Bloomberg Audio Studios, Podcasts, radio news. This is Masters in Business with Barry Ritholts on Bloomberg Radio.
This week on the podcast, yet another extra special guest. Steve Lpley is global cohead of bondytfs and investment giant Blackrock. He helps to oversee over a trillion dollars in bondytfs. He's got a fascinating background at both Bank America, Merrill Lynch and since two thousand and nine at BGI and Blackrock.
I thought this conversation was really fascinating. There are a few people in the world of fixed income that understands the bond market, the ETF market, what the Fed's doing, what is driving both institutional and household investors on the fixed income side. I thought this conversation was absolutely fascinating, and I think you will also with no further ado, my conversation with black Rock's co head of bondi pfs, Steve, Steve likely, welcome to Bloomberg.
Thanks for having me, Berry.
So what a perfect time to have somebody who specializes in fixed income and bonds. We've had all sorts of mayhem with tariffs on tariff's off rates up, rates down, yields starting to creep higher and hire. But before we get into what's going on today, let's talk a little bit about you and your background. BS degree in finance from University of Miami, NBA from Wharton Finance. Always the career.
Plan, not quite. So I went to Miami University in Ohio. Actually I grew up in a small town in Ohio. Yeah, so went there for ultimately ended up in the business school. I did start off thinking, you know, as many people might that, oh what should I do? Should I be a doctor or a lawyer? I decided to try doctor. I love biology, Organic chemistry not so much.
That's the that's the gut course that the reins a lot of future docs out.
Yeah. So I had a good friend who said, hey, I'm taking finance. I really like it, Maybe give it a shot. I took a finance class, really liked it a lot. It's sort of like math with dollar signs attached to it. So that's sort of the way I viewed. I really enjoyed it, and that was kind of that was kind of it. I was hooked.
So University of Miami in Ohio is gonna scratch out my next question, which which is how do you get anything done in the Florida Sun in Miami? But Ohio, I bet is a little easier study type of regime.
A little bit. It's still it's a beautiful campus, a lot of fun. But but yeah, it's uh, it was. It was a good experience.
So you come out of work and we'll talk a little bit about I shares and your previous history at Bank America Merrill Lynch. But what was it that drew you to fixed income?
I think a couple of things. One, I really I really did enjoy sort of the variety of things in fixed income. You know, I mean, you know, equities can be complex in their own right, but fixed income you can have so many different types of instruments and cash flows and structures. And it was just really interesting to me to see that variety.
And what do we have something like thirty five hundred individual equities outside of the pink sheets, and how many q SIPs are there for fixed income?
So I did this, I did this exercise on Bloomberg. Depending on how you filter, well north of a million, right well north, and it's you might even get multiples of that depending on how you filter. But yeah, fixed income, as you know once you once you issue that a company is going to issue debt, you know perpetually, they're going to keep issuing newq SIPs over time. So it adds up, no doubt.
So you're at Bank America Merrill Lynch as a senior member of the Interest Rate Structuring and Strategic Solutions. Sounds very institutional. Tell us a little bit about your time at Bank America Merrill Lynch.
Yes, so I think that group. The idea was to work with institutional clients to really help them manage risk, right, and so it was about using derivatives in particular in a sensible way to come up with hedging strategy. So
my particular focus was on the mortgage servicing community. They had a very very complex asset they still do, it's a little bit different now all these years later, but they had a tremendous amount of interest rate risk in those servicing right assets, right, So my job was to work with them to come up with, you know, thoughtful ways to hedge that risk. And there are you know, some very very vanilla ways to do it, but you know, we wanted to really try to be you know, more
thoughtful and much more tailored. And that was that was what I spent a lot of time doing. I really enjoyed it.
When I think of hedging risk on the fixed income side, not specific to that era, which was kind of unique, I think of interest rate risk, credit risk, the underlying security that subsequently gets securitized. Am I warm? Tell me if that's about right?
Okay?
What else do you consider when you're trying to find a way to hedge a fixed income risk?
Yeah, and so you just nailed almost all of it. So depending on what it is. So when you're dealing with something like a mortgage servicing, right, that's that lender you know, sells the loan off and then somebody retains that annuity that can get prepaid. So you go pay off your mortgage. I go pay off my mortgage, that annuity disappears. There's optionality there. You have to hedge that, right,
So you have interest rate risk, volatility risk. Things move up and down the more likely you are to decide if rates fall to prepay. So it's all of that good stuff, and then yes, you can have credit risk and other types of assets as well.
You use one of my favorite words, option because every time I have a discussion with people who are not in the world of finance. And they say, have you ever calculated how much it costs to take your boat or jet ski out? And figure out what each ride costs you? And I'm like, you don't understand optionality. I have the ability to do that every single day. Whether I choose to exercise that or not, that is still a value that would cost somebody something you join a
boat club or a rental club or whatever. Lay people don't get optionality. Tell us how that applies and fixed income.
Yeah, and you see this in different ways, Barry, So I mean not dissimilar. Right. So as an example, again going back to the homeowner part, if you have a mortgage, you can decide to prepay that. A lot of people don't. Interestingly, there are stories that exist, and I'm sure you've heard them where people still have ten percent mortgages somewhere get out.
Is that true?
There are stories about that, And so if you look at statistics, I haven't done this in a while, by the way, so hopefully after this law long period of time, maybe they've paid them off. But you can find these very high coupon mortgages that are still out there, and nobody really knows why. They haven't paid them off, but it is your right, but you're not forced to pay it off. You would think you'd want to if interest rates were low enough, but that exists in different ways.
Just like when companies issue debt, a lot of times they'll issue callable debt. So same idea. If interest rates fall or credit spreads titan, they can call that debt an issue cheaper debt, right, And so that's just sort of a basic tenet of how people like to structure their liabilities.
