Luis Maizel Discusses Diversity in Finance

basically do their own due diligence. They check out all of the various bonds that they buy on behalf of clients, uh, not relying on the traditional rating agencies, and um, they're essentially owned by their employees. It's a very interesting shop. And Louise does a wonderful job explaining why emerging market yet has really become an asset class and to itself, given how soft um actual yields are, and that half of the sovereign wealth debt these days, over nine trillion dollars,

is actually holding a negative yield. Uh, he thinks e M debt is going to be a not only a distinct asset class, but it's going to attract a lot of capital over the next decade, and he's very bullsh So with no further ado, here's my conversation with LM Capital Groups Louise Mazel. My special guest this week is Louise Maizel. He is the co founder and senior managing director at LM Capital Group, an emerging market fixed income shop managing over four point two billion dollars in assets.

The firm was founded in and is privately held. It is employee owned and provide It's a fixed income active management approach with a global macro overlay. Louise Mazel, Welcome to Bloomberg. Thank you very much. Berry, so you will launched this firm in nine nine. You're pretty much in the middle of a giant bullmarket. What made you decide to go into bonds instead of stocks? I started a second firm very actually, the first firm, Element Advisors, which

was managing money for high net worth individuals. Four July eighteenth eighty four, the US eliminates the thirty percent withholding. Up to then, foreign nationals could only invest tax free in T bills or in bank CDs. All of a sudden, they opened up the market. A lot of US brokers fly out to Mexico City and try to grab some of that money. And my friends started to call me saying, you're in the States. We know you quite don't you help us serve through these new way new market? So

we did. For five years we were managing high net worth individuals, but they were being managed like pensure plants because they were mostly taxed THEMPT And from there we jumped into the institutional market. So that was um But you bring a very different perspective to the management of assets. How did growing up outside of the United States shape your view of the world, be it developed or emerging markets? Think of it as planets. People in the US thing

that they're sitting in the sun. The US is the center of the universe. For US foreigners. We see the US as the biggest planet, but it's part of a system. So it's very interesting to see the impact of the US on the other planets. But it's not the center of the universe. It's just the biggest planet in the universe. And now we have China becoming another very large planet. How is that going to impact the way the US is perceived? I think the US is still by far

the most important country in the world. The Chinese, just because of the sheer size of population over four times bigger than the US, will be very big. But in the incompart capita they're still very small compared to the US, and the model of growth, which was export to the US makes them smaller. When you are gearing to become the big one, you're far away from it. Quite quite interesting.

So academic studies have shown that passive management of stocks has a tendency to outperform active over long periods of time. But the opposite seems to be true in the fixed income department. Active uh fixed income strategies outperformed passive. Why is that, Well, you have a choice on what bonds you buy. The bond market basically is like a landmine. If you don't step on your mind, you're gonna do okay, and the move along the yield curve will allow you

to react faster to what's happening in the economy. The passive in the index does not take into account the macro impact that's happening in the bond market. So how do you go about creating a macro overlay for fixed income investing? That has always been our approach. Verry we analyze. For us, money is a commodity. When it's scarce, it's expensive. When it's plentiful, it's cheap. So we analyze. We developed the matrix. You know, going from a qualitative process to

a quantitative way of processing. It's not easy. If you put three economies in the room, they're going to come out with four different theories, probably all of them wrong. So what we try to do is doing our macro analysis, studying the growth of the company, of the country's growing, understanding the inflation economic indicators. We assigned a value to

each of them. We created a matrix which gives us a point count and we call it the trendscore, which allows us then to go into the benchmark we're using, which the client is requesting us to use, and the trendscore will give us how long or short the benjamark do we want to be. So when you say trends, I tend to think of equity trends, where a market or a stock is trending either higher for a long period of time or trending lower for a long period

of time. Do you have the same meaning of the word trend in fixed income or does it have a slightly different. I think it's pretty similar. But what you're trying to understand is the current and future needs of money. If a country is growing very fast, you know there's going to be competition for money. If the deficity of the country is big, you know that the government is going to place bonds and it's gonna cipher now money

from the economy. If unemployment is very high, then you know that there's not gonna be a lot of need. There's not gonna be a brick and mortar investment, so money will be plentiful. In rates are going to come down. So there is a trend on what's happened in the past twelve months that will impact what will happen in

the next six or twelve. So when we look at the great bullmarket in bonds in the US from the days of Paul Vulker breaking the back of inflation in the late seventies early eighties, we've enjoyed a I don't know, let's call it thirty three thirty five year ballmarketing bonds. Is that still in an effect? And second, how does that ballmarket and bonds in the US affect the rest of the UH world? We were in a secular trend

or slower rates. There was an enormous addition of liquidity into the system, coming not only from these states, but from all central banks. The European Union was placing in enormous amount of money in the system, so was the Bank of Japan, so was China. A couple of years ago we saw a reversal in the trend. The announcement of the reverse of the easing, the quantitative easing, and the announcement by the fend that they were going to start raising rates created a mentality that we had hit

