May 29, 2025 • 44 mins
Private credit may be hot, but it isn’t for all investors and doesn’t do better than traded junk debt, according to Dimensional Fund Advisors, which manages $790 billion in assets. “There is no outperformance relative to high-yield public bonds,” Savina Rizova, the firm’s co-chief investment officer and global head of research, tells Bloomberg News’ James Crombie and Bloomberg Intelligence’s Jean-Yves Coupin in the latest episode of the Credit Edge podcast. “Some people might get disappointed with some of the attributes of private credit,” says Rizova, highlighting better liquidity and transparency in public markets. Rizova and Coupin also discuss Dimensional’s expansion into mortgage-backed securities, its active exchange-traded fund strategy and the firm’s overall credit exposure and positioning.
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Episode Transcript
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Speaker 1 (00:17):
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 2 (00:23):
And I'm Jeannief Cooper, senior analyst at Bloomberg Intelligence. This week,
we are very pleased to welcome Savina Risova, co Chief
Investment Officer and Global head of Research at Dimensional Fund Advisors,
at seven hundred and ninety billion investment firm. How are you, Savina, good?
Speaker 3 (00:39):
Thank you for inviting me.
Speaker 2 (00:40):
Savina joined Dimensional Fund Advisors as a research associate in
two thousand and four, and just of our year ago
she added the title of co Chief Investment Officer. You
also obtained a PhD in finance from the University of Chicago. Last,
but not least, Sabina was recognized as one of Barn's
one hundred most Influential Women in US Finance for two
years in.
Speaker 1 (01:00):
So we're going to get into all that, but just
to set the scene before we do. Markets have rallied
on high hopes of a broad ceasefire in the trade war,
but there's still a lot of uncertainty out there, plus
more volatility to come as the US moves on from
tariffs to tax and immigration. Reform, headline risk is very high,
yet credit markets project an air of complacency, with debt
spreads back below where they were before the so called
(01:22):
Liberation Day at the start of April. Keeping corporate debt
risk premium very tight is the fact that there's way
too much demand for a very limited net new supply
of corporate bonds, and unless the M and A machine
cranks back up, that supplied demand imbalance will probably continue.
On top of that, the US has lost its Triple
A credit rating, calling into question the idea of risk
(01:42):
free rate and investors are now looking more at Europe
and Asia as alternatives, but there are clear limitations when
it comes to scale and liquidity there. So, Sabina, what's
your take. I'm going to ask a really broad question
because it's one that keeps coming up on this show.
But is credit fairly valued at these levels?
Speaker 3 (01:59):
Well, the meension we don't pretend to have a crystal bow,
James and know where prices are relative to fair value.
We actually take priceses kind of given in public competitive
capital markets. But what we can say is where the
current credit spreads are relative to historical averages and medians,
(02:19):
and these days, what you mentioned is absolutely correct. Credit
spreads have are about eighty to ninety beps depending on
whether you look at US or global markets below historical
mediums of over one hundred, one hundred and ten basis points,
So definitely narrower credit spreads and based on academic research
(02:39):
underpinning our approach that suggests lower credit premiums expected in
the future. As a result, our core strategies tend to
not go to their maximum allowed credit allocation right now,
and our credit strategies are not allocated to the maximum
in what we call low work here single aay tripob
(03:02):
bombs for example.
Speaker 2 (03:03):
So in terms of allocation, I mean, are you looking
across the credit spectrum, do you have any views on
higher quality names versus lower quality names given the environment.
Speaker 3 (03:14):
Absolutely, And it's probably worth kind of taking a step
back and just telling people a little bit more about
who they mention is and how we approach investing both
in equities and fixed income, because I think it's pretty
unique and different from a lot of guests you've had
on the podcast. The Dimensional is a firm that was
founded in nineteen eighty one to implement kind of rigorous
(03:37):
research into robust investment solutions. One we would like to
think about. It is sensible ideas, implement it thoughtfully and
so and it comes to fixed income. You mentioned Gene
Fama being one of the academics tightly connected to dimensional
He did a lot of research in the seventies and
(03:57):
eighties in terms of what drives expect bond returns. And
if you think of the expected returnal defaulte free bond,
like what my thing, the US bond still US government
bands still consider it uh to your earlier point, UH,
you can actually write it down as like three terms
yield expected capital appreciation or depreciation depending on the shape
(04:21):
of the curve, so roll down as some call it.
And the third term is expected changes in the shape
of the youth curve. And between now and when you
expect to sell the bond. So the first two components
of that decomposition, yield and roll down together our called
forward rates. And there is a lot of empirical academic
(04:44):
reaserch showing that forward rates do contain information about subsequent
bond returns. So differences in forward rates across bonds contain
information about differences in future bond returns. And you can
apply the frame and tested and we have not only
across duration spectrum, but also across credit quality spectrum and
(05:07):
across currency of issue spectrum. So, for example, the differences
in fields or forward rates between longer and shorter bonds
tell you the term spread essentially contain information about the
future term premium. The wider the term spread is generally
the wider the subsequent future term premium is. Similarly for
(05:28):
credit premium and credit spread. That's why I said like
currently credit spreads are relatively narrower, which means we expect
relatively narrower credit premiums less reward for holding credit. And
then similarly you can apply it across different currencies around
the world. For example, HATCH to USD looking at what's
steep versus flatter, the steeper curves HASH to USD imply
(05:55):
higher expected reward for going into those bonds and hedging
back to USD right now. For example, the Japanese government
bond curve is relatively steeper haah to USD compared to
many other develop market currencies, so some of our strategies
that are allowed to go global are allocating more to
(06:17):
Japanese intermediate bonds. So in essence that the dimensional we
look at forward rates the combination of field and roll
down as the indication of where highest expected returns are
and allocate on a daily basis based on differences in
expected returns and those expected returns those forward rates can
(06:39):
change any day across the credit, the duration and the
currency of vision spectrum. So it is important to have
a daily process where we consume information, compute those expect returns,
and decide how to allocate new cash community or from
coupons or from cash flows, and what to buy what
to sell based on those expected return differences.
Speaker 1 (07:00):
Say, Savi, you have a sort of scientific approach to this,
and you know, you talk about decades of rigorous theoretical
empirical research. But as we've discussed, you know, the so
called developed markets are becoming highly unpredictable as politics becomes
such a big factor. You know, I would say that
they're behaving a lot more like emerging markets than they
used to. Who knows what social media posts will wake
(07:21):
up to on any given day that will royal global markets.
But how does that affect your approach? Do you need
new models for that? Do you rip up the script
and have to you know, really just improvise a lot
more than you used.
Speaker 3 (07:32):
To not really exactly, because we are kind of grounded
in evercreen principles of what drives expect the returns. All
we need is latest market prices essentially to identify bonds
with higher versus lower expect the returns. And that's why
we are big advocates for price transparency and we're very
(07:53):
happy to see trace that trade reporting and compliance engine
arrived in the early two thousands bringing a lot of
transparency to the corporate bond market in USD and now
there's tracks for a non USD. So we have that
and we use it on a daily basis in real
time during the day to essential monitor prices as well
(08:14):
as bidden as quotes across many different bonds to identify
differences in expected returns. But what we also do with
current market information as it changes all the time to
your point right now very volatile markets, is also used
current market information for the other two very important dimensions
(08:35):
of investing. So one day mention is expected returns. The
other two day mensions of investing in general are risks
and costs, and we use current market information all the
time to manage risks and control costs in our portfolio.
Is because we believe that you can add value by
systematically designing strategies to pursue higher expected returns, but you
(08:58):
can also add value through talk for portfolio management and trading,
how do you use current market information? In portfolio management, we,
for example, track to your point within the day through
and daily. The deer inventory trace gives us kind of
information on net deer buys and sales throughout the day.
We also get that information daily from similar information daily
(09:22):
from Blueberg and inter the day from trade web and
market access platforms that many of your listeners probably are
familiar with, and this helps us identify bones where dealers
might in augria have an inventory, accumulated inventory might be
willing to sell to us at a favorable price, and
similarly for sales, so der inventory is very important to
(09:44):
monitor to get great execution. Also, we use market prices
to monitor credit quality. To your point, in the last
five years, most of the credit rating changes internal credit
rating changes we've performed most have been driven by prices
information in current market prices, not by credit rating agencies
(10:05):
changing their ratings. So what we use there is not
just prices of bonds, trading or quotes, but also CDs
market prices. Even the equity prices of the issues of
those bonds, so you can use current real time market
information along with kind of the academic framework for what
(10:26):
drives expected returns to continue to deliver robust investment solutions
even in highly volatile times as we are experiencing this year.