My equity version of that is Blackrock SMP five hundred fund is like five BIPs, four BIPs. It's like practically free. And sometimes portfolios come into the office and why are you paying one hundred basis points for what's effectively an SMP five hundred index. Why don't we save you ninety five BIPs a year compounded over twenty years. That's a lot of money. So the market is kinda sort of almost efficient, is I don't know how else to describe it.
No, I think that's right. I mean, and over time, you know, we we've really started to see investors gravitate towards this idea of efficiency. And you know, again, you you this is a theme that you really really hammer home, which is, you know, basic sort of blocking and tackling is don't surrender a lot of your return to fees. Everybody thinks that's incredibly important. It took a while for people to wake up to it, but I do think over time people have really started to understand fees matter.
The strategy matters too, but the fees matter as well. And so we have want both. Yeah, you want both. You want both.
So I know we'll get to black rocks starting in nine. But how long will you at Bank America for?
From ninety seven through nine?
Oh? So you watched the debacle front row row? Did you start at Merril? Did you start at Bank America?
I started at Meryl, Oh you did. So.
A lot of people slag was John Thune. I thought he cut a great deal that worked out really well for metal employees and relatively well for Mental shareholders, at least compared to you know, Bear Stearns and Lehman and so many other companies. He he did a solid and it took a while before people recognized it. What was your experience like going through that mayhem?
I mean it was stressful, you know. I was not involved with the particular businesses that were under stress, but it was stressful for all of us as the headline scrolled day after day after day. You know, it was a front seat in history, as it turns out. And so I think, you know, hopefully a lot of lessons have been learned from from you know, that period of time.
As you know, and I think you've said this many times, each crisis looks a little bit different, so hopefully we take lessons from the last one, and that starts building a knowledge base up over time. So maybe then next time we're a little bit better equipped to deal with it. But it was, Yes, it was an interesting time.
Yeah, to say that very Hopefully we take the right lessons. Sometimes we drove the wrong lessons. That's a whole nother story. So how did you find your way over to black Rock in two thousand and nine? I'm assuming that was once the dust settled a little bit. Was it late past March on nine?
Yeah, it was.
It was.
It was interesting, you know, you you have sort of contact and networking with different folks, and I had and it was at the time Barclay's Global investors, and I did know, I did know a couple of a couple of folks over there, and we had just you know, had casual conversations. But at one point, and this is a former mentor of mine, gentleman named Matt Tucker, reached out to me and said, hey, you know, this is
an interesting opportunity. It's called bondy tfs. It's it's a business that that I've really been working hard on over here, and I'm looking for a skill set that that sort of maps to that. And and you know, I kind of think that that your background might be might be interesting for this. Oh you know, let's let's talk about it, and then you know, sort of the rest is history. But I was very very excited about it. And there is a funny story to this, which is I discovered
bond ETFs on my own, sort of accidentally. I was trying to buy treasuries and I was very frustrated by the commissions I was getting charged on that. A colleague actually pointed me to the Aischer's website and showed me that bonditfs actually exist and you could simply buy this on exchange without actually having to buy physical bonds and you know, pay a commission for it.
So and not only was the commission, you know, next to nothing. The spread and the price discovery seemed to be a little friendlier to buyers.
I was really blown away by that, and I could not stop, you know, scrolling through that website and fascinated by the idea that you could take bonds and put them on exchange. Absolutely fascinated by that, and feeling a little stupid that I hadn't stumbled on it before, but so so the fun part about that was it helped a little bit in the interviews to be able to say, yes, I'm familiar, and you know, by the way, yes I'm actually a customer, albeit at a small scale.
For those people who are unfamiliar with BGI or Barclay's Global investments. Eventually, what I have argued is the single greatest acquisition in at least wealth management history. Barclay's Global gets brought up by black Rock, and the whole I Shares product line gets really supersized with just a much savvier group of product developers, marketers, traders, just everything about it went next level. How much of that were you there to witness? Did you start a BGI started blacks.
It's funny because people often asked me what was BGI like I was there for one month before the actual Yeah.
Like what I've heard through the grapevine is it was a solid shop with a great product, a little sleepy, kind of backwater. If you are at Bank America Merrill Lynch and you still haven't discovered their bondy TF somebody is not doing the marketing job they should.
Well, it was interesting. They were very much i think quantitative and academically oriented, and I think I think a little bit of the culture was okay with with being you know, somewhat under the radar because it was, you know, a very proprietary place, and so that that might be might be some of it. But yeah, Blackrock did come in and uh, you know they did. That deal was interesting.
If I don't know if you remember Barry, there were there were some discussions about whether, you know, it would be some sort of a private deal or what have you, and then Blackrock kind of came in and said we'll take the whole thing in that that was announced I think in June, so I'd only been there a very short period of time, and then it closed in the fall, and I will never forget you could tell that Blackrock was was very efficient at this because the day after
the merger closed, the signage was up on the building. You walked in, all the screen savers that changed overnight. You had a nice pad, no pad with the logo on it, and you know, nice pens and all that stuff. So very very impressive. How they were able to do this so cleanly and quickly.
That's fascinating. And I failed to mention Black Rock is a little shop over on the west side of the city. Eleven twelve trillion dollars an asset someone in that range, how big chunk is fixed income and fixeding? Come ETFs at black.
We just hit one trillion in fixing, Come etf.
So keep at it. You'll get some aum soon. Keep keep plugging away.
Keep plugging away. Yeah, And you know, the industry is now globally the industry is approaching three trillion. We're at around two point eight trillion and change. And we think that number is going to get to six by the end of the decade for the industry. And we hope to be obviously a sizable chunk of that. But it's been you know, it's been experiencing double digit growth, you know, four years and years, and it's just been a very you know, fast moving river for us.
Huh really really quite fascinating. So, Steve, you just mentioned you think bond ETFs can reach six trillion dollars by twenty thirty, Is that right? What is the key driver of that growth that's doubling in less than five years.