bottom and we were starting to trend upwards. But now we've seen that stopped. I think that the issue of an upcoming recession, I don't believe it's coming. It's a little bit like the wolf. You know, everybody keeps crying the wolf is coming. We are not accustomed to a long period without a recession. But ever since globalization started in the world, the whole theory change. The formula of the past is no longer appliable. So would you say um tales of the death of the bundble market have

been greatly exaggerated. I think that we're gonna stay with low interest rates, especially we have big deficits. If we have an easy faith, I think we can go on for several more years without a major increase in rates. Quite quite fascinating. Let's go back to you have this big set of tax changes. How much of a game changer was that for launching affixed income firm. Actually, the game changer for LM Capital was the growth of pension

plans wanting minority money managers. You know, the change in Maxine Waters was at that time already you know, pushing for it. She's still in the in the in Congress and she's still doing the same the changing loss game for the high networth individuals or foreigners, not for pension plans. But there was this big push for hiring my minority money managers. Actually, they were carving out small pieces from

the bigger locations, from the big rfpiece. The big funds always have been very biased towards using the pimp costs and one cost of the world. Sure black rocks, but there was an desire to use African American Asian Hispanic companies. So we saw an opportunity there being a Hispanic firm to pick up some of that money. So that's the way we started. Nowadays, it's emerging managers. It's no longer minority.

There was court case that stopped the use of minorities as discriminatory, and by now we're a little bit too big to be considered emerging, so we have to compete on performance. So well, that's that's not the worst thing in the world. So when you say ur fps by big institutions, your clients and potential clients are these giant funds. They put out a request for proposal and you respond with a proposal, and that's the basis of either winning the business or not. Is that a fair way to

describe it. That's correct. They will get probably thirty to four responses. They will pick up five or six finalists, and then you they visit you, and then they pick up three or four that present to the boards, and then the board decides who gets the money. So what are those beauty contests as they've been called. What are they like when when a firm comes in and starts kicking the tires and looking around your shop, what's that

experience like? It's an interesting experience because you have the numbers to show for performance, but they want to understand the process. They want to understand the people. They want to make sure you have the back office to support it. Compliance has become so important. The most interesting part for me has been that almost all the teams look identical. Three men, one woman, everybody six one weighs two hundred and three pounds, whereas Brooks brothers suits and in our

is where different. First, my accent doesn't well, it helps. I don't think it hinders anything, but I'm not the typical presenter that they normally have, and I tend to joke with the boards and try to be more casual. Probably when you are a smaller firm and your own the firm, you feel that you don't have to explain to anybody who you made it or you didn't make the cut, or did you win the business or not.

So I like to enjoy this competition. I like to I enjoy to to be fighting against the big boys and hopefully sometimes winning. So is that an advantage to be relaxed and casual and informal and joke around with these people who are used to much more formal stiff The group that you described sounds like they're all manufactured in the same factory, and maybe that factory is Wharton or Harvard Business School. But the fact that they all look so similar and so similarly, does this give you

a tactical advantage when you're presenting. I think that in many cases he does. In others, they expect to have that and they want that traditional present presenter. I'm also product of the same school, you know, part results. But so there, my partner in the business went to the to Annapolis. So you have the square American six one blah blah blah, and you have this crazy Mexican coming in and joking with the board. So I think the combination makes them laugh and it makes you. It makes

you different in their eyes, and they remember you more memorable. Right. So I have a friend who's at PIMCO, and uh, he always he's now retired, but he used to complain that he doesn't have time to um, to do anything, or go to conferences or what have you, because they're so busy managing a trillion dollars in fixed income. And I used to bust his chops by saying, yeah, but it's not stocks, it's bond that's that stuff practically manages itself, which is a joke in the middle of a giant

bonds bull market. But the little tiny bit of truth in that is how how much was it like shooting fish in a barrel during the fat part of that bull market you had rates coming down from what down to practically zero? How challenging was it operating during that giant long term trend. There are two problems managing fixed inco. One is making sure you don't step on the mind. As I said before, that you don't buy a world Come bond or an end run bond or a Pacific

as an electric bond. On the other side, you have the matter of liquid it the incise. It's not easy to be a pimcoke when you have When you decide to move and you have to sell five million or a billion dollars worth of a bond, you have to find another piece, another buyer on the other side. It takes two to tango, and for them to find the counterparty is very hard. For a firmlike Hours that you move with ten or twenty million dollars, you can always

find the other side in a transaction. And after the crisis in oh nine, they allocated much less capital to the desks, so they don't have inventory. So when you want to do a transaction, you have to go out and beat it in the market, and it's very hard to find a big chunk of of the same product. If you want to be have commonality in your portfolios, if you if you're a buyer, what about if you're

a seller. Story Like, my assumption is if I have a ton of bonds to sell, I pick up the phone like called black rock, and they buy whatever whatever is out there. They will not. The thing is, they don't want to allocate money to bonds, they don't want to park money in bonds, so they will only do the transaction if they want them at that precise moment, and the broker dealers will only do them if they