Speaker 2 (10:36):
So in terms of your investment approach, I mean, I
mean the two main investment approach being top down or
bottoms up, and especially you know, looking at all these
data that is available in terms of as you said,
trade and ventory prices, how do you reconcile the two
and how your investment process I'm sure incorporates you know,
(10:59):
both of the top down view from rates to you know,
sectors and then the bottom up this this bond is
actually treading wide or cheap against another one, and that's the.
Speaker 3 (11:10):
Time to buy. Yeah, thank you for the question. It's
a common question we get because people are in fixed
income are generally used to two types of investing traditional
passive and by the way, these are the biggest kind
of ETFs and mutual funds out there. Indexed approach in
fixed income with some sampling under the hood, or traditional
(11:30):
active where you're typically either top down for making macroeconomic
forecasts and then driving your investment or bottom up picking
individual bonds based on research on specific sectors or currencies,
et cetera. We are kind of combining the best of
both worlds, traditional passive and traditional active in the sense
(11:52):
that we have broad diversification in our strategies and relatively
low turnover just like traditional passive, but we are taking
from traditional active the daily flexible implementation in the pursuit
of higher expected returns. How do we do it, though
different from traditional active? Are we top down or bottom up?
(12:12):
I would say we're both. Why because we start every
day by looking at the overall spreads out there, turn spreads,
credit spreads, and spreads across different field cares, heads to
a local currency, and that kind of guys the overall
positioning of a portfolio in terms of how much we
(12:34):
want to okay to credit corporates versus governments or different
types of currencies. Once we get do this kind of
top down analysis based on current market information, then we
try to kind of bottom up looking at what we hold,
what we want to hold, which bonds within kind of
the para. Now those parameters how much we want to
(12:54):
okay to corporate today versus governments within corporates, Let's say,
which are the bonds with highest expected returns, most attractive
forward rates, And we start kind of identifying bonds that
we would like to buy today based on that approach,
very systematic, and then what we do is we go
filter those bonds to a bunch of criteria including kind
of how liquid those bonds are in the marketplace today,
(13:16):
are we likely to get good prices for those bonds?
And then once we kind of set on a group
of bonds we'd like to buy, we pass this to
the trading that so for from portfolio management to trading,
where traders whould go to the marketplace and very flexibly
seek to purchase some of those bonds without being particularly
(13:38):
attached to an individual bond. And I think this is
also a huge differentiator for the dimensional is that we
are not chasing individual bonds picks of a portfolio manager,
not at all, and that gives us the ability to
have great execution. What do I mean by great execution?
When we compare our corporate and agency trades versus the
(14:00):
prior trade in the same issue or the next trait,
on average, our trades are twenty basis points better on
the buy side and five to ten basis points better
on the sales side because we trede flexibly with patients
with optionality out there, we have multiple bonds with similar
expactor returns that we're interested in buying or selling today.
Speaker 1 (14:21):
Your approach seems take a lot of trust in what
the market price is selling us in terms of transparency
in terms of the liquidity. But as you know, you know,
the further you get down the rating spectrum and the
more you get into sort of exotic credit you know
e merging markets, those markets get stuff wrong all the time.
You know, the signals are just plain wrong. How do
you protect yourself against that as an investor?
Speaker 3 (14:42):
Great question, James, Another great question. We have historically stuck
to the parts of the market that benefit from a
lot of price transparency. So, in terms of kind of history,
Dimensional started in high quality corporate and government back in
nineteen eighty three with its first fixed income strategy, and
(15:05):
then later on expanded to develop market currencies, so applying
our kind of variable maturity and variable currency approaches there.
And then we started investing in full investment rate only
in two thousand and nine, actually a few years after
trades arrived and brought transparency to the corporate bond market,
(15:26):
and then we started also kind of dipping our tools
in double bees, but not going below that. To your point,
once you go the low double bees into single bees
and three POC's and below, one major concern is the
default rates. The default rates increase meaningfully on average historically
for single bees they are like three percent for trip
(15:47):
o C and below twenty five plus percent. Those are
we viewed those as not necessarily suitable investments for ETFs
and mutual funds, which need to provide liquidity on a
daily basis. Similarly, we've stuck through history to develop market currencies.
We do not invest directly in emerging market currencies to
a large degree because of price tre experiency, but also
(16:11):
because of operational law and order consideration as well.
Speaker 2 (16:16):
I think there is an interesting point of you know,
create risk transparency and maybe to switch gears a little
bit and move into private credit. I mean, we've seen
a huge expansion of private credit, but also a lot
of comments and risks maybe out there, and some people
have been saying there is maybe a risk of you know,
(16:37):
ratings inflation, or risk of lack of transparency or very
credit trade. I mean, how do you approach private credit
as a nassage class within fix income.
Speaker 3 (16:46):
So as a manager, they mentioned it is in the
public space public stocks and public bonds and a systematic approach.
But we strive to be a very objective thought leader
in the industry put a lot of papers out are
the SIK to provide kind of a framework for how
to think about different investment topics. And so a couple
(17:07):
of years ago, with the growing interest in private and
the growing i'd say push of private out there, we
decided to actually buy data historical data from Burgess now
MSCI on private fund performance and study private performance across
four major asset classes, one of them being private credit.
(17:31):
So we looked at historical performance of private credit from
nineteen eighty to twenty twenty two, and what we found
there for private credit was that depending on the average
kind of historical ten year IRR is about ten percentage points,
which sounds appealing, But when you compare to hyat public
(17:55):
benchmarks like the Bloomberg Hi index, then what you see
is that public market equivalent or direct out of measures
comparing private to public performance are all kind of in
favor of the high index. There is no outperformance relative
to yield public bonds, which comes to tell you that
(18:16):
private credit is, at least historically has been a way
to get exposure to yield below investment grade credit. Does
private credit provide additional diversification beyond what's available in the
public market? Yes, absolutely. There are different bonds out there,
generally different issuers going for the private route versus public,
(18:39):
So there are some diversification benefits if you want to
add private credit to your public exposure. But of course
private comes with a lot of caveats and challenges, one
of which you mentioned very important ones for US prices,
frequent updates of prices, reliability of prices there it's not
(19:00):
by accident, it's called private. Also, lack of adequate diversification
because ultimately we cannot all own parts of all private companies,
you cannot get the full diversification you get in public
markets if you want to. And as a result, I think, well,
it will be interesting to see how private interesting private
(19:23):
credit develops, because there is kind of a an evergreen
value proposition for private It is has its own economic
function out there, but not everyone probably suited for an
investment in private people who might have short term immediate
liquidity needs, etc. Who cannot have a long horizon and
(19:44):
a for not to touch that part of money for
a long term might not be prepared for private investments
or well suited for private investments. In terms of information available,
definitely much less information available easily, and I think that's
why even in the when you look at buyouts, another
(20:05):
segment of the private market trades in the secondary market,
which attempts to mimic a public market right in terms
of getting some valuations for buyout stakes, et cetera, you
typically see haircuts of like ten fifteen percent, which speaks
to prices might not be as reliable they are as
(20:26):
they are in public markets.
Speaker 1 (20:27):
We've had some guests recently talk about a two hundred
basis points premium in private markets against public I'm assuming
that mostly talking about loans there, but sounds like what
you're saying is that there is no relative value in
private and actually there's better risk just to return in
hial bonds versus private debt. Is that is that correct?
Speaker 3 (20:48):
So it's very important what you compare private.
Speaker 2 (20:51):
Too.
Speaker 3 (20:53):
Many people might compare private to the Global or us
ag I Investment Grade Index. There you would see our
performance if you compare to Hyatt, you don't see our performance. Yes,
and it's kind of similar. On the private equity side,
many managers like to compare themselves to the S and
P five hundred. In our opinion, that's not an adequate
(21:14):
benchmark public benchmark. For private equity, you want to probably
take a look at well designed small happiness is small growth,
small value. And then the conclusion is very similar to
what we discuss for private credit. So it really matters
what you compare yourself to.