Yeah, And it's a number of things. And we've talked about these trends. So I think you have you have a series of waves of adoption that happen. And it's interesting because where we tend to see the largest uptake of bond ETFs is when you have stress markets, and so I think this is we have several several test cases at this point, so you know, we've had many
one since the financial crisis. So financial crisis happened, and I think that's the first time where I personally started getting reverse inquiry from sophisticated investors asking about the bond because they noticed that even at the worst of it, let's call it September or October of eight, they were still trading on exchange very robustly. Other markets not doing so well, right, and so that got the attention of
a lot of investors at that time. Products are probably too small for a lot of those investors, but they became very intrigued by them. Over the ensuing years, you had to you know, you would have occasional blips in the markets, whether it was some sort of energy dislocation in high yield or what have you. But what we noticed was every single time you would have one of these stressed markets, you'd see a huge surgeon volumes in BONDYTF trading on exchange that would get the attention of
larger investors. They would start adopting the products. Why because when you need to trade something, you were able to trade bonditfs even if other things were really struggling to trade. And so every single time you'd have one of these waves of dislocation and fixed income, you started seeing more
in more and more investors gravitate to bond ETFs. The big one was COVID, so for sure February March twenty twenty, you know, even treasuries, high quality investment grade, you know, the whole thing, everything was seeing dislocation, right, and so that's when we saw probably our largest wave of adoption in fixed income ets was during that period of time. Same story. You saw things that people would just take for granted, suddenly struggling, you know, in terms of bid
ask and depth of liquidity. But what could you trade? You could trade bond ets, you could trade them in size. That got at that point a lot of attention because now the products has scaled to a level where even the largest investors could use them in their portfolios, and so that was interesting.
So you're absolutely preaching to the choir I have heard mostly on the equity side, but also on the fixed income side. You know, these ETFs, you don't know what the underlying is priced at it. They're filled with all sorts of stuff. It's really hard to get a print on. When it hits the fan, you're not gonna be able to get in or out of it. You're gonna have giant spreads and no liquidly. That wasn't true in eight oh nine, that wasn't true during the flash crash COVID
and the most recent tariff volatility. Even in twenty two, when stocks and bonds were both down double digits for the first time in four plus decades, ETFs traded like rock stars. Why is this such persistent squabbling? You know, you'll say, just wait, is it that people are losing business to ETFs. Why is there so much fear and concern that for twenty five years have been completely unjustified.
Yeah, I think it's a little bit of it, might be a little bit of the hour grapes a little bit, but I think part of it too was after the crisis, there was it felt to me like there was this search for what's the next thing, right, it's the next thing that could go wrong. Not quite sure why that focus shifted to ETFs, but it was ets and probably
a number of other things. But I think the idea of a bond ETF in particular drew attention because the talk track was, well, you're taking something over the counter and you're putting inside this box, and you're putting this box on exchange and that might you know, cause some some interesting things to happen. And in reality what we've seen is just the opposite of those fears buried again.
Just you know, you pointed out the terraf folatility, same story, different verse, right, so you have you know, markets are really really stressed. You see a lot of dislocations, volumes on exchange once again set new records. I think, you know, on the day of the announcements, I think we saw close to one hundred billion dollars of bond ETFs train on exchange. Wow, way more than the previous record during COVID. But the sort of I think skeptic has always said, well,
you know, we haven't seen a good test yet. We haven't seen a good test yet. I think COVID was a good test. This was just a reminder, right, And so really what happens is, you know, the exchange keeps trading even if the underlying doesn't. And unlike you know, the fears, you don't see these quote unquote forced redemptions or anything like that. Nobody's forced to redeem an ETF. It can just trade on exchange. And I think that's the elegance of it, and it gets proven time and time again.
So I just want to define some terms you reference because in the back of my head, I'm always thinking, does my real estate agent mom or my art teacher wife know what that means? So when we talk about on the exchange, we're talking about anything that's publicly traded that you could just log onto your online trading account
buy or sell instantly. When we talk about over the count or OTC, that's one bond desk calling another bond desk and saying, hey, do you guys have this twenty nineteen you know, Munich California, Muni series whatever, and someone has to go locate that. So over the counter means two people literally speaking to each other to engage in a transaction. Is that Is that a fair description?
That's exactly right, and so yes, over time, bond trading has gotten more efficient. You know, in the underlying market you have electronic trading of treasuries and now and now credit. But you know, if you've go back twenty years when ets were first new, bond ets were first new, it was still very much a voice market. It was a very much pick up the phone exactly as you described.
And even today, I think even the most sophisticated institutions still believe in the you know, efficiency and the elegance of being able to trade a bond etf on exchange. You're trading if you if you just step back for a second and think about what you're actually doing, you're trading hundreds or sometimes thousands of bonds simultaneously at a penny bit ask on exchange. You actually still can't do
that in the underlying market. So you know, it does doesn't matter if you're an individual, it doesn't matter if you're a large sovereign wealth fund. That's still a very impressive feat to be able to do a transaction like that, and bonditfs allow you to do that. But I want to get back to you know, you would ask what are sort of the long term drivers. I think this idea of just okay, you can trade these things when
you need to, that's important. Another one would be when we're building portfolios, and we see this both again on the wealth and on the institutional side, do we need to build portfolios with hundreds or thousands of bonds or could we take a low cost bond e TF as sort of the core of that portfolio. Could we then use individual bonds to sort of flavor that or tilt that in different ways, and then maybe add our favorite
active managers on top of that. Might that be a more efficient way to do it than just going out and buying, you know, to your point, picking up the phone and calling around and putting together hundreds or however many bonds which might take days or weeks. And so I think there's this growing realization that you know, what it's fine to trade in and out when things are volatile, but actually might be more efficient to use these things
long term in a bomb portfolio. So I think that's a huge part of the adoption, too, is the recognition that this might be a smarter way to build bomb portfolios in general.
On the equity side, I'm fond of telling people, before you go chasing alpha, why don't you at least lock in beta. And I'm pleased to hear that's a similar approach on the fixed income side.
