What It's Like to Suddenly Become a Bond Manager in the Credit Crisis

for a brief period for portfolio management company. But no, I would say that between the two of us, we do not have a lot of collective experience actually in the market. Right, So have you ever wanted to have an in depth discussion with someone who actually makes investment decisions on daily basis? Yes, this is all I mean, to be honest, is all I want to do every day. You know, there's so many people who just talk and talk and pundits and strategists and people who tweet too much,

and it's like, forget all the noise. Let's just talk to someone who you know, actually has to put money to work. I mean, that's what people really want to hear, right, right, And of course it's one thing for us to kind of sit back and say, markets look frothy and this

is all there's signs of irrational exuberance. But if you're someone whose job is to actually put money to work, you have to find something to invest in, right exactly, or I mean, or theoretically you could sit out the market, but then you're going to be judged on that question too. But you definitely can't get away with just saying boring stuff like the markets are looking frothy and all of the boring stuff people say all the time. But anyway, why why are you uh, what are you getting at?

Are we going to have such a conversation like that today and we're gonna have a good conversation, Yeah, we are actually so. Today for our guest, we have um one of my favorite investment managers. Actually, it's David Shawl. He's a portfolio manager over It and River Investment. You've had him on your show a couple of times. He's a prolific tweeter actually, but he is also someone who makes money do things on a day to day basis. So unlike our conversations, we're not talking to a poker player,

We're not talking to a gambler. Were actually going to talk to someone who invests a real life credit portfolio manager. That's who we're talking to. Awesome, Well he's in studio right now. Hey David, Hey guys, thanks for having me on. Shall we start with well, why don't we back up a bit? Why don't you tell us what exactly you do and what kind of portfolios you manage? Sure? So I started a New River about two years ago and right now I manage an Opportunities again to Come strategy.

And pretty much what that does is it focuses on fixed income or fixed income like securities in the publicly traded space. So these are instruments such as mortgage reads, reads closed, and funds that have underlying bonds in them, preferred stocks, business development companies, and it's kind of a niche area of the market where a few players play. It's very liquid um and it's a little bit of

the wild West in the market, you know. Versus before, I want to ask you a question that backs up even further than that, because the idea of having a job where you can take money and buy stuff and sell stuff seems pretty appealing, but how do you even get there? So, how did you get to this role in life where you work for New River? Investments, and you have this money to invest, what's the what's the path to get there? Sure? So that's a great question.

So I started at a bank, Denovo bank called Square one Financial in early too. I was an eight and I started as a credit analyst. And Square one was a commercial bank, but they catered to the venture capital community. So a company would raise ten million dollars of the Series A and they might raise a little bit of debt to bridge them to the next equity round, and we'd make the clients keep all their deposits at the bank, and pretty much I was underwriting these these clients, so

it might be a formula line of credit. And so it was early two eight and the bank at the time had an outsource investment manager who had loaded them up to the gills in subprime bonds. And the CEO came to me and he said, hey, David, I heard you worked on Wall Street. And so I just moved back from New York. I was in equity research, so I wasn't in fixed them come at all, and he said, hey, I heard you work on Wall Street. We need your help.

I said, sure, with what? And he said, We've got a whole portfolio of subpreme bonds that are going bad and we don't know what to do, so we need your help. I said, that sounds really interesting, but I don't know if fix in come at all. And I said, you know, I've done the c f A program and that's kind of all theory and no practice. And he's like, doesn't matter. We need you to come over here. So

I went over there. It was, you know, early two thousand eight, and we had probably a portfolio five million of bonds that were going bad. And I remember looking at one of the mark to market reports and I think it was a negative million mark to market and the bank only had equity of twenties. So we were well and solving on paper, and um, they fired the investment manager. The treasurer at the time that was running

the portfolio quit. So I was left at the time, in the middle of the crisis, to run cash flows, re prospectuses, model cash flows, kind of figure out, you know, the mess that we were in. And so, you know, I had to meet with regulators, and I'll never forget one of the regulators coming in from the f d a C or Federal Reserve. I don't remember which one it was. And they opened up a intro to mortgage

backed securities book. So at that moment I realized that, you know, even they didn't know what was going on, and so I mean it was fascinating. I remember, you know, just looking into these bonds and seeing some bonds that were bought where you know, they decided to pick up an extra thirty basis points of spread by going from the senior A one class to the mezzanine tronch. And I looked at you know, these bonds were six months old and already of them had not even made one payment,

not even one payment. So you know, that's how I learned fixed income. I was kind of self taught in a lot of ways. So the portfolio that I managed there, it was kind of a wide range of you were thrown right in the deep end, strown right in the deep end. We ended up raising capital to recap ourselves.

