fixed income options in today’s economy by john milne, ceo jkmilne asset management
TRANSCRIPT
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Fixed Income Options in Today’s
Economy
by John Milne, CEO
JKMilne Asset Management
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What Are The Fixed Income Options?More than ever:
• Process: Active or Passive• Style: Sector Rotator or Duration Manager• Decision Basis: Macro Economy drives Top-Down
decisions? Or are decisions driven from the Bottom-Up by Micro Economic factors such as credit selection, issue structure and/or, optionality?
• There are increasingly more clearly defined style differences in Fixed Income that became evident in 2008.
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What Are The Fixed Income Options?More than ever: continued
• There are more “sub asset” classes such as Investment Grade, High Yield, Non-US, Distressed…and more.
• Who do you want managing your money? Big Box, Boutique, Mutual Fund, ETF?
• Is the money managers ownership structure important? Independent?
• Critical Decisions…the “vehicle” used to acquire the above characteristics.
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Why Are The Vehicles Important?
Manager risk has become as great as investment risk.
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The Fixed Income Opportunity Decision Tree
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There Are Long and Significant Secular Opportunities in Fixed Income
Investment Period Investor Risk Benchmark
Hallmark (What Happened?)
1946-1958 None “Low Interest Rates” largely a corporate bond market, no long bond exists
1960 None “Nothing” 1960 the Tsy 10yr was 4.67%; 1969 7.15%
1970 None “Asleep at the Wheel” 1970 10yr Tsy Yields 7.4%; 1979, 9.34%; 1980, 12.67%
1980 Lehman Aggregate
“The Mortgage Market Layup” As investors became risk managers they buy the market
components in the indexes
1990 Aggregate + “The Anything but Government Bonds Homerun” As the mantra is “buy corporates and
Drexel will make me alpha.” Drexel closes Valentines Day 1989
2000-2010 Barclays Aggregate
No leadership. Corporates hit all time wide spread October 2002, 2008 mortgages are
volatile
Source of yield data “Analytical Record of Yields & Yield Spreads” Saloman Brothers
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What is a common active bond market index?
•Primarily U.S. investment-grade markets
•Liquid and does not include cash
Barclays Capital Aggregate Index
Source: Barclays CapitalAs of July 31, 2010
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Barclays Aggregate Index Quality Exposure
Source: Barclays CapitalAs of July 31, 2010
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Barclays Corporate Bond Quality Exposure
Source: Barclays CapitalAs of July 31, 2010
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It’s Not Your Grandfathers Bond Market
• Corporates are increasingly correlated to the equity market
• The Total AAA Corporate Issuers are:
–ADP
–Microsoft
–Johnson & Johnson
• The result is a market heavily reliant on credit decisions
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Source: Bloomberg
Historical Interest Rates 10yr Tsy Note
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Treasury Yield Curve
Source: Barclays CapitalAs of August 31, 2010
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Source: Bloomberg
Yield Spread between the 2yr and 10yr Tsy Notes
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Market Returns
Source: Barclays Capital As of August 31, 2010
Total Return 1 Yr8/31/2010
Total Return 10 Yrs8/31/10 (annualized)
Aggregate 9.18 6.47
Intermediate Agg 8.25 6.21
Intermediate Gov/Credit
8.18 6.09
Intermediate Credit 11.35 6.70
Securitized 6.97 6.41
High Yield 21.52 7.54
S&P 500 Total Return
4.91 -0.01
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US Aggregate Year to Date Excess Returns
Source: Barclays Capital As of August 31, 2010
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What’s New?Liability Driven Investment (LDI)
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Government Debt as a % of GDP
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Selected Countries: Public Debt-to-GDP Ratio(In percent)
Sources: United Kingdom: Goodhart (1999) and IMF, World Economic Outlook database. United States: Historical Statistics of
the United States, Millennial Edition Online; Office of Management and Budget; and U.S. Census Bureau. Japan: Bank of
Japan, Hundred-Year Statistics of the Japanese Economy; and Toyo Keizai Shinposa, Estimates of Long-Term Economic
Statistics of Japan Since 1868. Data for Japan refer to the central government.
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The Reality of Fixed Income Options “Let’s get real”
• Interest rates are near or at record lows depending on if we look at short term or long term rates.
• US GDP has been losing “velocity” for 50 years now.
• The US is in a second jobless recovery.
• 245 million Americans over the age of 16 with 80 million not working (for any reason).
Source: US DOL, JKMAM
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What Are the Market Options?
• Hey, rates stayed this low for 12 years between 1946 and 1958. It does happen.
• Whoa, rates can go lower with low inflation or continued dis-inflation.
• No one in this room lived with deflation and its consequences so we take the scenario off the table for investment purposes.
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Snapple Cap Fact
• Interest rates can go negative, you pay someone to borrow your money.
MARCH 26, 2009 US Treasury 1Month TBill
-.005%
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Fixed Income Options in Today’s Economy
• Investors have more options to DIVERSIFY style, process, and culture of their fixed income MANAGERS.
• A very unique period that does not have any leadership creates the opportunity to insert OPPORTUNISTIC strategies. That is, hire a manager on the pretense that they will be terminated upon success.
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TAKE AWAY
• There is a need to find the optimal combination of NIMBLENESS and HIGH CONVICTION in the same investment process.
• That is to say, the “off the chart” low yields and high volatility need to be managed well or you will risk significant losses in bonds and fracture the manager.