The Long Bond Is in The Danger Zone, Loomis' Dan Fuss Says

has made a lot of right calls. I am so pleased to have you here. Dan. I want to start with longer dated US government bonds because duration levels have reached the highest on record. Rates are going back down near the record loads. You're seeing people pile into the longer dated debt. You have Jeffrey Gunlock coming out and saying it's the word first possible set up versus history. Do you agree, Well, my history doesn't go all that far back. It goes I'm not meaning to imply that

you can. I'm just you know, from your perspective, do you think that the long bond is poised for a big fall, a big fall. Note. What I do think, however, is I think interest rates are on an upward track. Right now. The Fed is raising short race and that gradually does feed out the yield curve. Now, if they do this for a long time, eventually, based on history, the long end of the curves sort of bends over. In other words, long yields will be lower than the

ten year, etcetera. So when the yield curve bends, it normally bends at the long year long end, and the fields keep going up, then at least the way it used to be back way back, uh to peak on polls in But something else is going on, uh, And we do have money flows into the country from elsewhere, and we also have something else I don't understand. I understand part of it, the liability matching at the long

end for the corporate to find benefit plans. I mean, we're that's important business for us, and so the money is coming in. UM now that's easing off a bit. But when stocks were really up there, it made sense to go say Salsa SMP five undered and go out and buy long investment grade corporates. If you can't get what you want, you buy the long treasury and then you hope to swap. Just to be clear, this is pension plans in particular. They're looking to lock in their

gains so that they can provide there. Well, what they're doing this is most nearly all on the corporate side. Uh. What they're doing is their liability man matching. In other words, the here's their liability and that's that's a double digit number in terms of duration, and so let's buy some long corporates against that and then get this volatility off

our income statement and off our balance sheet. Dan, I wonder if you could speak to the issue of liquidity in bond markets and what this means specifically for hedge funds that focus on fixed income. Okay, uh, let me find the short way to do this. The liquidity in the most of the fixed income market is good. It's actually a little better than it was the last time I was here, visiting all the way from treasuries on

down through investment grade corputs. Once you get to high yield, however, it starts to shift a little bit, and the liquidity in high yield and the lower edge of investment grade also is there for the on the run issues as you get off the run. Then liquidity uh is a sometime thing in the high yield area and once in a while in the lower edge of investment grade, so you can't count on it above that you can normally

count on. And one thing that used to worry me a lot, uh, well, the e T s. I worry far less about them now in the investment grade on up. I think they're actually a good thing for liquidity most not all, but most of the time. But but with respect to high yield perhaps, uh, it's a it's a

little bit of a diceer prospect. Its start hearing from you, you know, I want to just go back you were saying, you know, you seem pretty sanguine about longer term bonds, just based on the fact that pensions that have been going into them and locking in those yields, as well as the yield curved dynamic as the FED tightens the short end. But you know, there are a lot of other areas that people are worried about. People have been piling into a emerging market step, people have been piling

into high yield it. Do you think there are any dangerous spots right now that you personally are avoiding in debt markets. Yes, but uh, well the long end uh over the last couple of years. Uh, it's been pretty well publicized. We we are average maturity and the Loomis Sales bond Fund, the biggest of the funds, used to run around thirteen years. Not the average maturity, not the duration, the average maturity UM, and now it's about six. It was six and a half and then quite recently brought

down to about six. Uh. That's that's a huge difference, that's uh. And that's because I think the trend of rates is up and longer term even yes, I don't expect the yield curve to invert for quite a while. Now you say, well, in that case, Dan, how come Uh you know long end prices are going up at the moment. Yes, that's true, they are. Have you contrasted with a year ago? Oh? Good point? Okay, Uh, same

all the way out the curve. The curve has definitely flattened in treasuries, and spreads of everything else against treasuries have been narrowing. So you see what's going on. Well, more buyers and sellers whatever you want to call it, um, but it's not the way to bet. I think the Fed governors and regional bank presence in their speeches have made it very clear data dependent rates are going up at least two times more this year and maybe three