Speaker 1 (21:31):
And also you mentioned it, you know, it really depends
on the kind of investors. Not suitable for everyone, but
you know you're an ETF shop. There are ETFs now
for private credit. What do you make of that?
Speaker 3 (21:42):
We shall see, let's put it that way. In terms
of public bond ets, we see a lot of demand
for those. Obviously the largest ones are index focused, but
we now see growing demand for a kind of what
the types of ETFs with delivery dimensional systematic active, both
(22:04):
on the bond and on the equity side. We are
actually the largest systematic active ETF manager out there with
one hundred and seventeen plus a billion dollars in active ETFs.
We have forty one ETFs right now, thirty one on
the equity side, ten on the fixed income side, and
(22:27):
of the ten I was looking, which are kind of
all of them have positive flow netflows this year and
last year broadly used and the most used ones are
our US core fixed in committef along with global corporals
ultra short. So kind of a variety of segments where
(22:48):
people like to use a thoughtful, systematic yet active approach.
And I think for for focusing on public corporate bond
of public market bond markets, not just corporate government, corporate munis,
even mortgage backed securities. I think the ETF rapper is
a good wrapper, but of course even the ETF rapper
(23:10):
has to be well implemented. I think this is something
that I'm not sure your listeners have been aware of,
but there are some papers in the academic literature that
have looked at the baskets for fixed income ETFs in
the last years and suggests that looking primarily at index
(23:31):
of fixed income baskets that authorized participants, those that come
to the ETF you sure to create and redeem baskets,
create more shares of an EF essentially have been getting
an advantage in terms of pricing of these or picking bonds,
delivery which bonds to deliver some advantage over the issuer.
(23:52):
So when we set off our active ETFs, we are
very cautious to make sure that there's no all want
taking advantage of us in in that space of activitfs
where you have to kind of create baskets every day
throughout the day, negotiate baskets with APS, and we developed
(24:12):
a lot of infrastructure and criteria how to create our
baskets and in a typical dimensional men are also a
lot of infrastructure to track our execution of baskets over time.
So when we compare the bonds that we eventually bought
through a creation process from APS versus the bonds we
discarded and the bonds that kind of we started with
(24:35):
in the initial basket, we we don't find any underperformance,
no evidence of underperformance of what we bought versus what
we started with or what we discarded. Uh to the
point that we don't see APS pushing prices up to
deliver to acquire the securities we got, or to demonstrate
(24:56):
any informational advantage. And I think going forward, people shure
and hopefully will pay more attention to basket creation, because
this is where you might be leaving money on the
table if you're not careful enough.
Speaker 1 (25:09):
You're right. The ETFs in credit have just become so
huge and so influential, not just for retail investors, also
for institutional investors using them to trade. But I'm interested
in in, you know, the active elements of that, because
the passive guys just tracking the index sing to be
doing just fine and they're probably very low cost. So
what's the edge you get from being active in this?
Speaker 3 (25:27):
Yeah, And I love how you mentioned the first thing
people think about when when indexing comes to mind is cost,
low cost. And I was looking at kind of the
two largest ETFs out there are index ETFs. We all
know probably they are tickers and they're about three based
sports in expense ratio. And when people see that, they're like,
(25:47):
they're they're cheap, Like, why why should I go with
anything else? Well, because you can, again based on rigorous
academic research and top FOO implementation actually outperforms systematically benchmarks
net A fees and expenses over the long term. And
(26:07):
one of our the most popular flagship strategy of dimensional
in mutual fund format code investment grade portfolio in each
format code DFCF core fixed income. Both of those, the
longer one, the mutual font format since inception has outperformed
the same benchmark that the two biggest index city have struck,
(26:29):
the Bloomberg Us Act by thirty five to forty basis
sports per year NETA, FeAs and expenses over the last
ten years and since inception back in twenty eleven. And
I think this speaks to the point that there is
something you can do better. You can than indexing by
focusing on current information in for rates, to think about
(26:49):
where to position new flaws, where to kind of pursue
higher expector returns, how to control costs, how to manage
risks in the portfolio. And these are areas where the
indexing just falls behind and leaves money on the table
because it's index. Our index approaches are simply thinking about
(27:11):
sampling from the huge index universe, but then not taking
into account real time market information as we discussed, to
identify where the best opportunities highest expected returns are in
a systematic manner, or how to monitor credit quality on
a real time basis, or how to seek for being
(27:33):
flexible in what bonds to buy and sell to get
the best trading costs possible for the index approach, the
tradeoff is always tracking error versus costs or taxes depending
on the wrapper. For us, that's not the right trade off.
As we talk, tradeoffs are very important, but the right
(27:54):
tradeoff should be expected returns versus costs and risks.
Speaker 2 (27:58):
And then on the return side, I mean could investor
expect from those Well, what.
Speaker 3 (28:03):
I mentioned is for our investment great portfolio here in
the US has outperformed the Bloomberg Us Act by thirty
five to forty basis points. Again native fees and expenses,
So forget about industry, the feed differential, expense oration differential
versus the bloomberg Us Act over the last ten years
since inception almost fifteen years now. So I think it's
(28:27):
a it's a good trade off for many advisors and
many advisors in their end clients, many institutional clients. And
as a result, we've seen kind of growing interest in
systematic active fixed income. I think in fixed income, more
people are aware of the rigidities and flaws of indexing.
(28:48):
As a result, more more people know about kind of
the maturity cutoff where everybody has to sell one year
or once a bond is down organded, everybody has to
kind of sell it out of their portfolio because it's
leaving the index for investment BRAN and we still see
meaningful costs around those transitions. So people are open to
(29:09):
something better than indexing. But at the same time, people
often get disappointed with the inability of traditional active to
consistently systematically outgas the market, and as a result are
looking for an approach. It doesn't claim to have a
crystal ball, but see systematically based on science to deliver
(29:30):
with the understanding that it won't necessarily outperform the market
day in and day out, but over the long term,
based on academic principles and research, it should deliver higher
expected returns.
Speaker 1 (29:43):
The strategy kind of outline quality, you know, transparency, liquidity,
all this stuff. That's basically what everybody wants right now,
and there's just so many people chasing it. How do
you get your edge in that? I mean, how do
you get your allocation? How do you kind of muscle
in when there's so much you know, pressure to buy,
there's so much capital to allocate. You know, you have
(30:06):
to be selective obviously, but what's what's the strategy in
terms of just like getting enough assets to buy.
Speaker 3 (30:13):
Yeah, how do you execute efficiently right now? If other
people are also focusing let's say, only government bonds or
higher quality in a very short term, I say, go
back to kind of the key principles of our value
ads in portfolio management and training, being flexible. We believe
(30:34):
that they measure that optionality. Flexibility adds value as a result.
If you are starting the day with one hundred or
two hundred eligible bonds to buy in a given portfolio,
or a thousand for that matter, being able to walk
away from a potential trade because you know that there
(30:54):
are similar bonds with similar characteristics that you might be
equally happy to buy today. That is what helps us
in today's environment where others might be kind of looking
for similar type bonds at the same time. Uh, The
ability to be flexible, be patient, and not chase an
(31:16):
individual specific bond. As we discussed earlier, many bonds don't
trade on a given day, so if you are chasing
as particular, body are likely to push prices for that bond.
Whereas if you are flexible, you if you view multiple
bonds is substitutes for each other when you go to
buy or sell. That gives you more flexibility, and as
(31:39):
I said, this flexibility ultimately gets reflected in better execution.
We've been monitoring that for years and we see kind
of year in and year out as paying off, and
especially kind of in April, as I mentioned, our relative
trade price adventage was higher than in the in the
previous three months of the year. Again, when periods are
(32:02):
highly votile, this is what we see both inequities and
fixed income. A lot of people tend to panic, the
many immediacy try to kind of rush to market, and
people who are flexible, who are long term focused and discipline,
tend to benefit in those environments.