find the buyer immediately. If not, they'll just tell you there is no market for your bonds right now, and I will keep you in mind, and that might take three days or three weeks. So there's a little bit of an illusion of liquidity in bonds when it's actually harder to sell them than we tend to think. If I go to sell a stock, there's a bid and an ask. I can see the spread I know other than giant size. I can move pretty much any stock

in my portfolio. But if I have a very specific bond from a specific whether it's a corporate or a sovereign or a state and local bonds. You're saying it's not quite as easy to to hit that bid as it is with a stock. You're absolutely clear, right, I mean, that's why there are no time in sales in bonds. You'll never see in stocks. You can say, I put in my order the eleven fourteen in the morning, give me all the transactions between eleven fourteen and eleven fifteen,

and your order has to be there. No time stamping. No time stamping bonds. You know it might be three days or three minutes later when the transaction is done, and you want to have basically the same price if you're selling or buying for different clients, so you cannot buy little pieces and added up because it becomes very complicated to allocate in the right way the different transactions. Quite quite interesting. So let's talk a little bit about

that lack of liquidly. I'm I'm intrigued by your description of the bond market. Um, is this something that's relatively new? Was there always this much lack of liquidly? How as the market changed over the past thirty years since you launched LM Capital. I think that up to two thousand and nine, the market was pretty stable and there was enough money in the different broker dealers to make a market.

You know, they would buy the bond to keep it there and wait for somebody to come up, meaning meaning holding an inventory, and then when a buyer comes along, they would now so much anymore, it's gone gone, you know, probably went from Mary Lynch went from eight or ten billion dollars to maybe a couple of hundred million. Is that a risk management tool or they still suffering a little post traumatic stress disorder after the crisis. Is this is this smart of them or is this problematic by them?

I think that they're being smarter and the way they allocate their capital. I think that the spreads in bonds are not that high for them to make sense to keep them in inventory and being much tighter with the way they handle their money. Very very interesting. What about the rise of e t f s, which are clearly not just stocks, they're giant bondy tfs. How is that affecting both the way you run LM capital and and the way liquidity for specific bonds behaves in the in

the market. I think the tfs are not the right way to play the bond market. I think that they are very big, but I don't think they impact the market that much. The problem is when it becomes a herd mentality. If everybody is selling, you magnify the problem. Again. When there's a trend to get out of the bonds you need, you don't find the buyers. When there's a trend to buy the bonds, it's hard to find these sellers. So the e t fs magnify the problem instead of

making it less problematic. So I have a couple of questions on that. That's really really intriguing. So first, when there's that herd mentality like we saw in O eight oh nine, isn't everything being sold regardless when when, when, when the herd stampedes, everything seems to get run over. Is that any different for bond stocks or ETF No, it works the same way, but you don't have the dramatic cratches they do. So in stokes, the bargain hunters are probably not going to jump in because the bond

dropped two or three points. Two or three points is huge in bonds. In stocks, you can see moves of ten or twenty two or three points is a Tuesday. Nothing's exactly. Here's the question that pops into my head. Knowing that there's no guarantee of liquidly in the future, how does that affect your process for selecting what bonds you want to put into your portfolio. You you obviously have an awareness, Hey, when the time comes, there may not be the liquidly I'm hoping for if I have

to move these in a emergency. That's a very good question. Very What we tried to do is buy global issues, very big issues that a lot of people holding their portfolios. You know, at one time you would find a good issue of a hundred a couple of hundred million dollars. We go for the billion dollar issues at least, and we want the names that people want to hold in

their portfolio. There are some managers that try to create alpha from buying smaller issues because the issue is forced to pay a bit more because of the smaller sizes of the issue. We don't like that. We want to have the ability to get out whenever we want. So the liquidly premium isn't worth the risk to you. It's not quite quite interesting. So I've had this little personal theory for the past couple of years that part of the reason yields or as low as they are, is

that there's a shortage of quality sovereign bonds. We haven't been running the usual and old deficits over the past ten years, although clearly they've started to tick up post crisis and and most recently, And that there's so much capital around and such a demand for quality fixed income that it gets hoovered up by all the buyers and that helps to keep a lid on on rates. And am I remotely accurate or is that crackpot theory? You are accurate even though deficits have not been shrinking on

the country that have been growing bigger. Over half of the sovereign bonds now have negative yields. Nine point seven trillion dollars, mostly European bonds are negative, and we see Japan frequently dips into So by negative yield you mean here, I'm going to give you a pile of money, and you're gonna give me most of it back, but not all of it, because the yield is actually I'm gonna I'm gonna pay you to hold my money, which makes

no sense. At one time, many years ago, the only country that had This was Switzerland that showed that they wanted to sell the concept of safety, and they said, this is like a vault. Money that comes in here is totally protected, So I'm going to charge you for the use of my vault. Nowadays, it's Germany, it's Japan, it's Northern Europe. It's nine point seven trillion dollars. So the only play there if you're an investor, is hoping

that the currency. Because you're investing in the local currency, it's mostly euros or yends. Your hope is that the euro gains against the dollar, or the end gains against the dollar. But there are much better ways to play currencies than to buy bonds. You know, to invest a million dollars in bonds hoping for an increase in the value of the currency. You can do a fraction of that investment and do futures and you're in the same game,

