trying to be thoughtful about how we play geographically, so we get the benefit of that demographic tidal wave, but not necessarily compete with all our best friends when we're pursuing opportunities. And this was a joint venture with Watercrest

Senior Living, right, that's okay. Use that as an example to sort of explain how you survived the two tho eight downturn to then be able to do something like this because you were at Broadway Partners and boy, you probably have the scars to prove it. Yes, I was, UM, and I do and so UM, look what we're doing now is a very different business plan. UM for a couple of reasons, UM were big believers in the apartment sector.

There are all sorts of things driving the sector and I'm sure you've had other folks talked about it and all that kind of stuff. And this sector has performed very well in this UM cycle, and importantly performed on a comparative basis during that crash, okay, um better than other commercial property types. It's basically a less volatile, lower

beta sector. So whereas office buildings, UM, shopping centers, hotels experienced certain fluctuations and rents and values and so on, the market blows up, apartments experiences cycle, but at too much lesser degree. Coming out of what you refer to that that sounded pretty cool to me. So, Um, part of what we're doing is to take advantage of tremendous macro drivers that are behind the apartment sector. And part of it is, you know, as you point out, Um,

we're coming out of that cycle. The way we did something with a little bit less volatility felt pretty good. So what we did is, you know, we went through the cycle of Broadway. We had a lot of difficulty, Um, kind of experienced a little bit of everything and contending

with lenders and investors and so on. But we came out of it, I think a lot better than a lot of people thought we were gonna And when it was time to start investing again, we said, you know, it's been a few years since we've done a deal. Let's take a look around, decide what we think makes the most sense. I had assumed all along I would just get back in the office business. But when we looked around, we decided there was a lot to like about the apartment business, and we started by dipping our

toe in the water. We did a couple of deals with some part to check it out. Decided we were big fans, and decided to kind of go full speed real quick. Given the scars that you have, what are you looking for to indicate that another downturn in the housing market is UH is coming. Well, let me respond to the question a little differently. As far as another downturn coming, here's how we structure our business. Okay, And

that's what I spend the most time thinking about. It's not trying to forecast when the downturn is coming, but making sure we're positioned to contend with it. So we do extreme downside sensitivity analysis. Okay, we look at the numbers. Basically, we look at every acquisition as if two thousand and it was happening the next day. And more than that, we we show those numbers to our investors. And I

get asked that question all the time. I call it the ending question, Scott, what inning or in fact, I think you opened the segment that way, and my answer is always I don't know, but he let me tell you what's going to happen when, And I say, if this acquisition experiences two thousand and two tho nine, here is arithmetic, and the way you get there is with very conservative use of leverage and playing in a relatively

low beta sector like I described. And when you bring those two things together, you're able to very confidently say there's going to be a cycle. Here's the information, right. I don't know when, why, and how bad, but I know we're okay when it happens. And being a good steward of capital, I think is much more about being able to answer the question that way than saying we're in the seventh or eighth or ninth or whatever the case may be. Much appreciate it. Comeback spend more time

with us. Scott Lawler as the founder and the chief executive of Waypoint Residential, giving us his views on the real estate industry. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo wits one Before the podcast, you can always catch us worldwide on Bloomberg Radio