Speaker 1 (32:21):
Is there a way that you can get an edge
over the competition when we hear a lot of people
talking about CMBs, about MBS, about structured, about asset based finance,
but all these other things that they're trying to get
and you know, generate alpha from in terms of you know,
standing out when it comes to doing better than the
index and best than everyone else for returns. How do
you get your edge in.
Speaker 3 (32:41):
Mortgage back securities? I should have mentioned that earlier. We
do invest now in mortgage back securities as well in
some of our strategies. I think it's a fascinating asset class.
But we started investing in mortgage back securities only only
in twenty twenty. Again, if you track our evolution because
(33:02):
transparency price transparency arrives to the NBS and TBA market
in twenty eleven twenty twelve, when those transactions became mandatory
to report to trades, similar to what happened to corporate
bonds about ten years earlier. And so once we accumulated
enough price information and study or able to study the
(33:23):
MBSTBA market historically and essentially see that the same framework
for what drives expected returns in corporate government immuni bonds
can be applied. It is well supported in the data
for mbstbas. We started investing in nbs via TBA is
actually because they are ninety percent of the trading happens
(33:45):
through the TBA to be the announced derivatives market. And
we also engage with one of the top experts of
MBS in academy, again going back to our strong ties
with academia, Professor Sung from John Hopkins Carry Business School,
and we hold together a paper on the drivers of
(34:06):
Expected Returns of MBS, which essentially says, again kind of
field and roll down, but customized to the world of
MBS is with the prepayment kind of potential, there still
are the main drivers of differences in expected returns within MBS,
and this is kind of where we seek to have, say,
(34:29):
seek out performance within that spectrum right now in our
portfolios that invests in MBS tvas is basically by identifying
tvas with higher expected returns and allocating more to them
within our TVA portfolios. So again going back to having
a robust, academic scientific framework for how to seek systematically
(34:53):
higher returns and then applying in a very thoughtful manner,
because even though TBAs are the second most liquid market
out there after US treasurers, in case your listeners didn't
know even there, you have to be very thoughtful about execution.
You cannot be just demanding a particular TBA contract today
(35:14):
in huge qualities and expect that you're not going to
have any impact on the market.
Speaker 1 (35:18):
And for those out there, I don't know what TBA is.
What is it?
Speaker 3 (35:21):
It is an abbreviation for to be announced and it's
a very interesting mechanism. Maybe we should spend like a
couple of minutes just explaining it to people to bring
more liquidity and lower execution costs to this mortgage backed
securities market. So when I get got a mortgage on
my house, and I'm sure you guys have probably mortgages
(35:43):
on your house. Is the band that lends the mortgage
typically doesn't hold on to death. Mortgage sends sells it
to one of the three agencies out there in the US.
This is specific to the US market, and those agencies
package many mortgages, typically of the same term, so let's
say thirty or fifteen year with similar coupons, payments, so
(36:05):
interest rates on a mortgage, and they pass them to
investors out there and securitize that. And as you can imagine,
every month there is a new potentially package out there
from one of the three agencies with different terms, with
a different coupon. Lots of packages training issued over many,
(36:27):
many vintages, So the market is quite dispersed for mortgage
backed securities if you are One way to bring transparency
to that market is actually to create an instrument that
aggregates a lot of those characteristics, and that's what the
TBA delrivative does. It basically says, I promise to deliver
(36:47):
to you in a month or in two or three months,
a package of mortgages that is issued by one of
the three agencies that has this coupon let's say five
point five percent and has thirty year term, oh you know,
up until a few days before delivery, is just those
three characteristics. And by limiting the information exchanged across market
(37:09):
participants to those three characteristics, it makes the market much
more liquid. And as a result, tvas are very very
cost efficient to trade and a highly highly liquid market.
And one little interesting nugget on that is, when we
started researching MBS and tvas, I was surprised to see
that one of my huge mentors in life, can French,
(37:32):
professor Ken French from Dartmouth College, he actually had a
paper on tvas or related back in the day where
they made a comparison basically with diamonds traded in a
black bags in transparent bags similarly to reduced kind of
informational advantures or cross market participants in increased liquidity of
(37:55):
trading diamonds. And I found that comparison very fascinating.
Speaker 2 (37:59):
Maybe to talk a little bit about about risk, I
mean we're you know, fixing of investors and or analysts
and always worry about what could go wrong? But what
are the key risks that you see right now in
the market.
Speaker 3 (38:13):
I'd say they mentioned when we think about key risks
in portfolio, we always think the number one risk in
any portfolio is probably concentration and the risk that your
portfolio will be driven down by the underperformance or default
of particular UH issuer. And so from that perspective, the
(38:35):
best and the best way to address that risk of
concentration is diversification. Diversification across issuers, issues, garanteurs, UH sectors, industries,
countries of visions if if allowed, and currency of visions
if allowed. I think that's kind of always number one.
Speaker 2 (38:55):
Uh.
Speaker 3 (38:55):
Think about concentration, then liquidity obviously, how liquid are the
bones you're holding? Can you relatively quickly trade them around?
And of course when you're running an ITA for a
mutual fund, that's top of mind to have. Also kind
of a good pocket of liquidity in a portfolio, even
(39:16):
if it's long term, that can be turned around and
satisfy redemptions for example a quick notice. And after that,
I would say it's just generally the understanding that for us,
the other risk is obviously that the academic kind of
driven relationships in the data that we are pursuing turnspread
(39:39):
predicting turn premium credit spread predicting credit premiums might not
manifest themselves in the predicted by consistent with theory manner
every day, every month, every year, you might have a
period of one, two, three years underperformance because terms spread,
why don't but premium dinner wide after that? Instead it
(40:02):
narrowed and so building a roll bust well diversified portfolios
that even if those relations we are pursuing, based again
on academic theory and research, do not show up in
the data over a given period of time, you're still
left with a very good portfolio to hold, and applies
to both our equities and our fixing of so broadly
(40:24):
diversified systematic approach that will deliver kind of minimum costs
the good portfolio to hold regardless of what the future brings.
Speaker 1 (40:36):
Do you worry it's all about the risks that might
be brewing in private credit in terms of you know,
the risks that you cannot see that building your potential defaults.
There's a lot of payment and kind a lot of
amendments and things you can't see. But also essentially it's
taking away supply that maybe further distorts pricing in the
public markets.
Speaker 3 (40:53):
Whether I worry or not, I think that all of
those potential developments are there. The word is that actual
investors in the marketplace have are reflected in kind of
their trading decisions, bias and cells of different types of
bonds out there. If edything, some people might get disappointed with,
(41:17):
again some of the attributes of private credit or private
in general, if they are not going with enough kind
of research on what that type of investment can representing
their portfolio and in their investment experience. And I think
we all need to also kind of appreciate even more
the benefits of public markets, the transparency that we talked
(41:40):
about a lot today that gives us any immediacy in
liquidity that are instrumental to most people's needs when it
comes to investing.
Speaker 1 (41:51):
And as you say, your sort of more scientific approach
is quite different to a lot of guests we have
on this show. If you had to kind of say
how you most contrarian on credit, I mean, how would
you describe that? Are you contrarian at all? And if so,
how would you characterize that?
Speaker 3 (42:08):
I would say that our focus, our location to credit
depends on the current curves of their spreads and curves.
So in periods like now, where credit spreads are not
as wide as they have been historically, we are a
little bit less focused on credit and more on governments,
(42:31):
so you could say a little bit more focused on government.
And then in you know, in periods or in areas
of the market where we see steeper credit curves, so
intermediate segment us for example, generally steeper than short term
(42:52):
within a credit strategy would be kind of going longer
corporate bonds and less shorter corporate bonds, So depends on
market conditions. How have your corporate bonds?
Speaker 1 (43:03):
Great stuff, Savina Resova, co, Chief investment Officer and global
head of Research at Dimensional Fund Advisors. Has been a
pleasure having you on the credit edge. Many thanks, thank you,
and of course we're very grateful to Jehan ef Coupin
from Bloomberg Intelligence. Thank you so much for joining us today.
Welcome for even more credit market analysis and insight. Read
all of Jean Eve Coupin's great work on the Bloomberg terminal.
Bloomberg Intelligence is part of our research department, with five
(43:26):
hundred analysts and strategists working across all markets. Coverage includes
over two thousand equities and credits and outlooks on more
than ninety industries and one hundred market industries, currencies, and commodities.
