Dan Ivascyn Is Excited About a New Era in Fixed Income

In the years since the financial crisis, bond investors didn't get much return for taking on risk. With low interest rates and little sign of inflation, investors had to accept lower-quality assets to get any semblance of yield. Now that's changing according to Dan Ivascyn, the chief investment officer of Pimco, one of the biggest bond fund managers around. In this special 10-year anniversary episode, Dan reflects on longer-term trends in the bond market, as well as more immediate issues like independence at the Federal Reserve, concerns around data center financing, and worries of "dangerous" and inflated credit ratings.

Read more:
French Budget Endgame Means Stress Test for Stocks and Bonds
Pinebridge Sees Emerging-Markets Rally Tilting Toward Bonds

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Episode Transcript

Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, Radio News.

Speaker 2 (00:18):
Hello and welcome to another episode of The Odd Laws podcast.

Speaker 3 (00:22):
I'm joll Wisenthal and I'm Tracy Alloway.

Speaker 2 (00:24):
Tracy, you know, we've been doing this podcast for ten.

Speaker 3 (00:27):
Years, I am aware. Yeah, no, a whole decade.

Speaker 2 (00:30):
And we've been doing episodes about big picture things and
things that have changed and what's different now in twenty
twenty five or twenty fifteen when we started. And some
things are the same, some things that are different, etcetera.
But I think, and we've mentioned this before, I think
the one thing that could not be more different here's
the raids environment. We were right in the middle of,
like the zerp decade or the Zerp era, maybe in

(00:51):
twenty fifteen. Maybe at that point, the FED had tried
to hike one time already and then the market sort
of slapped it down and said, oh no, no, no,
no more, We're not ready for more rate hikes, et cetera.
The raid environment could not be more different than when
we first started this podcast.

Speaker 3 (01:06):
Absolutely. Can I say one thing about the anniversary, Yeah,
so we started the podcast in November twenty fifteen. Yeah,
we were going to celebrate for the month of November,
but we're now in December, So are we going to
make this a two month celebration.

Speaker 2 (01:20):
Well, you know, we're having our ten year anniversary party
in December, so I think it's allowed. Well's just believing,
you know, it's allowed to bleed the ten years into
both months, given that we're formally celebrating in December. I
think this is how I'm rationalizing this framing for this conversation.
Since yes, we're no longer we're technically no longer an

(01:41):
anniversary month.

Speaker 3 (01:42):
I guess it's our party and we can celebrate as
long as we want however we want. But you're absolutely
right about the rates environment, and you know you could
see that if you go back and look at some
of the old episodes. The other thing that strikes me
looking back at the old podcast episodes is how many
of them were about shadow banking, which of course nowadays
recall private credit. And that's another thing that's changed enormously.

(02:05):
So the private credit market now basically rivals the public
credit market in terms of size, and there's obviously a
lot of concern about what that means. The outlooks lots
of differences.

Speaker 2 (02:15):
Lots of differences. Yeah, completely dramatic and setting aside the
big picture questions, there are also some small picture questions,
maybe how you put.

Speaker 3 (02:23):
It, immediate questions.

Speaker 2 (02:24):
At the time we were recording this, it looks like
the December meeting is basically a lock that there's going
to be a cut. But up until recently there was
a lot of market uncertainty.

Speaker 3 (02:33):
If we recorded this two weeks ago, it would have
looked very different.

Speaker 2 (02:35):
It would looked very different, and you know what happens
after December highly uncertain on many dimensions the follow through
for the rate cutting cycle. There have been increases in
various credit concerns of various source. We've had a few
small blow ups, but you know, nothing that big. But
like what Jamie Diamond called the cockroaches, we mentioned it

(02:55):
on the show that suddenly people are talking about credit
default swaps uncertain high tech companies, which is very unusual.

Speaker 3 (03:02):
But there's that's what Star Wars meme. I haven't heard
that word in a long time, that's right.

Speaker 2 (03:08):
But with the AI build out and how much that's
getting financed by various forms of credit, suddenly people are
talking about the fact that big tech companies are credits,
which we don't really think about very much. And so
there are some big picture of things, but also some
things happening right here and right now that weren't further
understanding and further explanation from the people who really understand
them absolutely well. I'm very excited to say we really

(03:30):
do have the perfect guests, someone who we've had on
the show before, but someone we love speaking to. We
are going to be speaking with Dan Ivison. He is
the CIO over at PIMCO, which of course everybody should
know about. So Dan, thank you so much for coming
back on the Outlaws podcast.

Speaker 4 (03:45):
Thanks for having me, and congratulations on the big ten
year anniversary. It's an honor to be invited back during
this series of podcasts.

Speaker 3 (03:53):
Thank you so much.

Speaker 2 (03:54):
Yeah, very kind of you to say, let's start small picture.
I think this episode will be out before the meeting.
The market is saying it's going to be a lock.
They're definitely going to cut rates. But beyond that, when
you look into twenty twenty six, there's sort of two
different questions. There's the ongoing uncertainty about who is going
to be the next FED chair, and then there's just
the questions about how much appetite this existing committee has

(04:18):
to continue a rate cutting cycle, So I'd love to
get you know, what are you thinking about for the
twenty twenty six and what we could be expecting.

Speaker 4 (04:28):
Sure, so you know, we do think the Fed's likely
to cut rates at the upcoming meeting. We also think
that this is a FED that would like to get
rates a bit lower into twenty twenty six. The challenge,
of course, is that we expect to see a little
bit of reacceleration in the economy during the first half
of the year, and we also expect inflation to remain
comfortably above the central bank targets. So you know, we

(04:51):
believe this FED when they say they're going to continue
to focus on the data, we do think the data is.

Speaker 5 (04:56):
Going to be a bit confusing.

Speaker 4 (04:58):
The general view you know today at PIMCU, with significant uncertainty,
is that they probably do get rates down another half
of percent or so next year, which is close to
what's being priced into the market today. But again, if
you see meaningful reacceleration in the growth data, and more importantly,
if you see even a modest up ticket inflation, this FED,

(05:20):
you know, even with a new chair, will will likely
be willing to remain on hold and then I think
the other point, and this came up with one of
your recent guests, is that there's the front end policy
rate and then there's the reaction out in longer maturities.
We do think there's a chance if this FED cuts
aggressively into strengthening data higher inflation, you may actually get

(05:42):
a selloff in the long end of the curve. So
that could be a bit self defeating, and I think
something that will be a topic into next year if
we do get that reacceleration that we expect.