Very much, very much, And I think it's a and this has been a journey because you know you've run into this, and I've heard you talk about this on your show before. Everybody wants to believe that, you know, if I'm buying this security, I have intent, I did my homework, it matters a great deal. And that may be true for that security, But when you do that one hundred times, some of that starts getting canceled out right.
And so that's when you have to step back and say, all right, if I'm looking at my portfolio holistically, I want a certain beta, I want a certain tilt, I want a certain amount of yield coming from you know, one place or another. What's the most efficient the cheapest way to do that, and that's I think people are slowly recognizing that maybe the ETF actually that has that utility.
So this is a good time to ask a question about active fixed income investing. It seems like it's super challenging. On the equity side. We all know the stats. Sixty percent of active managers underperform the benchmark in year one. By the time you get to five years, it's eighty plus, ten years it's ninety plus, and by the time you get to twenty one, it's a handful of guys like one and Buffin and Peter Lynch. I don't see that
uphill battle of the same. On the fixed income side, it seems like fixed income active does much better than fixed income equity. Is that fair or.
I think there are a few things. So One, we think that all investing is active to a degree. Right, you're making decisions, So if you're using ETFs, you're making sort of these broad beta calls and you're deciding, you know, which beta, which sector, what have you. So there's an active choice there in how you build that portfolio. But to your point, strictly active in fixed income, what does that mean? That means that Hey, I'm going out and
I'm assembling a bond portfolio. I'm going to compare that to a benchmark, and I'm going to see if I beat it.
And you guys have the benchmark, the I shares core us AG, whereas everybody calls it the AG.
Yeah, the AG, we have agg we have the universal, which is I USB. One of the things that we've been vocal about is which benchmark are you looking at? Because sometimes you'll see a manager buy a bunch of high you bonds in their portfolio, not all, but like they'll hold, you know, a large allocation of high old bonds benchmark to the aggregate which has none, and say, oh look I'm beating the aggregate. Now that's that's fine, taking on more risks. They're taking on more risks. Okay,
that's fine. You may give some of that back every call it five years.
Right.
What we sort of preach to is, okay, let's get benchmarks that look a little bit closer to the risk you're taking and see what you're actually adding through security selection. Right, So some of it's benchmark misspecification, but fixed income markets still are less liquid, they're more fragmented. So yes, there are opportunities there, and so you know, people often ask me, do you believe in active or quote passive? We call passive index because actually even in an index choice yeah, exactly.
So market cap waiting, that's a choice.
It's a choice. And so my answer to that is we believe in all of the above. We think the best portfolios have elements of both of these things. Index and quote unquote active together, much better portfolio, much more resilient than just sort of suiciding one or the other. Oh, I'm all active or I'm all index, right, So we think both makes a lot of sense, and that's that's how we sort of design our products at give.
Given the million play plus q SIPs, the million plus bonds that are out there, my simple thesis was always, if you want to be an active fixed income manager, how hard is it to screen out the lowest quality, weakest credit, poorest yield relative to risk you have to take?
And if you're just cutting out the bottom half of that, that should do better than whatever the AG is going to do or whatever your benchmark is, because as you know, hey, this thirty five hundred stocks, not all of which are great. A million bonds, there's a lot of room for the bottom pick a number decile quartz asle half a lot of junk can get mixed up into that. I don't mean high yield, I mean lower quality fixed income opportunities.
Yeah, and this is the trick with fixed income. You could see great opportunities, but when you try to act on them, it can be really costly to actually implement. And that cost or just can you find that bond? Right? So you're okay, the search costs the actual transaction costs.
Wait, there's a search cost for locating a bond. I always thought it was kind of built into the transaction costs. I didn't realize, Hey, find me this, that's going to cost you just to ask that question.
Well, let's call let's call that the time it takes to actually get a hold of it. You're sitting in cash, right, and and I've I've heard you say this many times. You probably should not be singing in cash very long. It's a medium of exchange, right, So that's right, But this is the time it takes you to locate that particular bond, and then you have to pay the transaction cost, you know, the bit ask on top of it. So you know, yes, optically, you could see opportunities all over
the place. The question is are you able to actually move on them and implement them at the right at the right price. And that's that's where there's a lot of skill involved in fixed income, I think.
And I've heard some clients say, especially institutional clients, listen, my cash, my money allocation. I've got that I've hired you to do. You're my equity guy, you are my fixed income you are my opportunistic distress guy. I don't need you to carry cash. And I wonder how that impacts people's thoughts of when you start to see one, two, three, four percent creeping up as a cash balance. Got to put that money to work. There's an opportunity cost of just sitting in cash.
Yeah, yeah, and there is. I think what has happened the last couple of years is, you know, money market assets are you know, in the trillions.
Well, now that it's four and a half, that it's.
A five percent, and so there's been a little bit of what I would call, I think apprehension of giving up that certain or what people view as certain, you know, four and a half to five percent and then moving out the trick to that is, you know, if you wait too long, the market's going to move past you.
And we've watched it. You know, it broke below four, it went back over five. You're not locking that in, you're taking what Look, if you're saving for a house or something, six months, it's a year down the road and you're afraid of you know, twenty twenty two type year. Of course, a money market makes perfect sense. But if you're looking out a couple of years, you want a product where you can sort of lock in a higher yield fair statement.
Yeah, and you also want to be able to have it. So look, cash is great. We launched money market ets. Cash plays a role in a portfolio. To your point, it shouldn't be a huge part of the portfolio. You need to get those assets allocated, you know, on a risk basis, so whether it's you know, equities, safe bonds,
riskier bonds. It's like an orchestra, right, you have your string section, your horn section, they all need to play together and just sitting on the sidelines that's okay for a while, but it's it doesn't make very good music. You need to actually have everything you know kind of playing its role in the portfolio. And so I long term, that is what's going to actually, you know, build your return.