Please do subscribe to The Credit Edge wherever you get
your podcasts. We're on Apples, Spotify, and all other good
podcast providers, including the Bloomberg Terminal at bpod Go. Give
(43:47):
us a review, tell your friends, or email me directly
at Jcrombie eight at Bloomberg dot net. I'm James Cromby.
It's been a pleasure having you join us again next
week on the Credit Edge
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 2 (00:23):
And I'm Jeannief Cooper, senior analyst at Bloomberg Intelligence. This week,
we are very pleased to welcome Savina Risova, co Chief
Investment Officer and Global head of Research at Dimensional Fund Advisors,
at seven hundred and ninety billion investment firm. How are you, Savina, good?
Speaker 3 (00:39):
Thank you for inviting me.
Speaker 2 (00:40):
Savina joined Dimensional Fund Advisors as a research associate in
two thousand and four, and just of our year ago
she added the title of co Chief Investment Officer. You
also obtained a PhD in finance from the University of Chicago. Last,
but not least, Sabina was recognized as one of Barn's
one hundred most Influential Women in US Finance for two
years in.
Speaker 1 (01:00):
So we're going to get into all that, but just
to set the scene before we do. Markets have rallied
on high hopes of a broad ceasefire in the trade war,
but there's still a lot of uncertainty out there, plus
more volatility to come as the US moves on from
tariffs to tax and immigration. Reform, headline risk is very high,
yet credit markets project an air of complacency, with debt
spreads back below where they were before the so called
(01:22):
Liberation Day at the start of April. Keeping corporate debt
risk premium very tight is the fact that there's way
too much demand for a very limited net new supply
of corporate bonds, and unless the M and A machine
cranks back up, that supplied demand imbalance will probably continue.
On top of that, the US has lost its Triple
A credit rating, calling into question the idea of risk
(01:42):
free rate and investors are now looking more at Europe
and Asia as alternatives, but there are clear limitations when
it comes to scale and liquidity there. So, Sabina, what's
your take. I'm going to ask a really broad question
because it's one that keeps coming up on this show.
But is credit fairly valued at these levels?
Speaker 3 (01:59):
Well, the meension we don't pretend to have a crystal bow,
James and know where prices are relative to fair value.
We actually take priceses kind of given in public competitive
capital markets. But what we can say is where the
current credit spreads are relative to historical averages and medians,
(02:19):
and these days, what you mentioned is absolutely correct. Credit
spreads have are about eighty to ninety beps depending on
whether you look at US or global markets below historical
mediums of over one hundred, one hundred and ten basis points,
So definitely narrower credit spreads and based on academic research
(02:39):
underpinning our approach that suggests lower credit premiums expected in
the future. As a result, our core strategies tend to
not go to their maximum allowed credit allocation right now,
and our credit strategies are not allocated to the maximum
in what we call low work here single aay tripob
(03:02):
bombs for example.
Speaker 2 (03:03):
So in terms of allocation, I mean, are you looking
across the credit spectrum, do you have any views on
higher quality names versus lower quality names given the environment.
Speaker 3 (03:14):
Absolutely, And it's probably worth kind of taking a step
back and just telling people a little bit more about
who they mention is and how we approach investing both
in equities and fixed income, because I think it's pretty
unique and different from a lot of guests you've had
on the podcast. The Dimensional is a firm that was
founded in nineteen eighty one to implement kind of rigorous
(03:37):
research into robust investment solutions. One we would like to
think about. It is sensible ideas, implement it thoughtfully and
so and it comes to fixed income. You mentioned Gene
Fama being one of the academics tightly connected to dimensional
He did a lot of research in the seventies and
(03:57):
eighties in terms of what drives expect bond returns. And
if you think of the expected returnal defaulte free bond,
like what my thing, the US bond still US government
bands still consider it uh to your earlier point, UH,
you can actually write it down as like three terms
yield expected capital appreciation or depreciation depending on the shape
(04:21):
of the curve, so roll down as some call it.
And the third term is expected changes in the shape
of the youth curve. And between now and when you
expect to sell the bond. So the first two components
of that decomposition, yield and roll down together our called
forward rates. And there is a lot of empirical academic
(04:44):
reaserch showing that forward rates do contain information about subsequent
bond returns. So differences in forward rates across bonds contain
information about differences in future bond returns. And you can
apply the frame and tested and we have not only
across duration spectrum, but also across credit quality spectrum and
(05:07):
across currency of issue spectrum. So, for example, the differences
in fields or forward rates between longer and shorter bonds
tell you the term spread essentially contain information about the
future term premium. The wider the term spread is generally
the wider the subsequent future term premium is. Similarly for
(05:28):
credit premium and credit spread. That's why I said like
currently credit spreads are relatively narrower, which means we expect
relatively narrower credit premiums less reward for holding credit. And
then similarly you can apply it across different currencies around
the world. For example, HATCH to USD looking at what's
steep versus flatter, the steeper curves HASH to USD imply
(05:55):
higher expected reward for going into those bonds and hedging
back to USD right now. For example, the Japanese government
bond curve is relatively steeper haah to USD compared to
many other develop market currencies, so some of our strategies
that are allowed to go global are allocating more to
(06:17):
Japanese intermediate bonds. So in essence that the dimensional we
look at forward rates the combination of field and roll
down as the indication of where highest expected returns are
and allocate on a daily basis based on differences in
expected returns and those expected returns those forward rates can
(06:39):
change any day across the credit, the duration and the
currency of vision spectrum. So it is important to have
a daily process where we consume information, compute those expect returns,
and decide how to allocate new cash community or from
coupons or from cash flows, and what to buy what
to sell based on those expected return differences.
Speaker 1 (07:00):
Say, Savi, you have a sort of scientific approach to this,
and you know, you talk about decades of rigorous theoretical
empirical research. But as we've discussed, you know, the so
called developed markets are becoming highly unpredictable as politics becomes
such a big factor. You know, I would say that
they're behaving a lot more like emerging markets than they
used to. Who knows what social media posts will wake
(07:21):
up to on any given day that will royal global markets.
But how does that affect your approach? Do you need
new models for that? Do you rip up the script
and have to you know, really just improvise a lot
more than you used.
Speaker 3 (07:32):
To not really exactly, because we are kind of grounded
in evercreen principles of what drives expect the returns. All
we need is latest market prices essentially to identify bonds
with higher versus lower expect the returns. And that's why
we are big advocates for price transparency and we're very
(07:53):
happy to see trace that trade reporting and compliance engine
arrived in the early two thousands bringing a lot of
transparency to the corporate bond market in USD and now
there's tracks for a non USD. So we have that
and we use it on a daily basis in real
time during the day to essential monitor prices as well
(08:14):
as bidden as quotes across many different bonds to identify
differences in expected returns. But what we also do with
current market information as it changes all the time to
your point right now very volatile markets, is also used
current market information for the other two very important dimensions
(08:35):
of investing. So one day mention is expected returns. The
other two day mensions of investing in general are risks
and costs, and we use current market information all the
time to manage risks and control costs in our portfolio.
Is because we believe that you can add value by
systematically designing strategies to pursue higher expected returns, but you
(08:58):
can also add value through talk for portfolio management and trading,
how do you use current market information? In portfolio management, we,
for example, track to your point within the day through
and daily. The deer inventory trace gives us kind of
information on net deer buys and sales throughout the day.
We also get that information daily from similar information daily
(09:22):
from Blueberg and inter the day from trade web and
market access platforms that many of your listeners probably are
familiar with, and this helps us identify bones where dealers
might in augria have an inventory, accumulated inventory might be
willing to sell to us at a favorable price, and
similarly for sales, so der inventory is very important to
(09:44):
monitor to get great execution. Also, we use market prices
to monitor credit quality. To your point, in the last
five years, most of the credit rating changes internal credit
rating changes we've performed most have been driven by prices
information in current market prices, not by credit rating agencies
(10:05):
changing their ratings. So what we use there is not
just prices of bonds, trading or quotes, but also CDs
market prices. Even the equity prices of the issues of
those bonds, so you can use current real time market
information along with kind of the academic framework for what
(10:26):
drives expected returns to continue to deliver robust investment solutions
even in highly volatile times as we are experiencing this year.