Speaker 2 (05:52):
There's a lot you said there that I want to
follow up on just in that one answer, but just
very quickly, what is the idea, the gist behind why
you expect dead Q on reacceleration.

Speaker 4 (06:02):
Yeah, A lot of it's you know, related to significant momentum,
you know, in terms of capital investment, you know, associated
with AI as well as the delayed positive growth impact.

Speaker 5 (06:13):
Of the so called Big Beautiful Bill.

Speaker 4 (06:16):
A lot of the corporate tax extensions happened retroactively for
the consumer of the household in many instances, you're going
to begin to see the direct impact in terms of
positive refunds coming into the new year. So again, you know,
plenty of uncertainty, you know, a lot of cross currents
in this economy, but we do think there's the chance
that you'll get some moderate reacceleration in the first half

(06:37):
of the year. You know, we're looking at a growth environment,
you know, for next year in the United States at
least somewhere in the one and a half to two
percent type range. So again that's an environment we're from
a traditional tailor rule perspective. We don't think that the
FED needs to cut a lot more from here, although
you know, we do think that this FED, particularly with
new membership and a new chair, would like to get

(06:58):
rates lower.

Speaker 3 (06:59):
Since you mentioned the new chair, this is more of
a long term, thoughtful question. But obviously, for the majority
of your career as a bond manager, I don't think
FED independence has really been much of a concern, right.
We certainly haven't seen the degree of headlines that we
are seeing lately with Kevin Hassett emerging as the front

(07:19):
runner for the new FED chair position. How do you
as a bond manager view that particular issue and do
you have to start handicapping the way you invest because
of this?

Speaker 4 (07:31):
I think to a degree, I think if you go
back several decades, you know, you can question the concept
of FED independence a little bit, and I think even
from the perspective of this fed's expanded mandate in recent years,
what the market's really focused on is independence related to
the setting of policy rates, which you know, of course
have a direct impact. So from that perspective, we are

(07:53):
monitoring the situation like other investors. We do think less
independent FED has implications, particularly in longer maturities, where you
may need a bit more risk premium when you're dealing
with uncertainty around FED independence. But generally speaking, when we
think about you know, who's being considered for the FED role,
including Kevin Hasseert, you know, we do think that there'll

(08:14):
be a general spirit of independence there. We still think,
you know, the chair is one vote, so to speak,
and we have a committee that will continue to focus
on the dual mandate. So yes, it's a consideration, it's
an input into our decisions. It's not a major concern.
We do think that you know, the group that's being
considered are you know, certainly highly qualified and will likely

(08:36):
you know, continue to take a sufficiently independent view regarding
monetary policy.

Speaker 2 (08:42):
Let me ask you kind of the same question, but
with a slightly different framing. It's December twenty twenty five
right now, so we've had like over four years now,
I think over four years now of the FED missing
on its inflation on the two on getting inflation durably
back to two And if the FED is going to

(09:02):
continue cutting as it looks like it's going to do
in December, that signals a further willingness to ease policy
even with inflation over its ostensible target setting. Aside the
strict question of independence, do you think the FED, regardless
even the current composition and the likely composition going to

(09:22):
be forward, is just not going to take two percent
seriously as perhaps it might have in the past.

Speaker 4 (09:30):
Yes, that's a great question, and I think that in
a general sense the two percent target matters, but not
so much the current inflation rate. You're absolutely right. We've
been operating, you know, and living with an inflation rate
meaningfully above their target for quite some time. But when
you look at inflationary expectations, and I think when you
talk to central bankers you know here in the United

(09:51):
States as well as outside this country, the inflationary expectations
piece is what's critically important. So when you look at
longer term break even inflation rate, they've continued to be
very very well behaved. You saw a bit of an
uptick at the upbreak of the war in Ukraine, and
then you saw an uptick around the tariff announcements earlier
this year. But when you look at a ten year

(10:12):
tip break even rate, just to use one of several proxies,
no one measure is perfect, you're down around two and
quarter percent on CPI inflation. So to the extent that
inflationary expectations remain well contained, we do think that the
central banks willing to look through some of the more
higher frequency data to the extent that you see those

(10:34):
longer term expectations become unanchored. We do think that's a
risk for a FED that's too aggressive in cutting rates here.
We do think that the mindset will change, not only
the mindset of the Fed, but we think the market
reaction could be counterproductive, not only in terms of higher
long term interest rates, but an impact on risk assets
as well. So you know, the markets have let the

(10:55):
Fed get away with running fairly accommodated policy into a
three percent type inflation world. Because again, there are a
lot of other forces at work that very well could
be disinflationary over the long term, and there still is
significant confidence in global central banks and being able to
generally keep inflation close to the target on a longer

(11:17):
term basis. So you know, again, so far, so good,
but you know, this is all going to be a
key source of uncertainty, you know, into twenty six and beyond.

Speaker 3 (11:24):
I feel like uncertainty is constantly the keyword on our
podcast nowadays, since longer dated expectations and yields keeps coming up.
In this conversation, I got to ask, do you believe
in the term premium or rather, is the term premium
a useful concept to you as a big bond investor?

Speaker 4 (11:41):
It is, and you know, when we look at you know,
where we're going to invest, you know, we like to
get paid for, you know, taking more risk. We do,
you know, see an elevated term premium certainly relative to
where we were five or ten years ago, and that's
made longer maturity investments a bit more attractive. With that said,
there's lots of reasons why the term premium should be higher.

(12:02):
Inflation is one of them. Global debt levels, US debt
and deficit levels are another. We probably live in a
world today given what's going on in terms of focusing
on tariffs and bringing back supply chains, you know, to
domestic markets, the need for you know, higher risk premium.
So you know, as a firm today, we we like

(12:23):
longer maturity bonds more, but we're still you know, tend
to keep our positions concentrated in shorter maturities, and we
would expect over the next few years a little bit
of additional underperformance in the very very long end of
the yield curve. So we do think it's important. It's
interesting people focus a lot on the deficit situation in
the United States. As an investor, you don't want to

(12:45):
lend to a perfect high quality credit you get paid
so much to do so. So in some sense, we want,
you know, just enough fiscal irresponsibility where we and our
end investors get paid more to lend, but not so
much where it becomes a concern in term the overall
viability of the system. So we think we're in the
midst of that type of market environment today, but things

(13:06):
can go a bit too far if we don't get
the deficit or the inflation situation under control. Over the
next couple of a few years.