so with far less risk. Absolutely. Another interesting situation is the l d I, the long duration management of pension plans. They are buying bonds with the maturity that matches their liabilities, but with bonds that are not growing in value, it's incredibly expensive to match. I mean, because they're not growing so you're going to pay a million dollars a year thirty years from now, or a million euros. You have to buy a million thirty thousand euros in order to

have a million back. So it's very hard to manage money against with l d I when you have negative deals. Quite quite fascinating. So your firm uses something called scenario planning to mitigate against global event risk. Explain what that is and how can you actually reduce risk about events overseas. We think of all the weird things that could happen, very all the weird things that could happen. I mean, we have a scenario hopefully well it will never happen.

But for another we have a scenario for the bankruptcy of a money center bank. We have a scenario for oil going down to twenty or over a hundred. We have a scenario of North Korea throwing the bomb, and we tried to play through what our reaction would be to that event, so we're not caught by surprise if

God forbid they happen. So we know that if X or Y happens, we're gonna be selling or buying the bonds or whether we're going to be shortening or lengthening our duration, and we replay scenarios almost I mean formally once a quarter. Informally it can be any you're driving in and you hearing news in the radio and you say, well, that might cause a change in the environment. What would we do? So we go into the conference room, everybody participates, we use the blackboard, and we try to develop a

response to the event. Mhm. So so you mentioned, um that that's really quite interesting. So so you mentioned the nine plus trillion dollars in negative yielding sovereign debt. Given those liabilities that pension funds and really just retirement accounts are going to have, where can people go to find yields without adding leverage or adding a whole lot of risk to their portfolios. That is something that's keeping a

lot of people awake at night. Pension plans have if you do share responsibility, that grows at about eight percent per year, and they're not getting those learns from their portfolios. They need to have fixed income. It's like the retaining world in the portfolio and the source of liquidity if needed. But if that fixed income is yielding, say they have in fixed income, if the yield there is two or

two and a half percent. The other eighty would have to generate in order to make up for whether they're not making in fixed income. So they're going more and more to private equity, to venture capital areas that are definitely much riskier. And we can see what happened in No. Nine that the dropping value of individual accounts or pension plants was dramatic. They're looking for alternatives in fixed income, for example, bank loans, which in reality is just high yield.

With the floating rate, they're doing more and more high yield and moving down in the rating two towards disease, which again is very dangerous. Or an USA class that has become much more interesting, which is emerging market debt. At one time, these sovereign bonds in the emerging countries, countries like Mexico, Colombia, Brazil, China, South Korea, we're paying three to four hundred basis more than comparable risks in

the US. It has come down a lot, but you can still find very very good corporate names in the emerging world, both in local currency and daughter they nominated.

They can give you a very sizeable pickup and allow your fixed income portfolio to be closer to your needs in terms of growth than what you get out from the traditional US based core fixed So if I'm a US investor and I'm not happy with two and a half percent yield on traditional treasuries, how much additional risk am I assuming going to either emerging market bonds on a sovereign basis or e M bonds on a corporate basis to pick up another two D basis points? Is

that a fair amount? At least? To be honest, if you ask me, I don't think you're picking any additional risk. I think that if you buy a company that's solid investment grade in their own country and that generates let's say you bought daughter the nominated bonds and they generate the dollars to pay you back, both interesting principle, so they don't have to buy them in a tough time when their currency could have the valued You are taking no additional risk. Let me give an example. Bimbo, the

Mexican bread company. Almost sixty of their sales are abroad. You know, they're the largest producer in fourteen countries and they're present in about fifty five countries where they sell bread. It's a staple, it's a company that's been in the market for a hundred years. They are double A plus in Mexico. Their paper is yielding almost five that if I took away the name and showed you the financials, you would say this is a double A company in the US, and it would be paying maybe three ten,

three twenty. So you're picking up two hundred plus over against a credit paper in the US and almost three hundred over against a US equivalent from a Treasury bond. So you really are gaining a lot in a company that basically has no risk. So how much of this is just the home country bias? If you live in the US, you tend to buy US stocks and bonds, If you live in Germany you tend to buy German stocks and bonds, and the same as true in Australia

or wherever. How significant is that to that gap between domestic and emerging market yields? That pride of national product it used to be very prevalent, it's no longer there. The markets have become so global that buyers in Singapore or Berlin or New York are are buying from everywhere. So so what accounts for that two hundred and fifty

basis point difference in yields. It's the perception of things that happened in the late nineties and the beginning of the two thousand's, where one country got in trouble and all the other countries got in trouble. It has to have more work done to understand what you're buying in the US. And even the credibility of the rating agencies in the US has dropped a lot after all. Nine But here you see an A rated bond and you don't get too much into analyzing whether they will pay

you back or not. You believe if standard important movies said it's good to take it for granted, well I'm I'm assuming or I'm saying that you don't put a lot of stock. And with the credit rating agencies say you guys do your own due diligence and all these absolutely, and remember that emerging just taken back into crediting emerging countries. Eight of the companies are still run by the founding family. They took them public in order to create liquidity and

the state for state purposes. Go back a second. I want to make sure I caught that statistic right. In Emerging market nations eighty percent of the um businesses or of the publicly traded businesses. The publicly traded businesses are still run by the founding family. That's amazing, it's incredible. There was a radio company that went public here in the NYC and governance, I mean the eleven board members last name was usually it was all brothers, nephews and nieces.