Speaker 2 (10:36):
So in terms of your investment approach, I mean, I
mean the two main investment approach being top down or
bottoms up, and especially you know, looking at all these
data that is available in terms of as you said,
trade and ventory prices, how do you reconcile the two
and how your investment process I'm sure incorporates you know,
(10:59):
both of the top down view from rates to you know,
sectors and then the bottom up this this bond is
actually treading wide or cheap against another one, and that's the.
Speaker 3 (11:10):
Time to buy. Yeah, thank you for the question. It's
a common question we get because people are in fixed
income are generally used to two types of investing traditional
passive and by the way, these are the biggest kind
of ETFs and mutual funds out there. Indexed approach in
fixed income with some sampling under the hood, or traditional
(11:30):
active where you're typically either top down for making macroeconomic
forecasts and then driving your investment or bottom up picking
individual bonds based on research on specific sectors or currencies,
et cetera. We are kind of combining the best of
both worlds, traditional passive and traditional active in the sense
(11:52):
that we have broad diversification in our strategies and relatively
low turnover just like traditional passive, but we are taking
from traditional active the daily flexible implementation in the pursuit
of higher expected returns. How do we do it, though
different from traditional active? Are we top down or bottom up?
(12:12):
I would say we're both. Why because we start every
day by looking at the overall spreads out there, turn spreads,
credit spreads, and spreads across different field cares, heads to
a local currency, and that kind of guys the overall
positioning of a portfolio in terms of how much we
(12:34):
want to okay to credit corporates versus governments or different
types of currencies. Once we get do this kind of
top down analysis based on current market information, then we
try to kind of bottom up looking at what we hold,
what we want to hold, which bonds within kind of
the para. Now those parameters how much we want to
(12:54):
okay to corporate today versus governments within corporates, Let's say,
which are the bonds with highest expected returns, most attractive
forward rates, And we start kind of identifying bonds that
we would like to buy today based on that approach,
very systematic, and then what we do is we go
filter those bonds to a bunch of criteria including kind
of how liquid those bonds are in the marketplace today,
(13:16):
are we likely to get good prices for those bonds?
And then once we kind of set on a group
of bonds we'd like to buy, we pass this to
the trading that so for from portfolio management to trading,
where traders whould go to the marketplace and very flexibly
seek to purchase some of those bonds without being particularly
(13:38):
attached to an individual bond. And I think this is
also a huge differentiator for the dimensional is that we
are not chasing individual bonds picks of a portfolio manager,
not at all, and that gives us the ability to
have great execution. What do I mean by great execution?
When we compare our corporate and agency trades versus the
(14:00):
prior trade in the same issue or the next trait,
on average, our trades are twenty basis points better on
the buy side and five to ten basis points better
on the sales side because we trede flexibly with patients
with optionality out there, we have multiple bonds with similar
expactor returns that we're interested in buying or selling today.
Speaker 1 (14:21):
Your approach seems take a lot of trust in what
the market price is selling us in terms of transparency
in terms of the liquidity. But as you know, you know,
the further you get down the rating spectrum and the
more you get into sort of exotic credit you know
e merging markets, those markets get stuff wrong all the time.
You know, the signals are just plain wrong. How do
you protect yourself against that as an investor?
Speaker 3 (14:42):
Great question, James, Another great question. We have historically stuck
to the parts of the market that benefit from a
lot of price transparency. So, in terms of kind of history,
Dimensional started in high quality corporate and government back in
nineteen eighty three with its first fixed income strategy, and
(15:05):
then later on expanded to develop market currencies, so applying
our kind of variable maturity and variable currency approaches there.
And then we started investing in full investment rate only
in two thousand and nine, actually a few years after
trades arrived and brought transparency to the corporate bond market,
(15:26):
and then we started also kind of dipping our tools
in double bees, but not going below that. To your point,
once you go the low double bees into single bees
and three POC's and below, one major concern is the
default rates. The default rates increase meaningfully on average historically
for single bees they are like three percent for trip
(15:47):
o C and below twenty five plus percent. Those are
we viewed those as not necessarily suitable investments for ETFs
and mutual funds, which need to provide liquidity on a
daily basis. Similarly, we've stuck through history to develop market currencies.
We do not invest directly in emerging market currencies to
a large degree because of price tre experiency, but also
(16:11):
because of operational law and order consideration as well.
Speaker 2 (16:16):
I think there is an interesting point of you know,
create risk transparency and maybe to switch gears a little
bit and move into private credit. I mean, we've seen
a huge expansion of private credit, but also a lot
of comments and risks maybe out there, and some people
have been saying there is maybe a risk of you know,
(16:37):
ratings inflation, or risk of lack of transparency or very
credit trade. I mean, how do you approach private credit
as a nassage class within fix income.
Speaker 3 (16:46):
So as a manager, they mentioned it is in the
public space public stocks and public bonds and a systematic approach.
But we strive to be a very objective thought leader
in the industry put a lot of papers out are
the SIK to provide kind of a framework for how
to think about different investment topics. And so a couple
(17:07):
of years ago, with the growing interest in private and
the growing i'd say push of private out there, we
decided to actually buy data historical data from Burgess now
MSCI on private fund performance and study private performance across
four major asset classes, one of them being private credit.
(17:31):
So we looked at historical performance of private credit from
nineteen eighty to twenty twenty two, and what we found
there for private credit was that depending on the average
kind of historical ten year IRR is about ten percentage points,
which sounds appealing, But when you compare to hyat public
(17:55):
benchmarks like the Bloomberg Hi index, then what you see
is that public market equivalent or direct out of measures
comparing private to public performance are all kind of in
favor of the high index. There is no outperformance relative
to yield public bonds, which comes to tell you that
(18:16):
private credit is, at least historically has been a way
to get exposure to yield below investment grade credit. Does
private credit provide additional diversification beyond what's available in the
public market? Yes, absolutely. There are different bonds out there,
generally different issuers going for the private route versus public,
(18:39):
So there are some diversification benefits if you want to
add private credit to your public exposure. But of course
private comes with a lot of caveats and challenges, one
of which you mentioned very important ones for US prices,
frequent updates of prices, reliability of prices there it's not
(19:00):
by accident, it's called private. Also, lack of adequate diversification
because ultimately we cannot all own parts of all private companies,
you cannot get the full diversification you get in public
markets if you want to. And as a result, I think, well,
it will be interesting to see how private interesting private
(19:23):
credit develops, because there is kind of a an evergreen
value proposition for private It is has its own economic
function out there, but not everyone probably suited for an
investment in private people who might have short term immediate
liquidity needs, etc. Who cannot have a long horizon and
(19:44):
a for not to touch that part of money for
a long term might not be prepared for private investments
or well suited for private investments. In terms of information available,
definitely much less information available easily, and I think that's
why even in the when you look at buyouts, another
(20:05):
segment of the private market trades in the secondary market,
which attempts to mimic a public market right in terms
of getting some valuations for buyout stakes, et cetera, you
typically see haircuts of like ten fifteen percent, which speaks
to prices might not be as reliable they are as
(20:26):
they are in public markets.
Speaker 1 (20:27):
We've had some guests recently talk about a two hundred
basis points premium in private markets against public I'm assuming
that mostly talking about loans there, but sounds like what
you're saying is that there is no relative value in
private and actually there's better risk just to return in
hial bonds versus private debt. Is that is that correct?
Speaker 3 (20:48):
So it's very important what you compare private.
Speaker 2 (20:51):
Too.
Speaker 3 (20:53):
Many people might compare private to the Global or us
ag I Investment Grade Index. There you would see our
performance if you compare to Hyatt, you don't see our performance. Yes,
and it's kind of similar. On the private equity side,
many managers like to compare themselves to the S and
P five hundred. In our opinion, that's not an adequate
(21:14):
benchmark public benchmark. For private equity, you want to probably
take a look at well designed small happiness is small growth,
small value. And then the conclusion is very similar to
what we discuss for private credit. So it really matters
what you compare yourself to.
Speaker 1 (21:31):
And also you mentioned it, you know, it really depends
on the kind of investors. Not suitable for everyone, but
you know you're an ETF shop. There are ETFs now
for private credit. What do you make of that?