Speaker 2 (13:29):
Can you talk about the role of bonds in a portfolio? Again,
this is something that in twenty fifteen, bonds fit beautifully
into a diversified portfolio because they were paying something, but
also they had that nice and verse correlation and so
you got that natural hedge, et cetera. We haven't had
that very like that beautiful inverse correlation between risk assets

(13:51):
and bonds for a long time, which undermines one of
the cases for the diversified investor of having like a
big slug of perhaps longer duration assets. How do you
think in twenty twenty five, how do you sell the
case that diversified investors should still keep some allocation to
duration or fixed income.

Speaker 4 (14:11):
Yeah, so it's interesting. I know this is a ten
year anniversary show, so you know, went back it looked
at the performance of bonds versus other things, you know,
over the last ten years, and the divergence in performance
over the last decade has been remarkable and it explains
a lot. If you look at the S and P
five hundred over the last ten years, in absolute terms,
you generated a return of about fifteen percent a year

(14:34):
adjusted for inflation. I think it's up close to twelve
percent or so I'm rounding a little bit. When you'll
get the performance of you know, the Bloomberg aggregate index
over that ten year period, the return annually has been
below two percent in absolute terms. When you subtract inflation,
you ended up with negative returns in bonds for ten years.
So not only has the correlation broken down, but you

(14:57):
didn't make any money in owning bonds. When you look
at the starting valuations today under any type of reasonable
longer term valuation framework, none of which have to mean
revert quickly, but you know, you look at a you know,
a Schiller pe type arrangement or equity risk premium type argument.
You don't need a great correlation on bonds versus equities.

(15:17):
What the relative valuations would suggest is that there's a
good chance that bonds outperform stocks over the next five
or ten years, or at least have returns on a
risk adjusted basis very very close to stocks. So you
don't have to rest on a correlation argument. You know,
you don't have to focus on well bonds do well
during periods where people are losing their jobs or you know,

(15:39):
income growth is negative. You can just from a pure
valuation perspective, find the acid class quite attractive absolute and relative.
I think the second point around correlations is that correlations
between stocks and bonds will tend to break down when
inflation is the primary risk factor. Today, yes, inflation is
above central bank targets, but there's a lot of uncertainty

(16:01):
on the economic side. You do have this complex economy
where tremendous value you know within the tech sector, tremendous
capital and investment, yet lower income households are feeling considerable pain.
If AI is very very successful at increasing productivity, that
could mean significant job loss across key segments of the economy.

(16:21):
So the bottom line is that risks are more balanced.
We don't think correlations are going to ever come back
to the really, really neat clean levels you know a
decade or so ago, when inflation simply wasn't a problem
at all, you know, across the global economy. But we
have seen correlations improve a bit, and we would expecting
to go forward basis correlations to improve further. I think

(16:42):
it's important again to look at a global opportunity set.
I think that the correlation arguments are stronger in areas
of the world that have the best fiscal position. But
in general, you know, not only do we think that
the valuations are quite attractive, you know, we do think
the correlations will be a bit better certainly that we experience.

Speaker 5 (17:00):
It's coming out of the culture tray.

Speaker 2 (17:01):
Twenty fifteen, bonds were an easy sell. It turns out
they weren't the best investment. Twenty twenty five maybe a
harder cell, but the math says that now is actually
the time to expand your exposure.

Speaker 3 (17:12):
Well, I guess in ten years when we do the
twenty year anniversary, we will be able to judge. But Dan,
you know, since we're talking about why people should buy bonds,
one of the surprising things that happened this year was
we had the big tariff drama and we saw markets
go down, We saw a bond yield spike. Everyone was
talking about the sell America trade. So this idea that

(17:34):
you didn't want to hold onto US assets because of
all that policy uncertainty. And now you know, in December
twenty twenty five, yields have come down quite a lot,
although I have to say the dollar is still fairly weak.
You were always kind of resistant to the sell America idea,
and you pushed back on it. What did you see

(17:56):
that perhaps others didn't.

Speaker 5 (17:59):
Well.

Speaker 4 (18:00):
Again, I think a lot has to do with starting valuations.
After a significant period of underperformance across the US fixed
income or global fixed income, you ended up with a
decent valuation cushion. So I think that's always important in markets. Yes,
there was news that in a narrow sense was negative
for bonds and negative for US bonds or US assets

(18:20):
in particular. You started with a decent yield cushion. You know,
we began the year, you know, with yields ten year treasuries,
you know, up near five percent. A five percent yield
even in a three percent inflation worlds not that bad.
I think the second point, though, you know, we weren't
overly convicted in just owning the United States. And I
think if I could, you know, you're part of the
most important thing I can say today is that global

(18:43):
bond investing is back. For so many years, capitalists poured
into the US markets. It's poured into the US markets
focusing on private credit, you know, which has grown you know,
the most here in this country. But very very quietly,
you've seen underperformance across the global fixed thing come opportunities
set where today even you know, from a US dollar

(19:04):
based investors perspective, there's great yield, great sources of diversification.
So it's not that we were, you know, insistent on
just owning US assets. In fact, we've gradually diversified into
other areas of the market. We just thought that there
was good value and good yield in the US, a
sufficient cushion, and then by extending into these other markets,

(19:27):
a great way to generate incremental return by good old
fashioned relative value trading in markets today that are less
correlated than they were during those years coming out of
the global financial crisis and where you just have a
really really exciting time to troll dual fashion training across
yield curves, across markets and avoid what.

Speaker 2 (19:45):
Changed because it seemed like, you know, it felt like
international investing across any acid class was like a real
suckers thing. It's like, oh, this is going to be
the year that we're going to diversify internationally. You didn't
get paid at all for it. Flipped such that actually
both stocks too, because international equity markets have done very
well and have outperformed the US. It's kind of surprising

(20:07):
in many respects. But what switched such that now there's
been real opportunities to make money.