Right, And I'm spit balling these numbers off the top of my head. I have to double check them, but I want to say cash is a drag on performance four to five years in equity and nine out of ten years in fixed income? Am I close there? Bullpark?
Haven't heard that part in fixed income, But I see your point. I mean, you know, if you just sit forever in the FED cuts rates, you're going to miss it, right, And so that's that's right, that's and you know, and I think the consensus right now is, ah, you know, maybe they'll cut a couple times this year, maybe a
couple times next year. Things can move pretty quickly on the ground, and you know, it's one of those things where you know, yeah, by the time you wake up and decide to move, the market may have already moved past you. I mean, to your point, we were at around four and a half percent almost a year ago, and guess where we're sitting at today around four and a half percent. But it's been quite a bumpy ride up and down, and so who knows where we'll be in six months.
So the question is of if you were sitting in money markets for the past year, or you had bought some equivalent bond ETF which performed better over the past twelve months given all the volatility.
Well, on a risk adjusted basis, you could say, all right, I had less risk in the money market, and I'm sort of sitting where I was.
You know, But if you have high quality dons, how much risk.
Is if you bought sort of last if you think about where we were closer to five percent, you know you actually ended up locking in pretty good yields. Now, the one thing I would say is it's hard to time. It's hard to time rates. It might be actually the hardest thing to do is to time the top and yields. That can be a very very fleeting thing. So it's more about get invested, build a durable portfolio. Make sure
you have risk in the right buckets. You need some high quality bonds for ballast, you need some riskier bonds for income. Right, that all plays together with the equity side and the oult side of your portfolio. All these things need to come together. Yes, cash plays a role, but you will probably miss out on some very good opportunities. We haven't had yields like this in twenty years, right, So are you really going to try to hit the top when you're seeing yields that are as good as
they've been in a generation. Yeah, so you can get greedy, right, But.
Which is kind of funny because it I always laugh when I think about someone who's forty forty five years old on a stock desk, on a bond desk, have not seen seven percent yields in their entire professional career. And I recall people's bonds coming up, like the New York City geo bonds finally got called seven percent, like they were again, I'm getting fifteen percent? What am I going to do with seven percent? That was when New York City was going to collapse? You can't get fifteen
percent today. Seven percent treasuries. Hey, that's a good deal. No one realized how great a deal it was twenty five years ago, but that's just the reality.
Yeah, And you do have to go back to the mid two thousands to see yields at these levels. So it's a great opportunity. And you know, rather than saying, well I really want to hold on until five percent, you know, I mean, you just may miss it. So we think it's just a great, great time in fixing.
Absolutely, And I want to just remind everybody who thinks they can time yield. So the FED, collectively, everybody has been completely wrong about when the FED was going to start cutting, how far they were going to cut, how often they would have cut, Like the consensus could not possibly have been more wrong for like what three years,
four years? Here comes the recession, Here comes the Fed cuts, Here comes if you're waiting because you think you can guess if you're going to be a macro tourist, best of luck.
To you, right, yeah, exactly. It's build a portfolio for the long term, you know. And you may say, well I could have gotten a higher yield or hey I locked in a pretty good yield here. Either way, it's about the next ten years. It's not about the next month.
Huh. Really really interesting. So let's start out talking about fixed income today and the obvious spike in bond market volatility we've seen this year. Tell us what's going on.
It's we've covered a couple of these things, but it's pick your theme, okay, So let's let's go back a few years. We had COVID, we had the policy response to that. We then had transitory inflation, which became not transitory inflation. We then had the we had the reverse policy response, which was too aggressively high grates, the most aggressive tightening cycle in forty years. Right, So people were used to seeing rates, you know, bumping up against zero.
I think at one point the tenure yield was you know, somewhere in the you know, sixty seventy basis point range at the very very very lows. And I think this was quite a shock to people who were just sort of used to seeing the post crisis, post crisis story quantitative easing regime. All of a sudden, you have yields moving you know to a two handle, three handle, four handle, and then ultimately a five handle something. To your point, many investors haven't seen this before, and so it was
quite a shock to the system. Then we kind of hit sort of equilibrium. The economy seems to be doing all right. As we talked about, you know, people were worried about recession, it hasn't materialized yet. The Fed you know, paused for a while, started easing. Then all of a sudden, you get new policy initiatives coming in, specifically tariffs, right, and so that caused a general rethinking of the way the economy is going to move going forward. Will inflation
come back, won't it? It's just been you know a lot of up and downs. And as we were talking, if you just look at the trajectory of the tenure yield, you know, we just sort of do this large, you know, kind of sime wave between you know, call it sort of high threes and high fours. And we've been doing that now for a few years. So you're just sort of stuck in the middle of you know, kind of a fore handle. But you get these ups and downs depending on what the driver is.
And just to put some specifics on this, when when when we look at the broad economic consensus about tariffs, they're generally perceived as inflationary, sort of a giant vat tax on consumers. I know a lot of people in the administration push back on that characterization. But if you're spending more money on tariffs, you have that much less money to spend on other things. Therefore it should hurt corporate revenues and perhaps be someone inflationary. Is that a fair assessment.
It's it's hard to say, so I think, you know, I've heard both arguments. I think, really what inflation is about, right, so we whether it's tariffs or something else. You know, people often talk about these things is well, that's a one time shock versus something that happens repeatedly, over and over again. I think some of that's academic Inflation's really I almost think it's a mind game or an expectations game.
The real, I think question is does inflation, you know, a higher expectation for inflation somehow get embedded or get sort of resurfaced, right as a result of whatever policy initiative. And so I think what the Fed's looking at is less about a specific thing and more about whether people start worrying that inflation will be at X level like, which may be above where the FED wants it to be. To me, I think that's what they're really focused on, is you know, hey, we got things down. We're at
two point three percent. And by the way, what's interesting I actually looked at this. If you go back to let's call it ninety five to two thousand and five, average inflation was around two and a half not two. Right, So if you kind of look at a long, long time series on Bloomberg as an example, right now where we're sitting isn't too far off where we've been on a long, you know, twenty odd thirty odd year journey.