Speaker 3 (21:42):
We shall see, let's put it that way. In terms
of public bond ets, we see a lot of demand
for those. Obviously the largest ones are index focused, but
we now see growing demand for a kind of what
the types of ETFs with delivery dimensional systematic active, both
(22:04):
on the bond and on the equity side. We are
actually the largest systematic active ETF manager out there with
one hundred and seventeen plus a billion dollars in active ETFs.
We have forty one ETFs right now, thirty one on
the equity side, ten on the fixed income side, and
(22:27):
of the ten I was looking, which are kind of
all of them have positive flow netflows this year and
last year broadly used and the most used ones are
our US core fixed in committef along with global corporals
ultra short. So kind of a variety of segments where
(22:48):
people like to use a thoughtful, systematic yet active approach.
And I think for for focusing on public corporate bond
of public market bond markets, not just corporate government, corporate munis,
even mortgage backed securities. I think the ETF rapper is
a good wrapper, but of course even the ETF rapper
(23:10):
has to be well implemented. I think this is something
that I'm not sure your listeners have been aware of,
but there are some papers in the academic literature that
have looked at the baskets for fixed income ETFs in
the last years and suggests that looking primarily at index
(23:31):
of fixed income baskets that authorized participants, those that come
to the ETF you sure to create and redeem baskets,
create more shares of an EF essentially have been getting
an advantage in terms of pricing of these or picking bonds,
delivery which bonds to deliver some advantage over the issuer.
(23:52):
So when we set off our active ETFs, we are
very cautious to make sure that there's no all want
taking advantage of us in in that space of activitfs
where you have to kind of create baskets every day
throughout the day, negotiate baskets with APS, and we developed
(24:12):
a lot of infrastructure and criteria how to create our
baskets and in a typical dimensional men are also a
lot of infrastructure to track our execution of baskets over time.
So when we compare the bonds that we eventually bought
through a creation process from APS versus the bonds we
discarded and the bonds that kind of we started with
(24:35):
in the initial basket, we we don't find any underperformance,
no evidence of underperformance of what we bought versus what
we started with or what we discarded. Uh to the
point that we don't see APS pushing prices up to
deliver to acquire the securities we got, or to demonstrate
(24:56):
any informational advantage. And I think going forward, people shure
and hopefully will pay more attention to basket creation, because
this is where you might be leaving money on the
table if you're not careful enough.
Speaker 1 (25:09):
You're right. The ETFs in credit have just become so
huge and so influential, not just for retail investors, also
for institutional investors using them to trade. But I'm interested
in in, you know, the active elements of that, because
the passive guys just tracking the index sing to be
doing just fine and they're probably very low cost. So
what's the edge you get from being active in this?
Speaker 3 (25:27):
Yeah, And I love how you mentioned the first thing
people think about when when indexing comes to mind is cost,
low cost. And I was looking at kind of the
two largest ETFs out there are index ETFs. We all
know probably they are tickers and they're about three based
sports in expense ratio. And when people see that, they're like,
(25:47):
they're they're cheap, Like, why why should I go with
anything else? Well, because you can, again based on rigorous
academic research and top FOO implementation actually outperforms systematically benchmarks
net A fees and expenses over the long term. And
(26:07):
one of our the most popular flagship strategy of dimensional
in mutual fund format code investment grade portfolio in each
format code DFCF core fixed income. Both of those, the
longer one, the mutual font format since inception has outperformed
the same benchmark that the two biggest index city have struck,
(26:29):
the Bloomberg Us Act by thirty five to forty basis
sports per year NETA, FeAs and expenses over the last
ten years and since inception back in twenty eleven. And
I think this speaks to the point that there is
something you can do better. You can than indexing by
focusing on current information in for rates, to think about
(26:49):
where to position new flaws, where to kind of pursue
higher expector returns, how to control costs, how to manage
risks in the portfolio. And these are areas where the
indexing just falls behind and leaves money on the table
because it's index. Our index approaches are simply thinking about
(27:11):
sampling from the huge index universe, but then not taking
into account real time market information as we discussed, to
identify where the best opportunities highest expected returns are in
a systematic manner, or how to monitor credit quality on
a real time basis, or how to seek for being
(27:33):
flexible in what bonds to buy and sell to get
the best trading costs possible for the index approach, the
tradeoff is always tracking error versus costs or taxes depending
on the wrapper. For us, that's not the right trade off.
As we talk, tradeoffs are very important, but the right
(27:54):
tradeoff should be expected returns versus costs and risks.
Speaker 2 (27:58):
And then on the return side, I mean could investor
expect from those Well, what.
Speaker 3 (28:03):
I mentioned is for our investment great portfolio here in
the US has outperformed the Bloomberg Us Act by thirty
five to forty basis points. Again native fees and expenses,
So forget about industry, the feed differential, expense oration differential
versus the bloomberg Us Act over the last ten years
since inception almost fifteen years now. So I think it's
(28:27):
a it's a good trade off for many advisors and
many advisors in their end clients, many institutional clients. And
as a result, we've seen kind of growing interest in
systematic active fixed income. I think in fixed income, more
people are aware of the rigidities and flaws of indexing.
(28:48):
As a result, more more people know about kind of
the maturity cutoff where everybody has to sell one year
or once a bond is down organded, everybody has to
kind of sell it out of their portfolio because it's
leaving the index for investment BRAN and we still see
meaningful costs around those transitions. So people are open to
(29:09):
something better than indexing. But at the same time, people
often get disappointed with the inability of traditional active to
consistently systematically outgas the market, and as a result are
looking for an approach. It doesn't claim to have a
crystal ball, but see systematically based on science to deliver
(29:30):
with the understanding that it won't necessarily outperform the market
day in and day out, but over the long term,
based on academic principles and research, it should deliver higher
expected returns.
Speaker 1 (29:43):
The strategy kind of outline quality, you know, transparency, liquidity,
all this stuff. That's basically what everybody wants right now,
and there's just so many people chasing it. How do
you get your edge in that? I mean, how do
you get your allocation? How do you kind of muscle
in when there's so much you know, pressure to buy,
there's so much capital to allocate. You know, you have
(30:06):
to be selective obviously, but what's what's the strategy in
terms of just like getting enough assets to buy.
Speaker 3 (30:13):
Yeah, how do you execute efficiently right now? If other
people are also focusing let's say, only government bonds or
higher quality in a very short term, I say, go
back to kind of the key principles of our value
ads in portfolio management and training, being flexible. We believe
(30:34):
that they measure that optionality. Flexibility adds value as a result.
If you are starting the day with one hundred or
two hundred eligible bonds to buy in a given portfolio,
or a thousand for that matter, being able to walk
away from a potential trade because you know that there
(30:54):
are similar bonds with similar characteristics that you might be
equally happy to buy today. That is what helps us
in today's environment where others might be kind of looking
for similar type bonds at the same time. Uh, The
ability to be flexible, be patient, and not chase an
(31:16):
individual specific bond. As we discussed earlier, many bonds don't
trade on a given day, so if you are chasing
as particular, body are likely to push prices for that bond.
Whereas if you are flexible, you if you view multiple
bonds is substitutes for each other when you go to
buy or sell. That gives you more flexibility, and as
(31:39):
I said, this flexibility ultimately gets reflected in better execution.
We've been monitoring that for years and we see kind
of year in and year out as paying off, and
especially kind of in April, as I mentioned, our relative
trade price adventage was higher than in the in the
previous three months of the year. Again, when periods are
(32:02):
highly votile, this is what we see both inequities and
fixed income. A lot of people tend to panic, the
many immediacy try to kind of rush to market, and
people who are flexible, who are long term focused and discipline,
tend to benefit in those environments.
Speaker 1 (32:21):
Is there a way that you can get an edge
over the competition when we hear a lot of people
talking about CMBs, about MBS, about structured, about asset based finance,
but all these other things that they're trying to get
and you know, generate alpha from in terms of you know,
standing out when it comes to doing better than the
index and best than everyone else for returns. How do
you get your edge in.
Speaker 3 (32:41):
Mortgage back securities? I should have mentioned that earlier. We
do invest now in mortgage back securities as well in
some of our strategies. I think it's a fascinating asset class.