Speaker 4 (20:13):
Looking abroad, Yeah, well again, valuations have improved. You know,
we talked about, you know, the real poor performance of
the US bond market over the last decade. As we
all know, yields were outright negative in many areas of
the world, So we talked about low yields. You subtract
that low inflation rate, you end up with a negative number,
and big portions of the global fixed income opportunity set

(20:35):
you'd have to subtract anything you started with a negative number.
So a lot of this has just been the repricing
of markets that started not only at low levels, but
negative yield levels. Then the second piece relates to policy
coming out of the global financial crisis. Not only were
yields low, but you've had such incredible policy activism where
on any signs of economic weakness you had a massive

(20:57):
fiscal response, a massive monetary paul response COVID, you know,
the ultimate example of that. And today, you know, with
debt levels and deficit levels where they are, policy makers
don't have that flexibility. So you're back to an environment
where markets increasingly have to stand on their own based
on fundamentals and that's just an exciting time. It means

(21:17):
more risk premium in markets, more term premium, higher yields,
with significant valuation cushion absolute and relative to what looked
to be quite expensive equity markets, and then just less correlation.
You have situations even over the course of the last
couple of months where a political surprise in Japan or
France creates lots of local volatility in those markets. Uncertainty

(21:40):
and French politics impacts UK politics because they have similar
challenges in terms of getting their deficit situation under control
in economic productivity higher. So it reminds us a lot
more like the mid nineties, you know, back before you
had this massive volatility, suffocation from policy, and again with

(22:01):
deficits where they are, with inflation where it is today
versus central bank targets. It's likely that over the next
several years, you know, you're going to continue to be
in this type of environment good value, good relative value,
and then much less correlated markets, which you know lead
to you know, some some good opportunity to generate incredential
return above starting yield levels.

Speaker 3 (22:21):
Well, we wanted to talk about private credit as well, because,
as we said in the intro, this is one thing
that has changed quite a lot since twenty fifteen. People
obviously have different characterizations of private credit, but I'm curious
how you think about that space and how you would
define or how you would measure things like transparency and

(22:41):
opaqueness and customization in the credit waterfall and things like that,
because again, one person's extremely transparent market can be another
person's opaque morass of potential defaults.

Speaker 4 (22:55):
Yes, I talked for the rest of the show here
in this topic. First of all, surprise it took this
long to get to the private credit topic. But look
at you know, not much of this is new. You know,
when I joined PIMCO back in the late nineteen nineties,
I spent the good portion of my initial time at
the firm focusing on the underwriting of private assets. You know,

(23:17):
we call them pure privates, but these were you know,
four A two privates that were created as part of
the Securities Act of nineteen thirty three, one forty four
A privates, which are quite popular. I think the first
one was issued back in nineteen ninety. The technology that's
being utilized to fund AI infrastructure today, some of these
off balance sheet contingent or make whole guarantee type frameworks

(23:40):
were around in the mid to late nineteen nineties. The
difference today is that you have this massive capital investment need,
so the deals are larger, but a lot of the
technology has just been dusted off, so to speak, for
the new era. And the other point that's important, and
when we're talking about historical returns, I think this explains
a lot, is that what's been so unique in terms

(24:02):
of credit asset performance in general has been the post
global financial crisis period. Well, we have it at a
sustained period of economic weakness. In fact, one of my
favorite data series is looking at how lower quality lending
performed since way back during the Michael Milken days when
he helped to create that market. If you go back

(24:23):
to the early nineteen eighties all the way up to
the global financial crisis, if you had just blindly bought
the lowest quality credit that's out there proxy by high
yield senior secured loans direct lending blend the index, you
would have ended up with only about a half a
percentage point of incremental performance versus high quality bonds over

(24:43):
that entire period. And the way it worked was that
you made a lot of money. You have a lot
of money, a lot of money, a lot of money.
Then you gave it all back. Then you made a
lot of a lot of lot, gave it all back, and
we'd go back to the late eighties when you had
that period initial period of aggressive underwriting. You had the
savings and loan crisis of the early nineties, you had
the LTCM or the Asian Financial crisis in the late nineties,

(25:05):
than the Internet bubble and the telecom issues of the
early two thousands, then of course the Global Financial Crisis.
That was a more normal credit environment since the GFC
just blindly buying the lowest quality credit on the board,
whether it's private credit or lower quality public credit, you
generated seven percent a year more than high quality bonds,

(25:26):
and that explains a lot. Not surprisingly, you've seen massive
growth in that area of the market. Now, you know,
weaker credit tends to perform well when stocks go up
fifteen percent a year. But again, you know that's where
we are today. I hear all the discussion about God,
you know, underwriting's worse than the public side versus the
private side. The reality is, when you've grown this much,

(25:48):
when you've lent so much money to weaker quality borrowers,
when covenants have weakened, when spreads are tight, when equities
have gone up consistently as much as they have, you're
going to have challenges in these markets. So when we
think about credit, we look at it under sort of
two continuums. One liquidity. Certain assets are completely illiquid. The

(26:10):
only decision you get to make is the purchase decision,
so you better be right. And then at the other
end of the extreme, you have very very liquid assets
where you can change your mind on a regular basis.
And then you have economic sensitivity. You have assets that
are very insensitive to the economy, that are very very
high quality. Then at the other extreme, you have assets
with a tremendous amount of economic sensitivity, a tremendous amount

(26:33):
of sensitivity to AI related disruption, other forms of economic weakness,
an anticipated competition, and you just want to make sure
you get paid enough. And with stocks near all time highs,
with spreads tight, with covenants weak, they are going to
be problems. And I think as an investor, you just
need to acknowledge that you're not getting paid what you

(26:53):
got to take that risk five or ten years ago,
and you just want to be defensive. You want to
be skeptical, But it's not so much private versus public.
I think it's just thoughtful underwriting and just understanding that
we're at a time where, given the strong historical performance,
given the fact that we haven't had a sustained period
of economics slowing for a long time, some complacency has

(27:15):
worked their way into these higher risk areas.

Speaker 5 (27:18):
Of the market.

Speaker 3 (27:20):
Well, talk a little bit more about competition in private credit,
because I imagine it's good to be PIMCO when it comes
to sourcing deals and maybe negotiating the terms. But does
even someone like you, a truly big bond manager have
to deal with competitive pressures where if you don't agree
to one bond term, someone else will swoop in and

(27:42):
agree to it and take it away from you.

Speaker 5 (27:44):
Absolutely.

Speaker 4 (27:45):
And again, I think the other point about public and
private markets is that they're well integrated. You know, we
could talk about convergence, you know a bit a bit later,
have have some views there.