And in twenty seconds. Do you think that the longer end is going to suffer as the Fed unwind its balance sheet? Yes, okay, that was sort of got fifteen seconds left. If you'd like to elaborate, well, I mean it will actually be felt more in the intermediate area. All right, Thanks very much. Dan Fuss is always great to have you with us. He is the vice chairman of Loomis Sales. They're based in Boston, of course, home to Bloomberg twelve, and he is one of the managers

of the Loomis Sales bond Fund. They've got fourteen billion dollars in assets. We wish Matt Tucker a happy birthday, not for himself but for his fund. He is head of North American Fixed Income I share strategy at black Rock, and he helped found the suite of fixed income ETFs that have dominated headlines and dominated bond market trading for years. We want to talk specifically about the tenure anniversary of h y G. This is the biggest high old bond

et F out there with almost nineteen billion dollars of assets. Matt, we are so glad that you are with us. I want to start with being the black shape of the fund management complex for so long, so many people picked on h y G as sort of harbinger of doom in bond markets, that it was going to destroy things, that people were going to withdraw money all at once. Have those dark clouds lifted? Do you feel like much more embraced by fund managers and investors alike. Now, well,

thanks for having me this morning. So you know, if I think about the history of h y G and kind of how it's really matured over the years, I do think there's been a shift. I think initially people saw it as just an index fund in the high old market, and there are questions about how the fund would react in different stressed markets, what happened when investors

might rush in or rush out of the fund. But I think we've seen so many different crises since the fund was launched ten years ago, and so many different stress events in the market. You've got a lot of really good data now you can look at and say, well, what did what did the fund next to do? What is HyG actually done in his markets. I think people realize that, you know, what actually performs kind of as

you expect. You know, it trades like the high old market. Um. So it's used increasingly by a lot of institutions who might not have reached for it, you know, even five years ago. It's not becoming a pretty core part of a lot of institutional HIRLED portfolios just because it's another way to invest in the market, another way to get

access to liquidity. Let's talk a little bit about some of the characteristics of h y G. The I shares eybox high old corporate bond e t F and I wonder if you could start with this idea that the over the counter to an exchange traded fund. Yeah, I think a lot of ways this is the core innovation behind bond ETFs in general, and it's something that I think people lose sight of when they look at just e t f s broadly and look at equity t s. You know, the equity tp was a very interesting idea.

You took a bunch of securities, a bunch of stocks which trade on the exchange, and you stuff them and do this thing called an e t F, which is also on the exchange. UM. That is important a lot of benefits to it. But I think the fixed income ETF was really transformative because you took this over the counter bond market, which is very hard for a lot of investors to see, hard to invest in, challenges with information, transparent liquidity, and you put it onto the exchange. We're

successible and visible to everybody. And I really think that as a transformative change. I mean, you now can see a portfolio of high old bonds trading tick by ticks throughout the day UM, which is a pretty crazy concept when you think about it relative to the rest of the high old bond market, where it's really hard to

get information about transactions that are actually taking place. And h y G certainly was innovative and has been rewarded for that as UH it has become really a note of activity unto itself within the high old market and

really dominated a lot of the trading. I want to want to ask you though about some of the choices that black Rock didn't make, that I Shares didn't make, in particular leveraged loans, because we have seen, uh, you know, with throughout the fixed income space, we've seen a proliferation of e t f s, and we have seen some try to get into the leverage loan space and including invest Goo with their Power Shows Power Shares Senior Loan portfolio.

It's a nine point two billion dollar fund. There clearly is a lot of demand. Why has black Rock not created a fund like this? Well, you know we have, you know, but at products on the market, you you've got funds give you access to a lot of different segments to the market. We just didn't feel like it was prudent to launch a loan e t f UM. You know, black Rock has a big loan mutual fund business that we run UM and I think that the

real question we asked ourselves as well. You know, if you haven't asked a class like loans that really it's not really there's already even securities, right, loans are basically you know, actual bank loans. Those things cannot be in kinded, meaning that let's see, everyone wants to leave a fund. Everyone wants to go and leave h y G tomorrow. HyG can actually in kind of all its securities out give them back to investors. There's no liquidity risk that's

worn by the fund that is not presented to investors. Um, that's not the same thing in that market like loans, where you may not be able to actually liquid it all your security. So we just kind of looked at it and said, you know what, there may be some risks and some stressed markets that a lone ETF could present, and we didn't feel like that was consistent with how

we think about our platform. Are you concerned about the increase in proposals for active ETFs and non transparent et fs and the potential for this innovative, very simple model of creating redeem and taking something and putting it in in something that's transparent and able to trade daily like a stock. Do you think that that this new kind of element to the market could end up changing the

image of ETFs, which has so far been been fairly pristine. Well, I do think we're seeing an evolution in e t F and kind of what E t F means. Um, you know, for a long time, E t F meant index fund right in and meant index fund that had generally made a fund that had this in kind creation redemption, And to your point, pretty much every et F on