But the portfolio ended up managing was kind of a mix of mortgage backed securities, corporate bonds, preferred stocks, municipal bonds, asset back securities, so kind of the kitchen sink of fixed and um kind of with the only two constraints being you know, we had to keep the duration around three years or lower, and we probably could only have about half the portfolio and credit from there. It was kind of my job and I had a lot of flexibility and freedom to kind of be creative and set

the portfolio up however I wanted. So if I wanted, you know, of the portfolio in three year bonds, I could do that. If I wanted some in thirty year bonds and some at the front end of the curve, I could do that. And that's kind of the fun part is you know, taking different types of securities with different characteristics of credit duration embedded leverage in creating a portfolio that will perform in the types of scenarios that

you're looking forward to. So, David, that kind of leads into the question I wanted to ask, which is, yes, you've got into fixed income in two thousand and eight, which was definitely a special time to be doing it, and to some extent, everyone was learning new things, to put it mildly um during the financial crisis. But you came from an equity background, So what struck you as the biggest difference between equities and fixed income when it

comes to investing or analyzing portfolios? Good question. Well, I think the macro the macro components, So you know, so much is driven by interest rates obviously, So you know, obviously you know key characteristic of fixed incomes duration, So just how interesting for our listeners who don't know the definition of duration? What does that mean? So duration would be the first derivative, so it would be the change

in price for a given move and interest rates. So if interest rates move x, the duration will tell you how much the underlying asset will correct. So in theory, if somebody said duration was three in rates went up a hundred basis points, you know, the price would decline three got and vice versa. All right, so I interrupted you and you were sort of talking about the difference

between equity and fixed income investing. Yeah, so obviously I think that the macro implications, so you know, the implication, and the Federal Reserve policy, inflation, um, you know, other central banks throughout the world, and then just broadly, credit cycles. I mean credit cycles are a lot different than you know, equities obviously, so you know, there's different types of supply,

there's market technicals. Is the goal different because when I think of my biases, when I think of an equity manager, I think of someone who's really thinking about the upside and beating the indices. And when I think about a fixed income manager, I'm thinking of someone who's more about downside avoidances and you sort of know how much you could make, but you're trying to limit the potential losses. Is that a fair characterization of the risk profile or

is that not thinking about it the right way? I think it is because at the end of the day, um, you know your upside as you get your principle back and you get paid interest to so you know, so you're right. The risk reward is very different. And you know fixed income as it is and equities, so you know, if you have a year and fixed income, you know you might not have the two x like you'd have inequities to offset that. So you know your risk awards

a lot different. But what about your benchmarks are I guess what I'm asking is what sort of return profile are you aiming for? And you must be pegging yourself for benchmarking yourself to a particular thing or goal, right correct? So you know when it was at the bank, it was more of an asset liability framework and more kind of in terms of the Barkley's agg um. Now the Bloomberg Barkley is now stay well done, Joe. Joe is

totally on message. That's right. So I think, you know, for people that are not familiar, I would kind of call it the S and P five hundred of the bond world um. And that's pretty heavily weighted in treasuries and corporate bonds. So I would say in more agency mortgage backed security. So those are the main components of the Barkley's agg kind of intermediate intermediate benchmark um, you know, average life duration, you know, in the five is range.

Now I want to we want to talk about the market right now, but before we get there, let's see the next up. So you have this portfolio, how do you find what you invest in? What where do you start? Let's say someone let's just imagine a blank slate. Let's say you had a billion dollars to invest it wasn't invested anywhere, whatever it is, or you have a portfolio it's totally messed up and you need to fix it.

Where does the process begin to find investments that are a good or be uh sort of suit the needs of whoever money it is, right, so I think the first question would be, is this an open ended return where you're you're shooting for absolute return or total return, or is this an asset liability framework. Asset liability framework would be you know, for instance, a bank or insurance company that has certain types of liabilities do in the

future and you're trying to match those. So from that point of view, your investment process is very different because you're trying to meet you know, certain liabilities in the future, whereas kind of an open ended total return you know, kind of more like I'm doing right now. Um, you know, you're not trying to meet any liabilities in particular. So I think, um, you know what I tell people is kind of there's four ways to make money and fixed

and come. There's kind of like four drivers. Um, you know, first is duration, so you can take you know, more or less duration, you know, going longer on the curve. There's credit risk, so you know, you can go down in credit. You can buy triple C bonds instead of double B R triple A. The next is liquidity, so

you can kind of go down the liquidity spectrum. You know some you know, the pimp Coos of the world or double lines might need to buy you know, much larger issues, whereas a smaller investment managers can buy these small issues or just kind of off the run things. And then the fourth is leverage. And and that's either leverage that you could use you know, through repo or embedded leverage through you know, certain kinds of securities that

have that leverage within it. So any time you're shooting for more return or more yield in the market, really you're taking one or more of those four components. And I think the big thing when looking to form portfolios is you're looking to say, at the current time, which of those four aspects is most attractive. And there's certain times when it's you know duration, So after um, you know,