Speaker 5 (27:54):
But you know, when an.

Speaker 4 (27:55):
Issuer looks at their options, they're going to test the
public option, they'll test the private option. And there is
a lot of competition, a lot of competition for market share.
When you look at a lot of the managers, particularly
in the private credit space, they announce very very aggressive
growth assumptions. You know, as an investor sometimes you know,
I wish in certain quarters people would talk about, you know,

(28:17):
if we can find value for the end investor, we
will grow this much. All too often, you know, after
a pretty bullish environment for credit, it's was simply going
to grow a lot. So you know, we do see
time and time again situations where you start the underwriting process,
you get down to the point where it's time to
get into a final round and you don't get the

(28:38):
terms that we feel we need as extenders of credit
in this marketplace. And that's just again symptomatic of the
fact that there's a lot of demand for these assets
and there's a lot of demand relative to the supply
across many segments of the market. And that's true not
only of below investment grade risk, but it's very very
true of certain transactions with an investment grade rating, at

(29:01):
least from a rating agency. So you know, given tight spreads,
given the competition, you just have to say no. And
I'll go back to my earlier point. What's so exciting
about this market today is that you do not need
to take on aggressively underwritten credit to generate return the
high quality area of the market, especially if you expand globally.

(29:23):
If you take advantage of liquidity, which typically means flexibility
for end investors, you can have a high quality portfolio
where you don't have to sacrifice return. Very different than
where we were ten years ago, but again pretty exciting.
Now we can go up in quality without again giving
up return and in some cases ironically picking up expected return.

Speaker 2 (29:58):
I want to go back to something you said, and
I didn't quite get it, but I think it's important,
and of course it's very interesting to our audience. You're
talking about the AI financing, and I think you said
something contingent, makehold guarantees. I don't tell us about these
financing as you see them. And what is the history,
How novel are they relative to past financings, or how

(30:18):
much is it that these are structures that were very
much in place for something else are now being reproposed
into this new exciting area.

Speaker 4 (30:26):
Yeah, I'll start with what's new, which is lending to
support the growth and AI and related infrastructure.

Speaker 5 (30:35):
There.

Speaker 4 (30:35):
You're talking about several trillion dollars of investment need. So
that's what's new, But you know what's not so new
is this idea that companies would like to keep a
good portion of their debt off their balance sheet or
come up with structures that limit their overall financial liability
or give them some flexibility to manage that liability over time,

(30:58):
and as an end investor to lend to those companies.
You know, it's important to acknowledge that lenning against tech firms,
lenning against AI infrastructure, lenning against AI chips is risky.
That could be a real good investment if you own
the equity, may not be a great investment if you
own the bonds, where at most you get your coupon
and you hope to get par back at the end

(31:18):
of the day. So a lot of the underwriting of
these transactions, and there have been a lot and we
expect a lot more to come over the course of
the next few years, is to understand the form of
that guarantee and understand the entity that's providing that guarantee,
whether it's in the form of lease payments or other
type of makehold type arrangements. And these types of structures

(31:40):
are what have been around for many, many years. You know,
back in the mid in late nineteen nineties. You know
a lot of times these would be done by Wall
Street financial institutions, sometimes across a segment of their business
where they would use a corporate guarantee to arbitrage a
bit of the radio agency frameworks. At other time times
these deals were backed by large ships, equipment, other areas

(32:05):
of the market. So it was the same type of analysis,
the same type of underwriting checklist, which involves a lot
of lawyers to ensure that you understand the guarantee how
you have to realize on that guarantee, and that's not
so different today.

Speaker 2 (32:19):
And just to be clear, the guarantee we're talking about
here is okay, here is a hypothetical SPV that owns
a data center and it borrows money and finances, et cetera.
And the guarantee question is how much will the tenant
of that data center, which didn't want to have all
that DEBTA on their books, maybe like a Facebook or
one of the hyperscalers, how much are they actually committed

(32:42):
to being a tenant for the long term They're basically
that's what we're talking about.

Speaker 4 (32:46):
Absolutely correct. And why it matters here is you're typically
talking about investment grade rated counterparties on these transactions where
the infrastructure itself, the assets that are partially backing the
d a lot of stablone basis would achieve a very
very low rating. So how do you create a structure
where you improve the credit quality while meeting the needs

(33:10):
of those that are looking to borrow within this market.
So again, the whole key is to make sure that
something that the radio agencies may assign investment grade rating too,
is in fact investment grade from a fundamental credit quality perspective.
And I think that's another theme. You know, in talking
about private credit, you know there are more economically sensitive,

(33:31):
lower quality loans, and then there's been a lot of
growth on the investment grade side. It is very, very
dangerous to assume something has an investment grade rating just
because of the rating agencies assign a rating to it.
It's critically important that you do your own credit work. Today,
all too frequently you will have an investment grade rating
from one entity. And again, market participants for years have

(33:51):
always joked, if you can only find one investment grade rating,
it's pretty fair to assume everyone else's below investment grade.
So the bottom line is that there's been a lot
of aggress of underwriting going on, even with instruments that
carry an investment grade rating at least from one entity.
And again when spreads are tight, when documentation is relatively weak,
it's just critically important that you do your own fundamental

(34:13):
credit work. I do think Pimpco has some advantages in
that area, both in terms of experience and resources, but
it's super important because you're not always getting the terms
that you want. When you do, you can unlock tremendous
value for your clients. But this is an environment where
we have to be really really selective as a bond
investor at least.

Speaker 3 (34:31):
Yeah, when I think back to the twenty fifteen environment,
I remember a lot of people were writing stories about
the triple B bubble in investment grade. So Triple B
is the lowest tier of investment grade and that had
been absolutely exploding post financial crisis, and everyone expect not everyone,
A lot of people expected that to end in tiers,
and instead it ended with all those like Triple b's

(34:55):
getting upgraded and a lot of junk getting upgraded as well,
and having a bunch of rising stars, which I don't
think a lot of people were necessarily expecting, but talk
a little bit more about the rating agencies. What are
the pressures that you think are perhaps driving them to
rate some of these structures higher than they otherwise might be.

