Ep. 13 Evaluating Opportunity in Fixed Income
The Financial Commute

Ep. 13 Evaluating Opportunity in Fixed Income

Ep. 13 Evaluating Opportunity in Fixed Income

The Financial Commute

On today’s episode of The Financial Commute, host Chris Galeski welcomes Portfolio Management Analyst Hunter Daniel to discuss fixed-income securities. Hunter starts by talking about his path to Morton and how his prior experience helped him discover his interest in  portfolio management. Hunter joined Morton Wealth in 2022 and plays a critical role on Morton’s research and investment teams.

Hunter talks about the fixed-income selection process at Morton and how the importance of cash yield plays a part in the ultimate decision to pursue a particular fixed-income strategy. While this may be obvious to some, Hunter goes into detail about the level of diligence that goes into the selection process, particularly as it relates to money markets and Treasury Bills and how duration and illiquidity risks factor into those considerations.  

Hunter also discusses how the yield curve generally slopes upwards, meaning rates on long-term bonds are higher than short-term bonds; however, in recent months, the yield curve has become inverted. Therefore, Hunter says it may appeal to clients to invest in short-term U.S. Treasury Bonds or money market securities. He also expects the Federal Reserve to continue to raise interest rates, which could make short-term bonds even more appealing depending on an investor’s individual goals and risk tolerance. He says he has been investigating more liquid ETFs with high volume and low spread (meaning smaller differences between the buy price and sell price, translating to lower trading costs for the investor). He’s also been examining fixed-income securities issued by emerging markets because if the dollar depreciates in the future, then these securities denominated in foreign currencies might become more valuable in terms of dollars.

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Hello, everybody, and thank you for joining us for another episode of The Financial Commute. I'm Chris Galeski, your host, joined by Portfolio Management Analyst, Hunter Daniel. Hunter, thank you for joining us.


Yes, pleasure to be here, Chris.


So coming up on a decade of portfolio management and analyst experience, tell us a little bit about your journey.


Yeah, absolutely. My journey is a little bit nontraditional, so I ran cross-country and track and field at Humboldt State University, and I was fortunate enough to run semiprofessional out of school. I had basically a year deal with the Brooks Running Company, and so I didn't initially get a job right out of graduation. Nobody told me that that was pretty important to do because it set you up because graduating from college, I had a bachelor's in science and finance.

I still didn't know anything. I was keenly aware that I didn't know anything. But as you get further along in your career, you start to compete against lateral hires. So I identified that I wanted to really move into the financial world, and I knew there was a big presence in private wealth in Salt Lake City, Utah, with Goldman Sachs.

And so I was still training out of Humboldt State at that time. And so I picked up and moved to Salt Lake City, it proved substantially harder, getting into Goldman than I thought. Goldman Sachs, it gets about 500,000 resumes a year. That's it? Yeah, that's it. Yeah, they hire about 4%, so it's very prestigious to work there.

And I had a fantastic time there. That's where I began studying for the Chartered Financial Analysts exam. And that really ultimately led me from wanting to move within more of an operations presence to a portfolio management seat and really do the actual day to day trading and the asset allocation for individual client portfolios. I really liked the private wealth management as a whole.

The business, you could really see how you were helping clients. And so that was ultimately exciting for me. But I like the true quantitative like nuts and bolts, like really looking at the different order types of that. So with that, I was very fortunate to land a job in San Diego, and I was out there for about five years before.

I just didn't get to see the growth that I was looking for in my career. Yeah. And Morton, just we happened to come upon an opportunity. You guys had some people that the role opened up. And so far, it's been the perfect fit.


Well, we love having you here. And you're instrumental in helping, protecting, grow our clients nest eggs, not only from helping us deliver on the portfolio management side of things, but also the research. So as we're coming to a close for 2022 and heading out into 2023, the markets have changed dramatically. Stocks are going to kind of do what they're going to do and they're down a little bit this year.

But with all the growth that we saw last year, that's sort of normal. But the biggest change that we've seen is somewhat instrumental because it's been 15 years since you can earn any yield in fixed income that was attractive. And so it's really important for us to reevaluate our fixed income, how we're protecting, generating income and growing our clients moneys.

But this year has been a really nice year to kind of reevaluate fixed income as a whole. The Fed's looking to do some more rate hikes potentially. But tell me a little bit about the work that you've done here with us at Morton to help protect our clients and generate income more recently when it comes to fixed income.