And the New York Stock Seans did not like it. They said, you know, this is not good e s g Y S is horrible governance when the whole families in the board does not work. But that's pretty typical you're saying it is. So what you have to understand besides the financials is who those families are. So you

need to do social analysis. You have to understand whether you're funding a new plant or you're funding a new G five that the that the chair, you know, if a new girls stream versus a new exact making plants. You want to understand that they're investing your money into something that will be productive and create more wealth for the shareholders or the bond holders. And that's something that will bring more satisfaction to the founding family. That that

is that is really um fascinating. I had no idea. I'm learning a lot today. So I think people have changed the way they view and and think about debt over the past thirty years. Um, how do you see that? Well, first of all, do you do you agree? Do you see the perception of debt having changed in society? And

how does that affect building a bond portfolio. At some time, dead was seen as a bad thing, and now some of that's a little bit of a holdover from the Great Depression generation who never wanted to risk having a bank call something away from them. Exactly having debt meant that you were at risk. Nowadays debt makes sense for corporations. They don't delude their shareholders. Their EPs are higher and management is basically paid by the Their bonuses are based

on the value of their stock. So if you can borrow cheaply and buy back stock or do things without selling more equity, the performance of your equity will probably be better. So it's become a tool of growth without delusion. And I so once the CFO of Mark being interviewed, and he said they asked him why did he borrow two billion dollars when he had in cash almost eleven billion, And he said, you know, at two thirty for three year paper, I couldn't and being a taxi doctor, I

could not sleep if I didn't take out that money. So, in other words, the way the tax laws are set up around debt versus equity, corporate management is incentivized to borrow versus using exactly, I mean it makes a lot of sense to borrow in them. Buy backstock dividends are not tax deductible. Companies were borrowing or are borrowing below when they're paying dividends, so if they retire that stock, then they're making money in the spread that That is

quite fascinating. Can you still around a little bit? I have some more questions for you. We have been speaking with Louise Mazel of LM Capital Group. If you enjoy this conversation, well be sure and come back for the podcast extras, where we keep the tape rolling and continue discussing all things fixed income and emerging market related. You can find that wherever Finder podcasts are sold, Apple, iTunes,

Bloomberg dot Com, Stitcher, Overcast, et cetera. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. You can follow my daily column at Bloomberg dot com slash Opinion, or check me out on Twitter at rit Holts. I'm Barry Ridlts. You're listening to Masters and Business on Bloomberg Radio. Welcome to the podcast, Louise, Thank you so much for doing this. This is really an interesting conversation. I sometimes will chat with people, Um,

who do you have on the show this week? Oh, I have Louise Mozelle. He's a you know, emerging market bond manager, and I'll get that yawn back from them, and it's like, well, tell me when you have somebody interesting on. But this is really fascinating stuff. There is so much more to emerging market bond analysis than I think the average UM stock jockey really appreciates. UM, and you you are expressing it in a way that I

find intriguing. Um. There are a few questions I did not get to during the broadcast portion that I have to run through. Let me let me run through those before we get to our favorite questions. UM. I've heard over the years that bond investors are the smart money, that's where the bond vigilantes come from. Why is that? Why is bond investing considered quote unquote the smart money. I would not say smart money. It's the safe money.

It should be the save money. Nowadays, with leverage and with what's happening in the markets, you need to have a portion of your portfolio ready for events that might alter the value of the whole portfolio. I mean you have situations like the unicorns that the more money they lose, the more valuable they are. That's literally true. There was a column in Bloomberg that of all the past eighteen months of I p o s, the worst the financials were the better the first day I p O Pop was.

What you need to see is that bonds, bonds have much more meat in them. It's less hope and it's more reality. So when you say smart money, it means people have to analyze that you are lending to somebody that will pay you back. I mean, let's take Lift for for example. We don't know what's gonna happen with