Speaker 4 (35:17):
Well, again, there are multiple radio agencies that have different
philosophies to how they arrive at a rating, and there's
going to be understandable disagreement, you know, within markets. But
issuers are quite shrewd. You know, they're going to go
to where they get the most favorable ratings treatment. This
has always been the case, and I think the important
point to notice that when stocks are going up fifteen

(35:38):
percent a year, when the economy is growing, when you
don't have a sustained period of economic weakness, even poorly
underwritten credit will mature. We experience that in an extreme sense,
you know, during the two thousands. What we try to do,
is active investors is to underwrite two weaker economic environments,
environments where you know those underlying entities or the infrastructure

(36:02):
you know that you that you're lending against go into
a period of weakness. And I think that's where you know,
good fundamental credit work in this type of environment that
we're in today that's very much driven by rating arbitrage.
You know, seeking out investment grade ratings, you know, for
an insurance balance sheet or reinsurance balance sheet as an example.
You can lead at times to aggressive decisions. So I

(36:26):
think it's just a nature of the fact that you
have multiple agencies and some will be more optimistic in
certain areas than others.

Speaker 5 (36:32):
But that's great.

Speaker 4 (36:33):
You know, if we didn't have those sources of disagreement,
that wouldn't be opportunities to generate incremental return, you know,
versus passive alternatives.

Speaker 2 (36:41):
While we're here on credit. Actually, you know, there's probably
about a month ago or a month and a half ago,
that's when we were getting all those headlines about tree color.
And that was when Jamie Diamond made the sort of
famous crickets thing. I was getting real corea cockroaches.

Speaker 3 (36:58):
I hate cockroaches and I like crickets, So I want
to make that clear.

Speaker 2 (37:01):
Crickets are lovely. Yeah, right, I should not associate them
with credit blow ups. That's completely unfair to crickets. It's
fair to cockroaches. Jamie Diamond made those cocker I was
getting worried. I saw all these heads like going another
antity took a hit on this another entity. I was
like oh, this is very familiar. I don't like I
don't like how many times the same company appears in
the headlines. But we haven't gotten that much actually since then.

(37:22):
It's not like there have been five more of those.
I'm just sort of curing is setting aside some of
the data center, the sexy private credit stuff that everyone's
focused on. Do you do you think over the last
several years, was there some systematically bad underwriting going on,
especially over the last few years, or were there isolated
cockroaches the first cockroach before they had a chance to

(37:42):
lay eggs and make babies, the lonely cockroaches.

Speaker 5 (37:45):
Yeah?

Speaker 4 (37:46):
Yeah, So look again, because there's been so much growth
in lending to lower quality companies, and again, the last
major cycle was lending to lower quality households. Yeah right,
you know, there's going to be areas of excess, and
I think people are focused on these areas.

Speaker 5 (38:05):
But again, when you look at.

Speaker 4 (38:07):
The cumulative delinquencies and losses, yes they've increased a bit
over the last few years, but these situations have been
relatively isolated. But again, anytime you've had this much credit expansion,
you're going to have challenges, and these challenges are happening
in a relatively strong economy, so we don't think this
will be a catastrophe. The word I've used is that

(38:29):
there's likely going to be disappointment in certain areas of
the credit markets that have performed exceptionally well over the
last ten to fifteen years. But that shouldn't be viewed
as an overly controversial statement. That's how markets work. You know,
credit was very cheap ten or fifteen years ago, high
quality bonds were very very expensive. Today, credit spreads are
near all time tights, equities are near all time highs,

(38:51):
and valuate high quality bonds looks reasonable relative to their history.
So you know, starting valuations tend to be pretty big
drivers of future turns. If the economy continues to grow,
if stocks keep going up fifteen percent a year, yes,
these will be relatively isolated situations, but if you get
into a period of economic weakness, losses will go up

(39:12):
and they'll likely be some disappointment. I think that's the
best way to categorize it. And then I think the
second important point when you look at markets in a
longer term historical context, is that regulators hate bailing out
the same sectors twice back during the GFC, it was
lending to the consumer. It was excessive lending from the
banks that caused all of the problems, almost took down

(39:33):
the financial system, and not surprisingly, the regulations towards the
banks and towards consumer lending was massive. And today when
you look at the world, the household balance sheets, certainly
middle income and above cohort groups hasn't been stronger this strong,
and several decades there's record amounts of borrower equity in
these areas of the market have been very, very strong.

(39:56):
From an underwriting perspective, the areas that escape the scrutiny
of the last time, you know, a lot of lending
to non financial corporates, a lot of this mid market
private lending that came out of that period relatively unscathed
from a regulatory perspective, has grown a lot. So I
think a lot of this just relates to longer term cycles.
PIPCO is talking in a much different way back in

(40:18):
two thousand and five, in two thousand and six, where
we were screaming from the rooftop saying that you know,
what was going on was so irrational that there were
major problems ahead. That's not where we are and That's
why I sometimes sound a bit more negative than we are.
I think that the idea of disappointment is the way
people should think about some of these areas of the
credit markets. And the good news is you don't have

(40:39):
to accept disappointment. You can simply accept the fact that
you had a great performance run and that by going
up in quality, expanding into a global opportunity set that
hasn't been sufficiently embraced just yet, perhaps voting a little
bit of non dollar exposure gets you in the same
place with much more resiliency, much more downside protection, and
a lot more liquidity or flexibility to change your mind

(41:03):
in the future as well.

Speaker 3 (41:04):
Since you brought up household balance sheets, can you talk
to us a little bit about your housing outlook, because
I believe PIMCO has been pretty bullish on mortgages recently,
but at the same time we've seen a slight slow
down in the housing market. But then again, we still
have long term structural tailwinds, such as a massive undersupply

(41:26):
of homes in the US. Where do you see that
going in the coming years, particularly, you know, if we
were to see inflationary pressures start to pick up and
those longer end yields start to rise.

Speaker 4 (41:38):
Yeah, so we are very bullish on housing related investments
in the United States as well as in other areas
around the world. Agency guaranteed mortgages still traded very widespreads
relative to corporates. Even in an absolute sense. We think
it's a very high quality, liquid area of the market
that again makes a lot of sense to own a
cross a variety of different mandates. We also like lending

(42:02):
in the non guaranteed area against the house simply because
borrowers have record amounts of equity.

Speaker 3 (42:08):
So when you lend its collateral. Yeah, that's what it
sounds like. You love collateral.