the market fit that description. But we've already seen over the years, A lot of variants come in on this, you know, whether it's you know, funds that use commodities as opposed to securities, whether it's funds that employed leverage in some way, funds that are actively managed. I think what needs to happen is the market needs to get more sophisticated about subdividing the e t F as a

class and thinking about different types of funds. So maybe not everything is an e t F. There are things out there that we should describe as an active et F or as some other use some other term to help really specify the type of exposure it gives an

investor and the risks it presents the investor. Man, I wonder if you could speak about the use of h y G or indeed other e t s, but specifically h y G for hedging for portfolios for long managers or short managers who want a liquid instrument, whether it be the option or the actual underlying in order to hedge or in some way mitigate the risk in their portfolios. Yeah, this is I think been a really popular usage. We've seen in a growing usage of h YG in particular

as a high y old hedging instrument. I think if you look at an investors, say in the equity market, they're very cupful with the idea that there are liquid futures markets that allow them to get exposure to, you know, whatever segment of the equity market they want, right doesn't exist in fixed income. Right in fixed income, if you want to think about hedging instruments, you've got treasury futures

which don't really track HILED very well. You've got credit to fault swap in dissees which have their own basis or performance difference first to HILD cash market. So HG has really filled avoid and allowing people to go out and trade an instrument which actually has a return that resembles the HILED cash market, and you can buy it and go along the a t F. And we've seen that you can also borrow it and sell it short much like you would do a stock you know, borrow

and short sale um. And there's even an increasing options market on h y G, so you can think aboue different options strategies to be used as hedging. So I think this has actually provided a use case that investors needed for a long time and just didn't really have a product for So how big. Do you think the high led E t F complex can grow too? I said, set of management. Lie, you know, it's really difficult to forecast.

I think we're running right around forty billion right now in terms of US listed hildts, just across different flavors, different cuts to the market. Um, could that get bigger? I think it could, But you know, you know it's so can h y g B Instead of nineteen billion it is about now? Okay, it could be twenty or thirty I think definitely. Um. But I think we're actually going to see grow more rapidly is the trading volume on the e t F. And we've actually seen this

through time. Is that as the fund has grown and more investors have used it as a hedging as liquidity vehicle, the fun turnover has been increasing. I think it's the turn we're going to see really grow. The assets will grow, but I think it's really the volume and adoption by investors which is going to really be the big driver going forward. Thanks very much, Matt Tucker's head of North American fixed Income. I shares a strategy team for black Rock,

helping to manage more than seventeen billion dollars. Let's turn our attention now to Apple and a legal back all that Apple faces from Qualcom, and here to kind of give us the details is Shira Oviday, our technology columnist Bloomberg gad Fly, which of course is our fast commentary section of Bloomberg. You can follow Shira on Twitter at Shira Oviday. So Shara tell us about Qualcom claiming that Apple has made threats and has lied to regulators. What

are they making threats and lying to regulators about? Yeah, this is pretty pretty juicy stuff. So let me just turn the clock back to January that Apple basically kicked off this litigation basically saying that Qualcom, which makes very essential technology for basically every smartphone, every phone sold in the world, Apple basically said that Qualcom is unfairly abusing it's its market power to overcharge customers, including Apple, for

use of its wireless technology. Every phone that's sold or most phones that sold, Qualcom gets a cut of the sale price of that phone, regardless of whether the phone is using Qualcoms computer ships or not. And Apple basically said, you know, the way that Qualcom charges for its patented

technology is unfair. And Qualcom overnight basically said that Apple this litigation from Apple is bogus and that Apple kind of misled regulators UM who are also looking into the same issue and how Qualcom charges for its computer chips and technology. So stock traders seemed to have voted on who they agree with because Qualcom shares are down more than twelve percent since this litigation was first kicked off,

or as Apple is not down twelve percent. So is that is that an accurate portrayal or a trader sort of overlooking something? I think it's it's less about which company might win if this litigation can go to trial, and more about the risks for each company, So Qualcom. I mean, look if it Qualcom loses this case of the case goes to trial and qual Come loses, you can see a scenario where Qualcoms essential business model is

at risk. And so that's what you've seen in the share place people to pay for intellectual problem correct, Getting people to pay for intellectual property, which is UH generates the majority of Qualcoms profit. And so that's what you've seen in the stock price reaction. Is just this risk two Qualcoms business model and UH, if Apple loses, the