Lift five years from now. I would not buy a bond from leaft a five year paper because as I didn't buy a test LA bond, you know, if I buy a test last talk, I'm betting the electric cars or self driving cars are going to do very well. Their bonds did very poorly. You know, they came out a part. They're not trading at eighty eight cents on the dollar. So it's a situation where leverage is dangerous when you're not making any money. Bond analysis requires much

more substance than stock and alliss. So what about m risk mitigation? What sort of tools do you use to to control the risk you have? Well, we stress the portfolio based on if rates move up a hundred peers two hundred peers. We do it in either direction. We try not to concentrate in one industry. We personally impose some restrictions to our portfolio. We don't do casualty insurance

for example. Why not. We don't want to read about the tsunami and all of a sudden it turned out that the bonds of the company we hold, we're insuring every single house that was destroyed by the tsunami. So that's pretty much just a straightforward geographical diversification approach. We don't do newly deregulated industries that saved us from and run from World com We never did the airlines, for example. Newly deregulated industries are a higher risk bond than as

widely perceived management. Let me give you an example. Pacific Gas and Electric, or that the Pacific companies. They were running a utility, they were selling power, and all of a sudden they were deregulated. They went out and bought

the thrifty chain of drug stores. Wait, so when when was PGN and California Utilities deregulated in the nineties and the found out that selling crests toothpaste was not the same as selling power to Two years later they sold the company at a loss of one and a half billion dollars and they had their bonds downgraded because of it. If a manager was running an airline and he had specific routes, he could not move from them. All of a sudden he's competing with Joe and his brother who

both three planes and are doing the small cities. It became very dangerous to compete in that market. We saw every major airline go through bankruptcy. Communications you had the Big I mean Big Mabel. You knew the Big Mobil was the safest company in the world. Stuff. So when when they broke them up, you know, they ended up. I mean the world comes came up in the world and the Worlcome ended up going broke, So that's another

one of the areas we don't do. And the third one is nuclear power, and it's not for environmental reasons. It's if some idiot forgot to close about the plant might end up in a different state, so whoops, the Washington State utility had a major problem with a nuclear plant. Three my Leland is another example. We don't want to take the risk of an error creating a situation where

our bonds would dramatically change in races. So if I were to go around the country and look at the utilities that have nuclear power plants on their books, their bonds are going to be trading at a at a discount to what non nuclear utilities or is this just specifically specific to l M. Does anybody else do that? I don't know, But for us that risk mitigation is very important, and then we overlay our scenario planning so we try to avoid anything that we have to get

out very quickly if something happened. I don't think you're paid enough to take a little bit of an additional risk. If you were paying me another three d beeps, I mean three more in interest to taking to take additional risk, I would consider it. If you pay me five beeps point oh five of a percent more, it's not worth it. Not worth it. So so you had mentioned the rating agencies. Clearly they did a terrible job during the financial crisis.

We later learned that their whole business model had shifted from the bond buyers paying their fees to the issuers paying their fees, and it became a payola, pay for play sort of situation. And if I walk into one of them, if I walk into SMP and they don't give me the double A rating I want, I'll just say no thanks, and I'll go across the street to Moody's and I will be able to purchase whatever rating

I I want. So given that, do you put any consideration and to what the rating agencies do, either either whether they cover a bond or a country or an industry, or a specific upgrade or downgrade. How how important is that? Well, we do follow them, we do read what they print, and we do take into account their rating because they have good analysis. After on nine, they've strengthened their their analysis.

I think that in the case of the mortgages, they just did not understand the product so it was not only the paid to play, but it was also a lack of understanding how the different trenches would behave in a crisis. But first of all, the change in rating is not that impactful anymore. Now. When you went from a triple B to a triple B minus, the bond at one time would drop three points. Now it might

drop a quarter of a point. How much of that is due to the fact that they did such a terrible job when they were needed in the last last crisis.

It does impact what's happening, but the perception of whether you cover your needs three point two times or three times or two point nine does not make that big a difference, even in the case of I mean and now, triple beasts are the vast majority of bonds, you know, their borderline between investment grade and high yield or low investment grade, that's the nicest way of saying junk, you know,

But they're still considered an investment grade. They're investable for anyone who's um charter or portfolio policy statement says only investment grade exactly. But most pension plans, for example, today, have a bunch of non investment grade bonds in their books. At one time, you would think that that change would eliminate basically who could by those bonds. And ever since Michael Milken in the eighties the he created an industry for non investment grade bonds. I mean, he did not

invent the hi yield bonds. He just invented who could buy them. He went to the thrifties, thrifts, he went to the savings and loans, he went to the insurance companies, and then the patient plan said, well, let's make that also an asset class in which we can invest. So so let's talk about those pension funds for a moment.

You mentioned during the broadcast portion that their allocation has been gearing more towards alternatives like venture capital and private equity and hedge funds because they're looking for a higher total expected return, which they're not just they apparently you're not getting from stocks and bonds, but they also haven't been getting them from the alternatives they've been They're expensive. I like to jokingly say, come, come for the high fees,

stay for the under performance. But in all seriousness, they have built out ten thirty sometimes even of their total portfolios with these alternatives, and they've slapped a very high expected return six eight, ten on these. Why is that? How can they just say, even though we have decades of data showing that these are not going to get eight percent, we're still going to put an expected return of eight percent on this. What? What does that due

to the allocations? They were getting those results years ago in the eighties and nineties because there wasn't that much competition. There's been so much money that has gone into alternatives that now they're competing for deals and the yields are are lower. It's just that's just market efficiency, isn't it. You can't you can't have these big fat margins without attracting other people to say I'd like a little bit