Speaker 4 (42:13):
Yeah, we like good documentation and good, good, good collateral.
You know, at least all else equal. But you know,
it's not a major bet on the directionality of homes.
When you're lending against a household that has seventy percentage
points of of borrow equity, your home can go down
quite a bit and you're very well protected. That same

(42:35):
dynamic exists you know, over the UK, across Europe, you know,
and even in other parts of the world. So you know,
again regulators don't like building out the same sectors twice
that's pretty good acid allocation advice. It's quite straightforward. But also,
you know, you have much better fundamentals across households. But
to your specific question around housing, it's a tough situation.

(42:57):
We do think that homes are going to remain elevation
from a valuation perspective, and affordability is going to remain
quite constrained because there's no easy answer. You know, you
bring the mortgage rate down, the home price goes up.
You know, affordability doesn't change in a meaningful sense. What
we really need in this country and other parts of
the world are more homes, more housing units. And again

(43:18):
because of a lot of the post global financial crisis regulation,
it's been real hard to build new homes. So our
base case view is that home price is going to
moderate here on a national level. You could see, at
least in real terms, you know, some steady declines over
the course of the next several years in certain markets
that are a bit overextended, you know, a bit more volatility.

(43:41):
But we do think that you know, home price is
going to remain elevated from a historical perspective, just because
of the fact that people have locked in very, very
low mortgage rates thirty years, you know, not just five
or ten years. You know which which we're you know,
mortgage durations, you know, popular pre GFC. So you know
you're not going to see you know, two much turnover.
And unfortunately that means that homes for you know a

(44:04):
lot of younger Americans are going to remain out of reach.
But but again, maybe some incremental benefit, maybe you know,
this administration get mortgage rates down a bit through some
creative policy the next couple of years. By the way,
we'd like that given pimco's current positioning. But again without
without building new homes which are going to take you know, many,
many years. You know, there's no easy solution.

Speaker 2 (44:26):
I want to go back. You mentioned this idea, there's
there's an optimal amount of fiscal profligacy from the perspective
of the bond investor. Maybe you want them to push
it a little bit because then you get paid a
little bit for taking it on. But obviously you don't
want them to push so forth where you get some
fiscal dominance spiral leading to higher and high inflation. You
want to find that sweet spot, you know, I mentioned
we're talking a little bit about politics, earlier about whether

(44:49):
independent central bank can be sustained. But when you look abroad,
you know, it seems like in a lot of pretty
major current we're not the only country that's having political
volatility these days. We're concerned about the approach that the
new Japanese PM is going to take it. So we
know that rates are higher in Japan. France, very indebted country.
They seem to have like a new government every two weeks.

(45:10):
I like lose track of all the times their government
collapses and so forth. The UK, very indebted country. The
moment anyone takes office, their approval ratings plunge to negative
thirty or whatever. There's a lot going on on the
political front, and that sort of determines whether countries are
even it's even possible to run what might be more
responsible fiscal policies. Is that something that I don't know

(45:33):
keeps you up at night, is the right term, But
is that something that's a big part of your work
is trying to understand, especially when you think abroad, understand
the political dynamics and all these countries that are happening
right now.

Speaker 5 (45:45):
Yeah.

Speaker 4 (45:45):
Absolutely, And you know we get together once a year,
you know, talk about the outlook for economies and markets
over a five year type timeframe. And you know, one
of our advisors I think put it well was that,
you know, we used to live in a world where
you know, economic outcomes would drive politics. If economies were strong,
you know, politicians usually ended up in a in a

(46:07):
good situation. They're they're, they're, they're, they're, they're stay in office.
Today it feels like it's a bit reversed where political priorities,
geopolitical tensions are driving economics. And I think you see
that to a degree with tariff policy, you see it,
you know, to a degree with with various forms of reassuring.
You see it in terms of these populist tendencies across markets.

(46:29):
So they're all very, very important and a lot more
important than they were in the past. And I think
it takes a lot of humility from someone like myself
and others that grew up you know, doing you know,
discounted cash flow analysis and you know, derivative pricing as
opposed to understanding the political economy. So you know, we
think that that's important both from the perspective of gaining

(46:50):
in edge in markets, but also understanding that sometimes will
be wrong and when you're running the debt levels that
countries are running or your deficits in overall debt levels,
there's going to be some unpredictability. And that's why this
idea of looking to exploit a global opportunity set prudent
diversification targeting some countries outside the US that aren't running

(47:12):
you know, six seven percent deficits, and there are high
quality countries out there, Australia being an example, Germany being
another example, even the United Kingdom, although they have a
lot less policy flexibility than we do, given that there
were smaller open economy with their own currency offer attractive yields.
So this is less about picking your favorite country from
our perspective, it's more looking at take advantage of attractive

(47:36):
opportunities around the globe, with some tilt towards those countries
that are balancing their budget and that do have a
better overall fiscal picture. And we haven't talked about emerging markets,
but they are. You know a few emerging markets that
you know, this cycle got ahead of inflation, that have
been in some sense more fiscally prudent than their developed
market counterparties, and that have very very high yields even

(47:59):
ad just for inflation rates. So even some diversification in
some of the higher quality areas of the emerging markets,
from our perspective, represents real good value or real good
sources of diversification in return versus some of these assets
you know here in the United States that have performed
real well historically, but where when you look at the

(48:21):
likelihood for forward performance just just look a little bit
less interesting.

Speaker 3 (48:25):
Actually, this reminds me thinking back to twenty fifteen. Twenty
fifteen was actually a big year for PIMCO because it
was your first full year without Bill Gross, right, who
left in late twenty fourteen. Can you talk to us
perhaps how the culture of PIMCO has changed over the
past ten years, and how you would describe that evolution,

(48:47):
because I imagine it's been a long time, it must
have shifted a little bit.

Speaker 5 (48:51):
Yeah.