But I think what the Fed's worried about is will any particular action cause people to start worrying that inflation will be hiring. As you know, sometimes that can become sort of a self fulfilling thing. I think that's kind of the concern.
So I'm going to play devil's advocate on every point you said, and I want to hear you pushback. But before I get to that, former Vice Chairman of the FED, Roger Ferguson, did this accidentally very funny piece about the two percent target, and he could not find an academic basis for that number, but he traced it back to an interview from the Australian, their central bank chief on TV in the nineteen eighties, and he mentioned two percent as their target. That was the first mention of it.
I mean, it certainly was a credible target. In the post financial crisis, while we were trying to get up to two percent, inflation and deflation was the fear. But once the Cares Act and the new era of fiscal stimulus passed, isn't two percent kind of the wrong target? Why doesn't two and a half or three percent make sense in an era of fiscal not monetary stimulus.
I'm gonna I'm gonna say that is above my pay grade. But what I will say is, if you look at a long, long time series, whether it's two, whether it's two and a half, I mean, I think generally right now we're sort of in that zip code, right So can they get it all the way down to a perfect two? I don't know. And do they want to or you know, does do you risk going to one and a half? I mean, that's that's for them to worry about. I do think that we're not too far off if you if you were to look at this
over many, many, many years. The worry is, somehow does everything that's happening right now start sending you in the other direction again, people worrying about it, Does that start, you know, causing you know, specific actions that actually lead to it, to it becoming more of a reality. I think that's what the Fed's sort of focused on.
And I think transitory has become a dirty word, but we sometimes want stuff right now. I can make the case that this bout of fiscally driven inflation was transitory. Transitory just took a little longer than everybody expected compared to the sort of deep structural inflation we saw in the nineteen seventies. This wasn't structural. We passed a joint everybody, stay home. Here's two trillion dollars. Takes a little while for the pick to work its way through the python.
Yeah right, that's interesting. I mean, yeah, you had a huge, huge, fiscal impulse, you know, very very significant fiscal impulse, and sure it could take time for that to work through. If you couple that with the idea that you unleashed that fiscal impulse at a time when policy was still easy, the textbooks would tell you that you probably should expect
some inflation. But I think, you know, if you look at just the way people had sort of entrenched their thinking post crisis, they were caught off guard.
When you were at Wharton, did you have Jeremy Siegel as a.
Profession I did not. I did sit I was a little bit I was a little bit disgruntled about that work didn't work out scheduling. I did sit on in on some of his lectures, just as a guest.
But yeah, I had him in here two months after the first Cares Act was passed, and he was the first person I recall saying, Hey, this is economics, one on one, two trillion dollars, the largest fiscal stimulus as a percentage of GDP since World War Two. We're going to see a giant bout of inflation, maybe even double digits. And I got emails we love Jeremy, you've had him on the past, but he's crazy. We're not going to get anywhere near nine ten percent. He doesn't know what
he's talking about. And it was kind of shocking to hear someone stocks for the long run talk about inflation and bond yields, and he turned out to pretty pretty dead on.
Yeah again, if you just sort of go back and you look at a large fiscal impulse coupled with easy monetary policy, that's right out of the textbooks.
And yet it was so hard another failure of imagination. Was so hard to say, no, no, we've had inflation two percent for twenty twenty five years. What are you talking eight, nine, ten percent. It just seemed that regime change was so hard to incorporate because it just seemed like such a break from everything we've experienced before.
And it happened quickly, very very very quickly.
So so let's talk a little bit about the next easing cycle. I'm assuming that six months from now, by the time we get into the fall, the worst of the tariff is behind us, things will have stabilized. At that point, is the Fed starting to think, all right, we can unfreeze the housing mark a little bit and talk talk about a few more rate cuts this year or next, Like what sort of timing should we be thinking about.
That's what the market I've looked at this this morning. The market's pricing in a couple cuts by the end of the year, pricing in a couple cuts next year. And so it looks to me the markets sort of settled on this idea that maybe wind up with a terminal rate of around you know, three and a quarter, three and a half somewhere in that zip code. So
we'll we'll see. I mean, the cut definitely got pushed out to September, right, I think originally, you know, if you go back even you know, a few weeks ago, we were still thinking sort of you know, mid to late summer. But that's that's now pushed into September for sure, so we'll see.
So the big question is everybody's been expecting cuts for so long and has been so wrong. Is there anything in the data that you look at that suggests maybe we're going to get right this time in terms of the Wall Street consensus as to when the timing of rate cuts might think.
Well, you just said it. Consensus has a funny way of maybe not actually materializing, right. So I think everybody's sort of locked in on this, on this path. Now it looks like just the way the curve is shaped and everything else. Well, we will see the data has come in, you know, it depends you can find you can find people who have raised growth concerns, but then you can also find the resiliency crowd. There's just a lot of I think, sort of mixed data right now.
But overall, you know, the economy seems to be holding in pretty well so far.
Pretty resilient. You know. One of the things I always look at are spreads, and they seem to be relatively low for all the people running around with their hair on fire, they are. What does that tell us of the state of the economy and the state of the fixed income markets.
Yeah, I think whether you're looking at investment grade spreads or high yield spreads right to spreads to treasuries, they're both pretty tight relative to historical, long term, historical averages. So yeah, the credit markets are telling you that so far they are buying the resiliency story. They think that, you know, balance sheets are still in pretty good shape.
I mean, you've heard the say anecdote before that when yields were low, corporations did do you know, very thoughtful issuance and they were able to lock in yields and really you know, shore up their balance sheets and have these strong cash flow profiles. Now, ultimately people will have to refinance, and you know that may be at higher yields. So we'll see how long that holds. But so far, spreads are telling you that the resiliency story is intact.