Trump was elected and rates kind of sold off. You know a lot of things in duration, you know, really sold off hard, and things tied to the long ends such as um municipal bonds and preferred stocks. You know, you know, some some things tied to those really get hit hard. And there's opportunities, and you know, there's other times when it's really credit so say early in when we had the oil scare and how you'll blow out and um, you know, spreads on much lower rated bonds

were far more attractive. So, David, I want to ask you about the current market, thecause amidst all the talk about you know, lofty valuations and froth in the market credit and you know, things like corporate bonds, UM, high ye old bonds, those sold by junk rated companies UH, subprime auto a bs, even some consumer loan a b

s or securitizations. Those have all been name checked as potentially risky forms of investment in the current environment, or at least overvalued in terms of what investors are getting back for putting their money in those How do you make investment decisions when everyone is basically talking about things being overvalued in the market. Yeah, it's a great question. I think one thing is just to remind yourself that, you know, for how many years now have have people

been saying that? So you know, you know, the mere fact that that's being commented on doesn't necessarily mean that's you know, it may be true, but it may also continue. And that's not to say, you know, we're going to ignore risks in the market. Uh, Like you guys kind of alluded to in the introduction, if your task with managing money, you can't really just sit it out and say, you know, maybe you can in your personal account, but if you're managing assets, you can't really say I'm gonna

I'm gonna set this whole thing out. So I think it's looking at the different risks. For instance, UM, do you think that the risk return of you know, corporate issuers is more favorable than for instance, housing related debt, which I think you know, the last crisis was housing related debt, but I think that the fundamentals for housing related debt at this time are actually pretty favorable. You know,

consumer balance sheets are being repaired. Um. You know, there's really not non agency being issued, you know, if there is very very little UM. So you know, in my mind, something like the underlying tail winds and fundamentals of housing related debt are a lot more attractive than you know, corporates for instance. You know, but you can't, you know, just stop there, because you know the market may already be pricing in that. So UM. I think a big thing that you look at in the bond market is

loss adjusted yield. So you're not just looking at the yields and spreads you're getting, but you're having to loss adjust that. So you're you're looking at different scenarios and saying, well, if if the credit cycle is benign and defaults here run at x, you know, what what does my return look like? But you know, if it's very unfavorable, then what will look like Because I think, you know, you have to have humility in this job and say what I think is going to happen is probably not going

to happen. So we're gonna look at various scenarios and we're gonna say, and um rates up X happens in base scenario you know why happens? And rates down see happens? Or in you know, benign credit cycle this, you know, great credit cycle that, or terrible credit cycle, you know something else. So you're looking at different scenario analysis, and you know, sometimes not all bonds are gonna win for

you at the same time. So for instance, at the bank, you know, one of the things I did was I was very long and zero coupon California school district communities. And it sounds crazy, and in isolation, people might not have bottom because they were thirty year zero coupon bonds, but they had very very widespreads and very good risk rewards. And when you mix that with things that were very short at the time, it created a very favorable overall dynamic.

So I think one of the things that you can have a bond in isolation that might look ugly or it might look unfavorable, but when you add it into a portfolio, you know you can create superior overall profiles. And I think that's that's the fun of it. You're mixing different ingredients in and trying to create a profile that will match what your overall assessment of the market is. Well, David Shaw, I think that was a I love that

last answer. I love that it ended on a thirty year California school district zero coupon bobs because probably an area of the market that not many people have perhaps ever thought about in their entire life. But I think that was a great talking to you. That was like sort of a great explanation of what you do. And then also I loved real quickly name those four things again,

the four vectors through which there are opportunities and fixed income. Correct, that's duration, right, sensitivity to raids, credit risk, liquidity risk, and weapons. Great stuff. David Shaw, portfolio manager at New River Investments, Thank you very much for joining us. Thanks guys. So, Joe are you are you? Are you thinking of changing jobs? I am going to switch jobs and put all of my money and I think thirty year California zero. No. I think that was like that was the old trade.

I imagine that opportunity is not there anymore. Aectually. Uh by the time people hear this podcast, I have to admit it does sound really fun, he said. He said to use the word fun at the end. The idea of actually having money on the line, not just talking. There's this gigantic world of fixed income trying to find the diamond in the rough. You got to admit it

sounds like it would be a pretty cool job. It sounds pretty frustrating to me, actually, just because there's so many there's so many factors to consider, and I guess I'm a risk averse um kind of person. So I would sit down and I would look at a particular bond and I would just basically list off all the things that could go wrong, and I'd probably never invest in anything, and I'd be beaten by all my peers

and I would be very very bad at this. Yeah, I know exactly what you're saying I think the journalist mindset is to focus on the downside, probably a good reason why we're in our current jobs and not David's job. Yeah, you're right, all right, Well I feel better, so should we leave it there. I'm Tracy Halloway. You can follow me on Twitter at Trey see Alloway, and I'm Joe

wisn't Thal. You can follow me on Twitter at the Stalwart, and you can follow David Shawl on Twitter at David shaw and our producer Sarah Patterson Sarah pat with two teas. Thanks for listening.