of that. I tend to joke saying that hope is not a strategy, and a lot of the buying of private equity adventure is hoping that in the future that will be worth much more. If you own stocks or your own bonds, the value is there every day you know, you run a statement, you check what the value of your stocks are. You can find out the value of

your portfolio every day. If you have private equity, you have no clue how much is it worth when it goes public when there's a liquidity event, then it's when you know what happens. But it might take five or ten years, and you never know the real value of your investment. And you can always put any increased value you want and it will show us though you're doing well, and you might or might not get that value that

you put it down in your state. So the non publicly traded assets give people the ability to mark, to not mark the market, but mark two what hopes and dreams is that what you suggest that it's not that bad. But the answer is yes, you know, it's we used to call it mark to make believe in the middle of the crisis, but it's not. You know, we're not suggesting that. You're saying it gives them a little bit of accounting flexibility, exactly. I think that things are worth

what the buyer is willing to pay. I mean, I think that if you ask them people who their house is worth, you're going to get tent responses that are higher than the actual market. But that's an emotional bias that that makes some sense. It makes It's the same as when they're valuing companies. Endowment effect is is certainly present.

You know, you want to believe that everybody is going to see the same that you are seeing, and the buyer, even if they perceive that the value is the same as you do, they're going to fight to get a They still want a discount of absolutely. You know, nobody likes to pay retail sure, So you are really thinking hoping that you're going to get the values you're putting down in this statement, and that does not necessarily going to happen. Sometimes you're going to be very pleasantly surprised,

but most of the time you won't. So I used to joke with a friend who is at a pension funds about what I perceived as their absurd expected returns on their alternatives, and the response was, we need seven or eight percent. So I used to say, well, let's assume you get two and a half percent from your bond portfolio and you get five percent from your equities, and I'm up, there's your seven a half percent. And it took him a moment to realize, well, that's not

how you do a blended portfolio. But it's every bit as ridiculous as expecting ten percent from asset classes that haven't returned. That sort of number for twenty or thirty years. You're right, but you always kicking the can a little bit further away. So probably by the time the pension plan runs out of money, you will not be there, right, So I mean that you say that half jokingly, but

we know that's true. Governments, state and local governments have done that with their police pension funds and their fire pension funds and their teacher funds that by the time it's really problematic, the politicians responsible for that they're long out of office. That someone else's headache. How can we realign the incentives so that we're not just kicking the can down the road or is that just human nature? And this is what's going to happen. Look at the

state of Illinois. They have excellent managers managing the money at the pension plans, and they're underfunded by I mean, they probably are funded for thirty five it's politicians that have not wanted to raise the contributions that are trying to be re elected, so they don't pressure the public workers to give more of their salary to their pension plan. And you know, it's now a huge problem because they're

running out of money. So there are certain states that have high taxes and big state spending, but seem to have their budgets and their pension plans more under control. California comes to mind, New York comes to mind. Amongst the states a little better or or a lot better. Clearly Chicago and Illinois have problems. I hear about problems in New Jersey and Connecticut both have pension issues. How significant is this going to be for funding UM in

the next twenty to thirty years. It's a huge problem, huge huge Look at Detroit. Detroit had to file for bankruptcy because of the pension place. So now what happens. So now, if you're a company and you file for bankruptcy, judges have a tendency. Courts have a tendency to say, before you even get to the creditors, employee compensation, salary and pensions is sacrosanct. We don't touch that. What happened in Detroit with the the employee pensions post bankruptcy, some

of it were cut down. Cities can go bankrupt, states cannot by law, right, But you know, they got to the point where they were about to sell the paintings from the museum in Detroit in order to pay pension plans. The city is being revitalized, and they hope that eventually they're gonna pull out, But again I hope. To me, hope is not a strategy. Right, So, we know that post hurricane, Puerto Rico has had or let's let's phrase

that a little differently. Post hurricane, it was revealed the precarious state of Puerto Rico's finances, sort of like Greece to the EU, Puerto Rico managed to borrow it rates that were more suitable for the US than for Puerto Rico. They're not a state, they're not a city, They're they're a territory. What happens with that situation? Are they going to be able to get a refinancing? Is bankruptcy even

an option for a non state, non city territory. Well, first they can go to bankruptcy with the state owned enterprises, but Puerto Rico had a big problem even before the hurricane, and you know, the electric company had been in trouble paying back even before the hurricane. So they are still fighting it. They're still fighting with bond holders and the pain. The public workers are crossing their fingers that their pension will be there when they need. They were suffering a

brain drain before the hurricane. Because if you're in Puerto Rico and you're making X, and you could just take a plane to Florida or Texas or wherever you want to go, because you're a US citizen, you could get a job with that skill and make one and half or two X. They seem to have lost a lot of really talented people. They have, even though they created a lot of incentives for people to go leave in Puerto Rica. Very low taxes, very low taxes. The first

year you pay I think three percent income taxes. That's not too shabby. A lot of big big money managers. That's federal income tax, not state. So instead of a top rate of thirty seven, your top rate is three. Yeah. H fund managers have moved to Puerto Rico. Weather is not too bad. It's not too bad. Good beaches. Huh. So I only have you for a limited amount of time. Let me get to some of my favorite questions I