So corporate debt issuers refinanced that at lower rates, households did it. Everybody did it except Uncle Sam. We'll save that for another time. But if you're a buyer of debt, how should you be thinking about duration? When do you start extending your duration looking to lock in a little higher yield on the possibility that we see lower rates in the future.
This this is the debate capital thg right, So I think we've been very much in the camp of you know, the intermediate part of the curve is pretty attractive. So you know, if you're looking inside five to seven, three to seven, somewhere in that zip code, you know, whether it's in treasuries or or high grade or even even high yields in that area. Anyway, that's the maturity profile. But if you look at that versus say thirty years, I think that, you know, right now, a lot of
debate going on on the fiscal situation. Moody's actions sort of resurface that debate if you look at it term premium meaning and you know, again let's define terms. The amount that investors want for holding very long term bonds has gone up quite a lot over the last several months, and I think all of this is sort of playing into this idea that, yeah, longer term yields are flirting
with five percent, could they go higher? They might. There's a lot of ambiguity around what our fiscal trajectory is. Are we at risk for further deterioration? We are running deficits with a growing economy and that is, you know, and we're running larger ones than we historically have with a with a growing economy. So that's what's caused this fear of the long end. Now our longer term bonds to be avoided completely. I think there's healthy debate on that.
I do think that they still hold some shock absorber value depending on the situation. So, you know, we like we kind of frame this as being positioned, you know, overweight in sort of this belly of the curve because we think that's a sweet spot. It doesn't mean that you should have zero long term minds, you know, it could be having some might be a good sort of you know, insurance policy in a way.
So when when yield comes down, bond values go up and vice versa. If you're making a bet, what's the next two hundred basis points in yield? Is it more likely to go higher and more likely to go lower. It would take a pretty big screw up to send yields up two hundred basis points not a zero possibility, but is that kind of the core bet we're more likely to see move down then up.
I think the current view is that long term yields could edge higher on this edge higher, edge higher, like twenty five to fifty basis point that's been discussing because of this idea that depending okay, depending on how the tax and spending bills come out and how people score that, and what's that going to look like for the deficit, et cetera, et cetera. You know, the discussion could be could you see further pressure on the very very long end.
The intermediate part is probably okay. So the real debate is are we going to see more of a steepening depending on the outcome of the you know, tax and spending bills, et cetera, et cetera. That's been the debate. Now, if you get an unexpected slow down, you could see long term yields come down temporarily. And so to your point, you know, do you get two hundred basis points up
or do you get fifty to one hundred down. It all depends on you know, the unexpected by definition, If you get a sharp slow down, then nobody saw coming. You probably do see longer term yields coming down, and I think not a lot of people are expecting.
That at all, well except everybody for the past five years predicting recessions that never showed up. The other question that I always like to ask is, hey, what happens if we yields don't go appreciably higher or lower? Can we just be stuck in a four and a quarter to four and three quarter, you know, money market yields plus or minus around four and a half percent. What does that look like? Can we just stay in that range for three, four or five years?
Sure? Are you likely to? Probably not? History would tell us that except for you had this long period, that doesn't look really like anything that we wanted in the twenty tens, right totally. So unless we go back to the twenty tens, probably not. But I think you know my earlier point, it's gonna be really hard to call like this is the best yield that I want to get into. It's more about we're gonna have ups, we're
gonna have downs, we'll have cycles. It's really about building that portfolio out for the long term and getting income. So it's the first time in twenty odd years the income is back in fixed income. So that's pretty compelling.
So if someone's fixed then come investor or looking to add fixed income as a sort of shock absorber to their equity. Portfolios. What segments of the fixed income market do you find attractive? Where are the opportunities today?
We've been seeing flows mostly go into very high quality so that being treasuries, that being investment grade. That's where you know, the bulk of flows have been moving into. And again much of it has been in that sort of belly of the curve type of exposure. Now, mathematically, as a shock absorber, you're going to get your biggest kick from the very long end of the curve. We just talked about that, Right, You're taking some risk there.
So because if it goes the other way, it goes the.
Other way, it hurts. And so the debate's going to be, you know, will it play that role if you get a big slowdown, right, if you get a huge risk off, will you see long long term yields rally like they have in the past in light of some of the fiscal concerns. That's the big, big.
Defence the doll Yeah, that's the debate. And what about you know, we always have clients who are looking into their retirement. You know, I just want X dollars and not worry about taxes. Uh, if you're in a high tax state, how are you looking at the muni markets these days?
Yeah, and I think munis have have really you know, seen some whipsaw as well. Right, so a lot of folks now look look at muni's and see some opportunities there. Again, this discussion around tax policy has really really sort of caused a lot of volatility. At some point, you just have to really make an allocation decision. And if you're if you are, you know, in a high tax bracket, I mean, unis can be pretty compelling, and they've cheapened up a fair amount.
All right, so I only have you for a limited amount of time. Let's jump to my favorite questions that I ask all of my guests, starting with what's keeping you entertained these days? What are you watching or listening to?
H Well, so, the funny part about this is it's so masters in business, big fan and I we already talked about that.
But no, I also whenever someone says that, I always feel like Rodney Dangerfield and Pattie Shack, keep it fair, Keep it fair.
No right now, you know, streaming wise, my wife makes this joke. So she and and my my older sons, you know, will watch Yellowstone or something like that. I've always got my laptop.
Right.
It's so she's like, you don't really watch TV with us, You pretend to, But I think one of the fun things I'm watching, you know, friends and neighbors right now.
So interesting, it's fun. Are you are you caught up?
Not caught up?
Not caught up from so the what whatever? The last episode was five really fun twist no spoilers, no spoilers, absolutely, but yeah on it not unexpected, but the way they execute it was really well done.
All right, cool, that'll be some good bit. And I am still very fond of binge watching Law and Order. I will try purposely to hold out because I do like binge watching all of the above. Right, So, whether it's organized crime or what have you.
So my wife makes eight o'clock the screens go away, you can watch TV. You have to put that away. So that means right before I go to bed. Ye, last couple of minutes. Let me just try to impose that rule.