risk is is lower. Can I just say um. There was a story about Apple's initial litigation where uh Apple's CEO Tim Cook said that the situation was analogous to someone buying a sofa and then charging that customer a different price depending on the price of the house that it goes into. Is that a valid argument, I don't know. I mean, Apple is not the only person to pick on this particular business approach by Qualcom of charging a patent royalty based on the total cost of a phone

rather than a component cost. Right, So, I'm sure there's gonna be lots of scathing analogies back and forth about sofas or whatever other living room furniture there might be. Look, this is a business dispute. Putting aside all kinds of high minded analogies, This is a business dispute. Um. Qualcom

has a business model that it wants to protect. Apple's revenue and profit margins are under pressure like they never have been before, and it's trying to reduce the costs that it pays for components of iPhones that can make more money. Business dispute. I wanted to just pick up on that theme because the backdrop to this is there are companies which depend on Apple orders for the significant

portion of their business. I'm thinking today about the drop and this shares a Dialogue Semiconductor in Germany down about fourteen and a half percent because there's a rumor or there's a thought that maybe Apple is going to go out and create their own ships, which they have done in the past. Does that really kind of cast a shadow over all the set of Apple decides they're gonna make their own chip, then you know, Qualcom can do

whatever it wants with that Snapdragon. Yeah. I mean, look, there's a whole cottage industry of of suppliers to Apple and other smartphone makers that are highly dependent on Apple for business, right, And that's what you see when you have these relatively small companies or even a big company like fox Con, even the specter of losing business from

Apple sends the share price down. The same thing happened to Qualcom um Apple and its latest model of iPhone used chips from Intel, qualcom competitor in some handful of of UM phones, and that was something when when that first got announced. That's sent down Qualcom's share price. Now Qualcom is not a tiny uh component maker like Dialogue, but look you it is. It is dependent on Apple for business. So does Qualcom have any leverage here? Does

it have leverage? I I mean because basically there are other like Intel. Apple could just go to Intel to make the parts. Yeah. Or Apple could just say, look, we're gonna leave you unless we unless you allow us to pay so much less for for your parts. Qualcoms mobile technology and chips are pretty essential. I don't know to what extent um Apple would be able to completely

shift away from Qualcom if it came to that. I think Qualcom does have leverage just because of the power of its technology and how essential it is in in mobile phones. Qualcom has been the target of other regulators,

notably in South Korea. Tell us what happened there? Yeah, I mean, this is again, this is not an unusual fight that in South Korea, in China, in the US with the Federal Trade Commission, the regulars are looking into have been looking into similar issues that Apple is alleging, right, which is again Qualcom kind of abusing it's uh, it's market power to use its intellectual property to get customers to pay more um. And you know the question about places like South Korea and in China too, is are

the regulators kind of carrying water for local UH companies. Right, So Samsung is obviously one of the largest and most powerful companies in South Korea, and so the question is, did regulators kind of go after Qualcoms business model to help Samsung? Just to give us a sense of how much money is its stake? How much money is its steake? It's a little bit unclear, so um, we don't know exactly what um Apple pays Qualcom for each iPhone sold,

but it's probably like tens of dollars per phone. And when you're talking about the scale of Apple, right, three million iPhones sold every year, it's a lot of money. Shara Ovida, thank you so much for joining us and explaining things UH in clear terms without even using you know,

sofas or lampshades anything else. So Shira O v Day is a technology called columnist for Bloomberg gad Fly, which is our fast commentary group here at Bloomberg, and his terrific I mean, I just throw that in there anyway. But it's a fascinating debate and it's obviously has a very big standing on a huge swath of business. It frankly has been driving a lot of growth in the US regulatory reform and Dodd Frank legislation. What's the future for it in Washington and how will it affect banks?