asked all of my guests. It adds a little bit of a sort of cinema verity when I move off Mike and people can tell that I'm doing that. I kind of like that especially at the end, not during the broadcast portion. Um, but let's jump to these questions. We'll call this our speed round. So what was the first car you ever owned? Year make and model six dog Dart dodged. They were My sister had one of those. It was a sixty six or sixty seven. Those cars

could not be killed. They were three thousand mile cars from the sixties. I wish it had been my sisters in that mind. So you had a problem with it. I did not like it, but because when my father gave me it wasn't the prettiest car, but they were kind of indestructible for that they were, Um tell us the most important thing that your friends and family don't know about you. I love red wine. That's my passion,

and I'm a collector. Very interesting. Who were some of your early mentors who helped shape your view of the fixed income markets and investing? A Nobel Prize winner professor at Harvard before I really got to know him, Bill Gross, before you got to know him, not after, not after, And I would say that the mentor was my father, not in terms of investing, but in terms of values. Hard work is the only thing that makes you do well makes it makes a lot of sense. Um, tell

us about your favorite books. What are you reading? What, what do you recommend other people read? Fiction, nonfiction, investing related whatever. In fiction, I love the Mill Nelson, The Mill, I love the series by ken fall It. And in nonfiction I'm reading now a great book of the woman that ran the Spye Network for the French in the Second World War, Madame for God, And I love Harari's the Israeli guy that's part historian, part philosopher. The one

Questions for the twenty one Centuries an amazing book. Really. I read same guy who wrote Sapiens Schapions, and then Homo which was a little darker than say, and now The Questions in Tours a great book. I'm gonna I'm gonna put that one on my list. The the ken Fileted series, He's had a number of different series, which one you were find both the Piers of the Earth they went about the building of the Cathedral, and then the one that takes him through the Three Wars. I mean,

his writing is amazing. I love historic novels. That's really quite interesting. Tell us about a time you failed and what you learned from the experience When I was living in Mexico. I found the smoking withdrawal system from water Peak, so I flew to Fort Collins and negotiated with them. The representation in Mexico brought it to Mexico, and then found out that Mexicans did not want to stop smoking, so it was not a good business. I just thought that I could carry over what was happening in the

US new Mexico. And you have to understand local mentality and local desires. Is that still true or Mexicans still big tobacco smokers relative to what it was like thirty years ago. It's lower, but it's much bigger than in the U. S. I mean it's fallen. I grew up in a I've never been a smoker. My parents were smokers. They eventually stopped. But in the United States it's fallen off a cliff like it's like it's almost noteworthy when you see someone in the street with a cigarette. I'm

not even talking about vaping an actual tobacco cigarette. It's almost like, you know, a rarity. It's like spotting a wild unicorn. In Mexico, you cannot open your restaurant without it. Darris for smokers, but they're not allowed to smoke in the restaurant proper. That's a smaller part of the restaurant. That's that's amazing. Um. What do you do for fun? You mentioned red wine? What else do you do to stay busy out of the office, traveling, reading, watching sports

on TV, and playing some golf? What what sports do you watch? I watch basketball and I watch golf, and my wife says I would watch Jackson if they show the tournament. Um, what has you most excited about the bond market these days? What? What are you enthusiastic about. I love the idea that emerging market that has become an asset class, and almost everybody is not pursuing it. We've been at it for thirty years and I think

one of the stronger firms in the country. On So, if a young college grad or millennial came up to you and said they were interested in a career in fixed income, what sort of advice would you give them? Try to go beyond what you're reading the in the financials. I mean, reading financials is one thing. Understanding what the company does or who runs it is probably more important

than anything. And our final question, what do you know about the world of bond investing today that you wish you knew thirty years ago when you first launched the firm, that the trend torch lower rates was gonna last thirty years. I would have made a ton of money. I would have bought only thirty year paper. It wasn't obvious back then that this was the start of a three decade

long bullmarket. No, we were coming out, I mean from the Jimmy Carter days with big inflation and globalization had not taken over yet, so boom and bust was still part of the story of the economy in the US. The economy in the US has changed so much, you know, it's no longer that globalization. If there's a crisis, all you do is called your supplier and say in China or in Mexico, and you tell them those ship the next six months. You don't have to shut down the plant. Huh.

Quite quite interesting. We have been speaking to Louise Mazelle of LM Capital Group. If you enjoy this conversation, well, be sure to look Up an Inch or down an Inch on Apple iTunes or wherever you have access to this podcast, and you could check out any of the other two hundred and fifty podcasts we have broadcast over the past five years. We love your comments, feedback and SIGG questions right to us at m IB podcast at

Bloomberg dot net. I would be remiss if I did not thank the Crack staff who helps put these conversations together each week. My producer slash audio engineer is Medina Parwanna. Taylor Riggs and Michael Boyle are our bookers. Attica val Brunn is our project manager. Michael Batnick is our head of research. I'm Barry Results. You've been listening to Masters in Business on Bloomberg Radio