It kind of falls apart.
No, No, she's a strict, stern task master, she who must be obeyed. All right, So let's talk about you mentioned one of your mentors. Tell us about the folks who helped shape your career.
Yeah, and many of them are are folks who have moved on. But I think there are certain people that I remember, you know, who really gave good advice. And you know, I'll give you a couple of examples. I had a boss, one of my first ones out of business school, and he basically said, look, I viewed my job as teaching you. I want you to listen and learn, and then if you work hard, have you My other job is to help you create financial security for yourself
and your family. But you have to do those things in order for that to happen. So if you listen and you work hard, I'll try to keep up my side of it as well. And that always struck me and I thought that was a great way to put it. You know, he viewed his job as teaching but also if I did the right things to help me in the long term, and so I thought that was really interesting. Another mentor, you know, told me that you can be really good at what you do, but you really have
to get along with people. You really have to be able to know where somebody else is coming from. Work well with people, because you can be great at what you do, but if you're not pleasant to work with. It's not going to get you too far at all, And so I think that's that's another lesson. I mean, you know a lot of times you like to think you're right in a certain debate or whatever, but you really do have to learn to bridge those gaps or it doesn't even matter how good you are what you do.
Huh. Good, good advice for anyone listening. Let's talk about books. What are some of your favorites. What are you reading currently?
Well, reading How to Think Like a Monk.
I saw that Amazon was Yeah.
No, it's pretty cool. I had a friend of mine. I'm not sure why he recommended that book to me, and there might be a hidden message in there, but I think that's pretty cool. Read too much one of my you know, I I like history books, and so you know, I've read a lot of the ken Burns stuff. I think, in particular, the things I've been fascinated with the sixties I think really helped shape the world that we're living in this So I've been a junkie of a lot of that stuff and authors and books ken
the ken Burns stuff, all. Yeah, I really like that. So but but I'll watch any number of documentaries. I just think that really was a pivotal time for the country and the world, and it kind of has echoes and you know, really long shadows. So I always thought that was that was really interesting. I like a book that really kind of stuck with me over the years. It was about you know, I love math, statistics, all that stuff. It was a book called Against the Gods and it was the story.
Oh my god, so one of my favorite, one of the old time great finance books that most people absolutely one should be reading, no doubt about that. So I always pick out a handful of books to read over the summer. I'm so happy sitting on the beach, waves crashing in the background, banging through book after book. What just came a couple of days ago was Ron Churnow's Mark Twain. Oh wow, and you know Churnout, did Hamilton need a bunch of giant books. I'm super excited about that.
So I'll let you know if that's interesting. I can't imagine it's not, given both the author and the subject matter. All Right, our final two questions, what sort of advice would you give to a recent college grad interested in a career in either investing, or specifically fixed income and ETFs.
Yeah, I think the most important thing is you have to be honest with yourself about what you like to do. And so I I have met I've met students who say they want to get into the markets, and you know, when you ask why that is, they have trouble articulating why. So I think part of it is you just really got to want to do this, because if it's gonna be your life's pursuit, you've got to wake up on good days and bad days and still want to do
it right. And there are good days and there are very bad days, and you still have to have that same sort of love of it. And so if you don't love it right, if it's not if you're just saying, well, you know, I heard it's a profitable thing. I want to you know, I have these certain personal goals, that's
that's not a good reason to do it. But if you really do love the idea of markets and just this, you know, really elegant thing where somebody, you know, two people on the opposite sides of the planet can somehow find a common price. You know, what's the saying a trade is an agreement on price, A disagreement on value. I always thought that was the coolest thing, right, So you know, just this idea that you know the markets find a way. I think if you love that, then
it's the right career for you. But that's the key thing. Find what you love and be really really honest with yourself. And you know, it's fair to say I don't know yet, And that's why you have to feel around a little bit. You know, whether you're trying different things. You know, you may land on one desk and hate it, rotate to another one and love it. It's a process, but you got to really be honest with yourself.
Huh. Really really interesting. And our final question, what do you know about the world of fixed income ETFs and investing today? You wish you knew back in the nineteen nineties when you were first getting started.
Yeah, I'm gonna admit this to you. I know many of your your admonishments about investing, I was. I was an original sinner, many of them.
No one bigger than me. I learned the hard way.
So I did, in fact do a lot of the common mistakes. You know. I chase things. I remember, you know, during the original Internet boom buying some really expensive, racy mutual funds, which I subsequently rode into the ditch. So I think part of it is, you know, the long term idea, you know, really really taking like that long term view. Now, I did learn not to panic over the years, right and not, you know, sort.
Of useful skill set if you're running a trillion dollars.
I think, try to try to you know, keep your money, you know, don't pay away too much of fees, and definitely don't chase the hot hot thing. I think being diversified. You look, it may not be fun to talk about with your friends, but having a broad, diversified portfolio over time, you're gonna be fine. It's it's it's hair raising sometimes, but you're gonna be fine over the long term.
Yeah, very often the cocktail chatter, it's not what makes you money. I love the title of Ned Davis's first book, do you want to be right? Or do you want to make money? And that really sums it up well. Steve, this has been really fascinating. Thank you for being so generous with your time. We have been speaking with Steve Likely, Global cohead of BONDI tf's at black Rock. If you enjoy this conversation. Well, check out any of the five hundred and thirty we've done over the past eleven years.
You can find those at iTunes, Spotify, YouTube, Bloomberg, wherever you find your favorite podcasts, and be sure and check out my new book, How Not to Invest The ideas, numbers, and behaviors that destroy wealth and how to avoid them. I would be remiss if I did not thank the crack team that helps put these conversations together each week. John Wasserman is my audio engineer, and A. Luk is my producer. Shortan Russo is my researcher. Sage Bauman is
the head of podcasts at Bloomberg. I'm barr Utltz. You've been listening to Masters in Business on Bloomberg Radio.