Yeah, absolutely. So I think that there's two main things that we're really focusing on from the portfolio management perspective. The first one may seem obvious, but I'm not sure that everyone's as diligent with it. So we're really looking at cash yields. We're really trying to make sure our clients are in the highest bearing risk free instruments. We want to ensure they're safe.

So on the Treasury side, we're focused, or on the money market side, we're focused on Treasury and purely highly high quality securities. And for a lot of clients that have different kind of funding needs or excess cash. We're out there actually buying T-bills or Treasury bonds, depending on the duration for the clients. A lot of that we're buying in a 3 to 6 month range.

The yield curve is very steep. I was looking in the market today. Three months is about 4.1 and a six month is almost creeping up to 4.7. So coming into the beginning of the year, I don't know that I foresaw yields being like that. So that's relatively attractive for clients for parking short term safe. You know, the one thing to note is those do fluctuate.

So the goal of investing in Treasury securities is to hold to maturity, but if we have clients that have more uncertain funding needs, we're really trying to make sure that they're in high quality money market funds that hold that net asset value of the dollar for them.


Yeah, thanks. I think it's important. It's been we've talked about this on some other episodes that, you know, cash is now an asset class. Yeah, it hasn't been for quite some time. You and the investment team worked very diligently over the past month to reevaluate our current fixed income and come up with some new ideas. So tell me a little bit about that process that you guys go through to evaluate our managers, the amount of time and research that goes into choosing new investments for our clients.


Yeah. Thanks for giving me the opportunity, Chris. I think that's one of the things that's really, really exciting here at Morton. We meet every Monday for an hour, the investment research team, and we're talking about everything that’s going on and really, really trying to figure it out. I know that you hear a lot in this industry that people just say they can't know, and I think that's fair.

There's a lot of things that are hard to know and we can't know for certain, but I believe that it's our job to try. And so that's something that I think just radiates through the halls here. Morton is people are trying to figure out we're trying to do the best by our clients and to stay on topic with the fixed income.

The last month, we actually scheduled a whole fixed income deep dive week. We have we've had six rate hikes year to date. I think that we're probably going to have another another one coming up probably around the 50 basis point range, you know, but the market's moving. Jay Powell could surprise us, but we interviewed seven different portfolio managers from prospective funds, two funds that we're at.

And we really want to get their understanding of where they're at from a macro perspective, what kind of trades they're looking at, and just what's attractive in the market with yields going higher. And coming out of that, we made two significant trades. We'll be entering two new funds that we haven't used before that are really, really exciting. The really exciting part of it is they're going to have really strong yield to worst ratios.


Yield to worst means that's the interest that they're going to receive worst case scenario if a bond gets called early.


Exactly. That's absolutely right. So, you know, bonds can be issued as a as a simple T-bill where the government doesn't have the ability to take that out of the market. They have to wait till matures and they give the money back. But some typically, you know, municipals, different types, mortgage backed securities, you know, a client may that a piece of that mortgage backed security they may prepay their loan.

They may decide that they want to sell the house that they're in and buy another house. And so that basically refunds part of that. And so the yields to worst is an equation that we're trying to take that into account to really see, you know, in the scenarios that people prepay, you know, what's a it's a more true estimate of yield and so it's more conservative.


Yeah. Thank you for diving into that. I think we tend to use a lot of these terms. And I just wanted to kind of explain what yield to worst meant, because there's a yield that you're expected to get, but yield to worst is the truer interest that you can earn. So thank you.


Yeah, absolutely. And so with these two new fund managers, they're, they're both smaller in AUM, one of them is about 190 million and the other one's about 240. And we're really excited because we're going to be a reasonable part of that fund with the yields that have already hardened and increased in talking with those portfolio managers, they feel like this is a good time to be deploying capital.

You know, something really interesting that's going in the market right now last week, Thursday, the Treasury ETF TLT the long duration is 20 plus years, took in their second biggest day in AUM on Thursday they took a 1.5 billion.


No kidding.


The real, the yield curve is deeply inverted. You know, you've got that, you know, like I was saying.


Inverted means the shorter maturities have a higher yield than longer.