Speaker 4 (48:51):
Look, well, you know, the way Bill left the firm
was an ideal, to say the least. But you know,
Bill left us in an incredibly strong position. You know,
he created a lot of the frameworks that we still
use today to make decisions. Bill was a strong personality,
but he believed in teamwork and believe that investing was
a team sport, you know, so to speak. So from

(49:12):
that perspective, there didn't need to be a lot of
change or certainly not radical change. But over this period,
you know, markets have become you know, so much more specialized.
Client needs have evolved, you know, over time, the introduction
of a more sizable private opportunity set has been important. Technology,

(49:33):
big data, using you know, trading techniques, portfolio trading in
other automated you know type, you know, trading strategies are
all critically important. So you know, we're a much more
specialized firm today, which is a function of again, you know,
evolving client needs, but also just you know the realities
of this world that we live in today, where data
is abundant, much less expensive to access. So from that perspective,

(49:58):
we've needed to adapt, you know, even more global. So
you know, we tend to utilize regional committees in regional
decision making structures, but a lot stayed the same at
least in terms of mindset, and we try to really
leverage you know, the history and the experience the firm
has had managing and navigating through more challenging markets. Twenty

(50:20):
two is rough, you know, from both stocks and but
you know, in general, you know, the environment's been reasonably forgiving,
but you can always get into these you know, tougher periods,
and again we try to use these structures that you know,
build put in place and buill deserves.

Speaker 5 (50:37):
Trying to about a credit for.

Speaker 2 (50:38):
It's funny in your last answer there there were like
five things you said that could merit full follow ups
or even full follow up episodes, like about changing client
needs over time, or what happens when the cost of
data goes from costly to fairly affordable, et cetera. All
those sort of interesting things. But just my last question,

(50:58):
and it sort of relates to technology. You know, when
it comes to AI in investing, we've talked a little
bit more on the short term like high frequency side
and the sort of models that they use and the
signals that they use, and how that sort of relates
to AI and their application. But for a firm like
PIMCO and when you're thinking about longer term holding periods

(51:20):
and you want to have some a good collateral and
good documentation, et cetera. Currently today, have you found ways
to apply cutting edge AI technology to the process of
good security selection.

Speaker 4 (51:33):
We have, and we're finding ways to utilize the technology
at an accelerating rate. We do some of this and
some of our you know, more quant focused strategies, you know,
where we look to use AI to actually drive alpha,
But just AI as a tool to drive efficiency has
been will be critically important to managing an investment platform.

(51:59):
Just the ease in which you can access data that
you can use AI to help support overall analysis, both
at the company level, the individual investment level, but even
coming through economic history and understanding some of these geopolitical
trends in themes that are hard, at least intuitively to
grasp are going to be critically important. In fact, before

(52:20):
our discussion today, spend considerable time with our head of
technology and our head of implementation talking about various firm
wide initiatives. And I think the only other point is
my own use of AI, both at home and at
the office has gone up almost exponentially over the last
year or two. And I'm the last person you want
to rely on to understand this technology. It's the younger

(52:41):
folks that we hired over the last year that are
helping us with a lot of this perspective. So this
is going to be quite disruptive, probably productivity enhancing, you know,
at the economy wide level, but it's also going to
lead to considerable disruption, and it's important that we don't
get disrupted and that we use this technology to drive
client returns. But you know, it's going to be important

(53:03):
in so many ways and we're really really embracing it
here here at Pimco.

Speaker 2 (53:07):
Dan Ivison, thank you so much for coming on odd Laws.
That was a fantastic conversation. Really appreciate you taking the time,
and we're going to check back in with you in
twenty thirty five and see how well you got how
well one got paid for taking a little bit of
duration here.

Speaker 4 (53:21):
Great Joe Tracy, thanks again and correct congratulations on the
big milestone and so much.

Speaker 3 (53:26):
We thank you so much. Dad really appreciate it.

Speaker 2 (53:28):
Thank you guys, Tracy. I thought that was greatly I
really enjoyed talking to Dan. Fantastic overview.

Speaker 3 (53:46):
Yeah, so a couple of things stood out to me.
So number one the idea of no more free lunch
and credit, although people have been talking about that for
a while now, and obviously with the great environment changing,
you can see that argument. The other thing that I
really liked was his description of policymakers don't want to
bail out the same thing twice.

Speaker 2 (54:05):
Yeah, that's interesting framework or way to think about it.

Speaker 5 (54:08):
Yeah.

Speaker 3 (54:08):
Absolutely, And it kind of reminded me of there's another
person in credit who used to tell me a line
about how he invests, which is follow the bad guys. Right, So,
like the guys that blew up in one part of
the market usually, you know, start doing.

Speaker 2 (54:26):
Something to act, they're going to get their acting. Are
you saying they're going to get their act together? Or
they're going to do something I'm saying, they.

Speaker 3 (54:31):
Move to the new thing, and then that blows up.
And so if you can just identify the bad guys
and just follow their career trajectories, just short everything the
bad guys do.

Speaker 5 (54:41):
I love that. I love that take.

Speaker 2 (54:43):
You know what was really I had not realized that
stat he said about how little you got paid for
taking for buying poor credits up until the GFC. Yeah,
and then post GFC is just totally flipped that you
just got you should just go as far out on
the credit at risk curve as you possibly can, and
you've just walloped anything safe. And I knew that, I

(55:05):
guess on some level, but the extreme of that statistical divergence,
but you know, you have to think we had that
well it was more than a hiccup in twenty twenty,
but we did bounce back very fast from it. So
really what we were looking at is, you know, well
over fifteen years now of the lines just going up,
and you have to think about what are the things

(55:26):
that accumulate over that time, or the patterns that accumulate,
or the habits, etc. And this idea that there's a
lot of safety at the far end of the risk
curve and that people don't care and that maybe now
some of the perception that there's safety at the far
end of the risk curve and how much that's been
burnished into people is very interesting.

Speaker 3 (55:44):
Absolutely. The other thing he said that I thought was
very poignant was the idea of you have all these
private credit firms starting up right and promising these astonishing
returns for investors. And he made the point that, like,
you can't just say you're going to make all this
money at private credit because like those deals might not
be out there and available to you. You have to

(56:06):
do it on a risk or value adjusted basis. Yeah,
and as I say that, I see a headline in
Bloomberg about Capital Group getting into private credit as well.
So this is the thing. Like it's a booming market.
There are a lot of competitive pressures, both on the
lender side and also on the credit rating side, and
you can see people really scrambling to get into the

(56:29):
market and accumulate as much as they can. And so
the temptation, of course is to you know, accept lower terms,
accept lower quality totally. All right, shall we leave it there.

Speaker 2 (56:39):
Let's leave it there, all right.

Speaker 3 (56:40):
This has been another episode of the Odd Loots podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.

Speaker 2 (56:45):
And I'm Jill Wisenthal. You can follow me at the
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