But we started investing in mortgage back securities only only
in twenty twenty. Again, if you track our evolution because
(33:02):
transparency price transparency arrives to the NBS and TBA market
in twenty eleven twenty twelve, when those transactions became mandatory
to report to trades, similar to what happened to corporate
bonds about ten years earlier. And so once we accumulated
enough price information and study or able to study the
(33:23):
MBSTBA market historically and essentially see that the same framework
for what drives expected returns in corporate government immuni bonds
can be applied. It is well supported in the data
for mbstbas. We started investing in nbs via TBA is
actually because they are ninety percent of the trading happens
(33:45):
through the TBA to be the announced derivatives market. And
we also engage with one of the top experts of
MBS in academy, again going back to our strong ties
with academia, Professor Sung from John Hopkins Carry Business School,
and we hold together a paper on the drivers of
(34:06):
Expected Returns of MBS, which essentially says, again kind of
field and roll down, but customized to the world of
MBS is with the prepayment kind of potential, there still
are the main drivers of differences in expected returns within MBS,
and this is kind of where we seek to have, say,
(34:29):
seek out performance within that spectrum right now in our
portfolios that invests in MBS tvas is basically by identifying
tvas with higher expected returns and allocating more to them
within our TVA portfolios. So again going back to having
a robust, academic scientific framework for how to seek systematically
(34:53):
higher returns and then applying in a very thoughtful manner,
because even though TBAs are the second most liquid market
out there after US treasurers, in case your listeners didn't
know even there, you have to be very thoughtful about execution.
You cannot be just demanding a particular TBA contract today
(35:14):
in huge qualities and expect that you're not going to
have any impact on the market.
Speaker 1 (35:18):
And for those out there, I don't know what TBA is.
What is it?
Speaker 3 (35:21):
It is an abbreviation for to be announced and it's
a very interesting mechanism. Maybe we should spend like a
couple of minutes just explaining it to people to bring
more liquidity and lower execution costs to this mortgage backed
securities market. So when I get got a mortgage on
my house, and I'm sure you guys have probably mortgages
(35:43):
on your house. Is the band that lends the mortgage
typically doesn't hold on to death. Mortgage sends sells it
to one of the three agencies out there in the US.
This is specific to the US market, and those agencies
package many mortgages, typically of the same term, so let's
say thirty or fifteen year with similar coupons, payments, so
(36:05):
interest rates on a mortgage, and they pass them to
investors out there and securitize that. And as you can imagine,
every month there is a new potentially package out there
from one of the three agencies with different terms, with
a different coupon. Lots of packages training issued over many,
(36:27):
many vintages, So the market is quite dispersed for mortgage
backed securities if you are One way to bring transparency
to that market is actually to create an instrument that
aggregates a lot of those characteristics, and that's what the
TBA delrivative does. It basically says, I promise to deliver
(36:47):
to you in a month or in two or three months,
a package of mortgages that is issued by one of
the three agencies that has this coupon let's say five
point five percent and has thirty year term, oh you know,
up until a few days before delivery, is just those
three characteristics. And by limiting the information exchanged across market
(37:09):
participants to those three characteristics, it makes the market much
more liquid. And as a result, tvas are very very
cost efficient to trade and a highly highly liquid market.
And one little interesting nugget on that is, when we
started researching MBS and tvas, I was surprised to see
that one of my huge mentors in life, can French,
(37:32):
professor Ken French from Dartmouth College, he actually had a
paper on tvas or related back in the day where
they made a comparison basically with diamonds traded in a
black bags in transparent bags similarly to reduced kind of
informational advantures or cross market participants in increased liquidity of
(37:55):
trading diamonds. And I found that comparison very fascinating.
Speaker 2 (37:59):
Maybe to talk a little bit about about risk, I
mean we're you know, fixing of investors and or analysts
and always worry about what could go wrong? But what
are the key risks that you see right now in
the market.
Speaker 3 (38:13):
I'd say they mentioned when we think about key risks
in portfolio, we always think the number one risk in
any portfolio is probably concentration and the risk that your
portfolio will be driven down by the underperformance or default
of particular UH issuer. And so from that perspective, the
(38:35):
best and the best way to address that risk of
concentration is diversification. Diversification across issuers, issues, garanteurs, UH sectors, industries,
countries of visions if if allowed, and currency of visions
if allowed. I think that's kind of always number one.
Speaker 2 (38:55):
Uh.
Speaker 3 (38:55):
Think about concentration, then liquidity obviously, how liquid are the
bones you're holding? Can you relatively quickly trade them around?
And of course when you're running an ITA for a
mutual fund, that's top of mind to have. Also kind
of a good pocket of liquidity in a portfolio, even
(39:16):
if it's long term, that can be turned around and
satisfy redemptions for example a quick notice. And after that,
I would say it's just generally the understanding that for us,
the other risk is obviously that the academic kind of
driven relationships in the data that we are pursuing turnspread
(39:39):
predicting turn premium credit spread predicting credit premiums might not
manifest themselves in the predicted by consistent with theory manner
every day, every month, every year, you might have a
period of one, two, three years underperformance because terms spread,
why don't but premium dinner wide after that? Instead it
(40:02):
narrowed and so building a roll bust well diversified portfolios
that even if those relations we are pursuing, based again
on academic theory and research, do not show up in
the data over a given period of time, you're still
left with a very good portfolio to hold, and applies
to both our equities and our fixing of so broadly
(40:24):
diversified systematic approach that will deliver kind of minimum costs
the good portfolio to hold regardless of what the future brings.
Speaker 1 (40:36):
Do you worry it's all about the risks that might
be brewing in private credit in terms of you know,
the risks that you cannot see that building your potential defaults.
There's a lot of payment and kind a lot of
amendments and things you can't see. But also essentially it's
taking away supply that maybe further distorts pricing in the
public markets.
Speaker 3 (40:53):
Whether I worry or not, I think that all of
those potential developments are there. The word is that actual
investors in the marketplace have are reflected in kind of
their trading decisions, bias and cells of different types of
bonds out there. If edything, some people might get disappointed with,
(41:17):
again some of the attributes of private credit or private
in general, if they are not going with enough kind
of research on what that type of investment can representing
their portfolio and in their investment experience. And I think
we all need to also kind of appreciate even more
the benefits of public markets, the transparency that we talked
(41:40):
about a lot today that gives us any immediacy in
liquidity that are instrumental to most people's needs when it
comes to investing.
Speaker 1 (41:51):
And as you say, your sort of more scientific approach
is quite different to a lot of guests we have
on this show. If you had to kind of say
how you most contrarian on credit, I mean, how would
you describe that? Are you contrarian at all? And if so,
how would you characterize that?
Speaker 3 (42:08):
I would say that our focus, our location to credit
depends on the current curves of their spreads and curves.
So in periods like now, where credit spreads are not
as wide as they have been historically, we are a
little bit less focused on credit and more on governments,
(42:31):
so you could say a little bit more focused on government.
And then in you know, in periods or in areas
of the market where we see steeper credit curves, so
intermediate segment us for example, generally steeper than short term
(42:52):
within a credit strategy would be kind of going longer
corporate bonds and less shorter corporate bonds, So depends on
market conditions. How have your corporate bonds?
Speaker 1 (43:03):
Great stuff, Savina Resova, co, Chief investment Officer and global
head of Research at Dimensional Fund Advisors. Has been a
pleasure having you on the credit edge. Many thanks, thank you,
and of course we're very grateful to Jehan ef Coupin
from Bloomberg Intelligence. Thank you so much for joining us today.
Welcome for even more credit market analysis and insight. Read
all of Jean Eve Coupin's great work on the Bloomberg terminal.
Bloomberg Intelligence is part of our research department, with five
(43:26):
hundred analysts and strategists working across all markets. Coverage includes
over two thousand equities and credits and outlooks on more
than ninety industries and one hundred market industries, currencies, and commodities.
Please do subscribe to The Credit Edge wherever you get
your podcasts. We're on Apples, Spotify, and all other good
podcast providers, including the Bloomberg Terminal at bpod Go. Give
(43:47):
us a review, tell your friends, or email me directly
at Jcrombie eight at Bloomberg dot net. I'm James Cromby.
It's been a pleasure having you join us again next
week on the Credit Edge
Host
James Crombie
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