Absolutely. That's exactly right. So you've got the six month right now. I was telling you, you know, 4.6to 4.7. But going out to ten years, you know, you're looking at 3.5 to 3.6 and it's come down it was closer to 4, you know, in later November. But it's comedown. So, you know, if you're an investor and you're just thinking about it in simplistic terms to lock up your money for ten years, you're actually getting one less percent than investing it for six months.


Six months? Yeah. No, that's interesting. Now we see a lot of people say, oh, just buy an index fund and like look the other way. What are some of the biggest risks that you see in investing in an index fund in the bond world and why we chose to go with active managers?


Yeah, that's a really ,really great question. So I think so you had Bruce Tyson on your podcast a few episodes ago, and I think he really laid it out well. Indexes for bonds, they have some inherent problems with them. From a market weighting perspective, you're giving a highest weight to the companies that have the highest amount of debt.

Yeah. Now, that may be a good thing because it kind of provides operating leverage for the company, but they may be overindebted. And so in the fixed income space, that's why we're really focused on the active managers. And another thing to think about with that, too, is, is bonds don't trade every day. So they're inherently kind of an illiquid product, which doesn't necessarily lend it well to the creation and redemption process.

That's a really, really unique factor of ETFs on the equity side, particularly the large, large caps companies that have very, very deep liquidity that market makers can move in and out of.


Do you think like Apple trades, like 20 million shares a day or something?


Exactly. Yeah. And so, you know, they can basically, you know, it's a unique process within the ETF space to basically create and redeem shares. And there's an arbitrage mechanism that authorized participants are able to basically take advantage of, and that keeps the price of the ETF and the underlying holdings, the net asset value it keep sit very, very close.

The majority of the ETFs that we trade have basically a one penny spread on each size, and that's for pretty deep liquidity sizes. You know, we could be trading, you know, over $1,000,000 in notional value and I'm not moving the market. And so that just shows you how competitive it is on the equity side. But on the bond side, you know, if a fund manager has significant outflows and they, you know, their ETF price could dislocate significantly then the net asset value because some of the underlying holdings, the bonds are not as liquid.


Yeah, no, that's a really good point in the sense that bonds aren't as liquid as stocks. Everybody talks about using index funds or ETFs for low cost. And believe me, as an RIA, we care about the fees that our clients pay, but we also care about what the return is for them in their pocket. So using active managers in the fixed income space has provided a lot of value.

What are some of the yield to worst that were we're getting right now in the fixed income space because again, going back 12 months, it wasn't very attractive. It was maybe in the 3 to 4% range. So what are some of the yield to worst that we're getting now?


Absolutely. So the two funds that we introduced, were targeting about a 9% yield to worst. They're both a little bit lower in quality. So they're going out there and trying to pick up the yield by identifying companies that they think have a better opportunity to continually operate well. And they've got great management in place. One of them is at a high yield short duration.

It's a really unique strategy. It's more event driven. So they're really looking at companies that have something new coming up. You know, an example would be, you know, they have credit on a natural gas company. As you know, prices for natural gas have really, really risen over the last year given the crisis that we have going on with between Ukraine and Russia.

So that's really allowed companies to be significantly more profitable. And so if you have debt that's more expensive, it's a very opportunistic time to be refinancing that. Another example is, you know, there's a merger and acquisition. You know, maybe they have an asset that they sell off which provides significant cash flow to them. They may want to go and refinance out some of this.

So they're looking to pickup some of these less liquid, higher yielding. And, you know, they may not hold them all the way until the maturity. They may get refinanced out, but sometimes the refinancing takes a significant period of time. And so they're able to pickup that yield. And that's why for this strategy, the yield to worst is a very important metric to look at.

Yeah, the other strategy that we're looking at is more in the structured credit space. So mortgage backed securities. What's also really unique about this fund is they have a broader investment mandate. They can even look into the emerging market space. The dollar has been very, very strong this year. It's come down a little bit recently. And if the dollar depreciates a little bit more, settles at a little bit lower level, that will be a significant tailwind for emerging markets.

And so we think that's something that is we want our fixed income managers to be focused on. We think that's a harder thing for us to do internally.


Yeah, no, that's great. I love the fact that not only do we reevaluate our investments on a very consistent basis, but we're willing to go in and spend real dedicated time on who we're currently working with. What's changed in the market, and what are some new investments that we might want to consider to help protect and grow our clients assets so Hunter, thank you for that deep dive lesson on kind of some of the ways that you play an integral role to helping our clients.


Yeah, my pleasure, Chris.




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