That's why we have Frank Sarentino. He is the chairman and the chief executive of Connect one Bank Assets Center management more than four and a half billion dollars. They're based in Englewood Cliffs, New Jersey, and you can follow Frank on Twitter at Frank three as in Roman numeral three. All right, Frank Sorrentino, tell us about Dodd fran legislation. How will it change and how can banks take advantage of the changes that you foresee? Well, thanks Lisa and

Pim and so. Dodd Frank obviously was written in haste in two thousand and ten UH to solve what was thought to be or was a financial crisis here in the United States, and a lot was put into that bill that really wasn't well baked. It took a number of years for all the regulations too, and I think, yeah, even as of today, they haven't all been written, and so we don't even know what a lot of uh

the regulation is going to look like. I think only sixty or sevent of the bill has been written into regulation, and so as you can well imagine, um all banks were thrown into one bucket. Regulation was set for you know, banks pretty much of all sizes. And so what I think we're seeing today is a much calmer mood relative

to bank regulation. And I think we need to segregate the smaller community banks and mid size banks from the largest money center institutions and tailor regulation based on those financial institutions and the risk appetite for each of those types of financial institutions. And it's not just size, right, there are banks that are ten billion dollars today that could potentially be much riskier than a hundred billion dollar

institution that has a much more simple business plan. And this is something that even some of the current regulators, or as of a few weeks ago, current have even acknowledged that community banks have gotten disproportionately hit by Dodd frank um and that this needs I mean, even Daniel Tarullo has come out and said that I'm wondering how quickly do you think that some of these provisions could be rolled back, given that Dodd frank itself took years

and years to even get written, let alone get implemented well it's not going to happen by executive order, and we need Congress to have uh, the want and the desire to do this there you know, as in any political discourse, Uh, there are those on both sides who have different opinions about what cannon can't be done. And with the agenda that's in front of Congress right at the moment, I think this is one of the top three or four priorities, but I'm not sure it's the

top priority at the moment. So I think we'll see. I think we'll see it in stages. I think we'll see some simple things be done sooner than later, and

I think that would be good. I think, you know, changing some of the changing some of the caps, whether it's the fifty billion dollar threshold for city institution, the ten billion dollar threshold for when the CFPB starts to you know, regulate institutions, uh, some of those asset based numbers, and and and this differentiation between community banks and the larger money center banks. I think we'll see legislation around

that move quicker. I don't know if that means this year or next, but certainly there's a bill in Congress today that uh, you know, that that they're looking to do just that. So how much better would your banks earnings be if some of these rules were changed. It doesn't really, Uh, it wouldn't impact a bank like connect One Bank all that much. We have a very simple business model and we're sort of in that sweet spot

right now. We're way below the ten billion dollar threshold at four and a half billion, and Connect One Bank has a fairly simple model. We take in deposits in our local market and we make loans. We don't do a lot of other things that really step over the line. There would there may be some compliance cost savings. A lot of banks are complaining these days about the cost of of of compliance component within the institution and what they've had to put in place relative to the regulations.

So I think there would be some savings there on the expense side. As far as your bank goes, I'm wondering if you could tell us about the health of business, because I know you've got a background and construction, so construction lending is is important, and uh, tell us a little bit about how you see the pricing of of

money for those kinds of projects. So today there's availability for you know, construction projects Um, there has been some pullback in the marketplace, you know, just relative to pricing expectations going forward, the threat or the or the the outlook that interest rates are rising, although you know, I sort of have a mixed view about that going forward. Uh, tell us about that, because I mean I keep asking myself, well, gee,

you know, well, twenty five basis points really crater a project? No, Um, I think I think to the extent that interest rates are are up at fifty basis points, Uh, that's fine. The problem we're sort of heading towards, though, is that the long end is not moving, is not cooperating with the short end. And as you know, banks make their money based on a you know, the slope of that curve, and if it gets flatter over time, that's not great

for banks. When will your bank or has your bank started to pass along the higher rates that we've seen in the front end two depositors, So again, it's it's not it's not that simple a question to answer. A lot of banks haven't. We'll become an interesting sort of pressure right now. So as as rates have gone up on the short end by fifty basis points over the last six months or so, the rates on the long

end have actually come down. Right. Rates were as high as to sixty seventy not too long ago, right after the election, and uh they're now down to to thirty or so today. Um, so what's actually happening. There has been some flattening in the curve and so banks are not able to pass those savings along. If we see if we see the curve steepening, I think you will see and both are going up at the same time. You will start to see depositors start to benefit from that.

Thank you so much. Frank Sorrentino, Chairman and chief executive officer of Connect One Bank in Englewood Cliffs, New Jersey, with about four and a half billion dollars under management. Should I say Frank Sparentino the third? I should say Frank Sarentino the third? What just makes it easier on the Twitter handle? Yes, yes, there's an anything else that the other middle names we should add. Uh, this is a This is a fascinating topic though, and it is

important to to keep track ups. So we really appreciate you taking time with us. Frank Sarentino, thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at iTunes, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm out there on Twitter at pim Fox. I'm out there on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio