Podcast: Beyond Boundaries: Global Bonds, Unconstrained

Joseph Dore: Hi, I'm Joseph Dore, head of International Consultant Relations at Allspring, and welcome to SpringTalk. Today, I'm joined by not one but two very important senior portfolio manager voices here at Allspring. They're both on the Plus Fixed Income team. Those voices are Noah Wise and Sarah Harrison. Welcome to SpringTalk.

Noah: Good to be here.

Sarah: Thanks for having us, Joe.

Joseph: So, the global income solution that you both manage is truly unconstrained and truly global. Therefore, I guess I can go anywhere with my questions today and I certainly will. So, with that, and as per today's episode title, we're going to go beyond boundaries across all edges of the credit markets, across all edges of the globe. Let's get going. To kick things off, I'm going to start with you, Noah, if I can. Your global income solution makes full use of Allspring's entire fixed income platform. That's $400 billion of fixed income firepower, 150 fixed income professionals, of which 70+ are global credit analysts. Now, Noah, that's a lot of ideas. So, I'm going to ask you to take a few steps back and explain to our audience members how difficult is it to process all these great ideas that get thrown at you? Come on, Noah. Where does your process possibly start?

Noah: Absolutely, Joe. So, you're right. It is a challenge. And I think it's a challenge that's made even more difficult because of the quality of those investment ideas. At the Allspring global fixed income platform, 97% of fixed income composite assets on a gross basis have outperformed their benchmarks over a five-year period as of June 2024. And 90% of those assets have outperformed their benchmarks in a five-year period as of June 2024 on a net basis as well. So, a lot of good ideas and also a very, very good problem to have. How we do that from a process standpoint is important. We've been implementing that process consistently over the last couple of decades. So, I think that is critical. And then, the other aspect is the team. We have a team of very experienced individuals that are specialists in each part of the global fixed income marketplace that have worked together for a very long period of time. So, I think it's really that team, that process, that consistency, and also being able to draw from a wide pool of really good ideas.

Joseph: So, agreed. Probably so many ideas being thrown at you is not the world's biggest problem. But I'm going to stick with you, Noah, just to put this all together in a real-life market example. So, I think we can all agree we've had rather Olympic-fast market volatility over the summer. Spreads blew out. I believe they blew back in. And rates have certainly come in aggressively. So, can you take us through, Noah, what your process looked to do to capitalize on some of this credit market volatility? What did your process tell you to do?

Noah: Absolutely. So, our process involves setting these high-level targets, trying to capitalize on these types of volatility episodes. So, we got all of our senior portfolio managers together. Markets were quite volatile at the beginning of August. We isolated an opportunity. We saw some underperformance in U.S. high yield corporate bonds and U.S. investment-grade credit. We thought that relative outperformance is driven by technical factors rather than changes in underlying fundamentals. We saw a better relative value, made the decision that day to shift the allocations within the portfolio, and then we were able to quickly, with that flatter structure, execute and implement those ideas with our sector specialist portfolio managers very, very rapidly to take advantage of that brief volatility. Fast forward, we've had some outperformance from those areas. We've actually started to take some of that exposure down now because the relative value is starting to diminish. So, I think it highlights really that ability to be agile, why the team is structured that way, and why that process works.

Joseph: And then, I guess just a quick follow-up question there, Noah―what, in your view, actually drove some of this credit volatility? Are we talking typical wafer-thin market liquidity or something more substantial?

Noah: Yeah, seasonality certainly plays a component here. Liquidity tends to be a little bit worse in the summer months. We certainly had that component in early August. There was some data that led to this. It was a modestly weaker employment figure in the U.S., but that didn't change the overall underlying trends in the U.S. economy or the global economy, in our view. Instead, what we saw is significant volatility in Japan. There was an issue with a yen carry trade potentially unwinding. We saw a significant drawdown in the Japanese stock market. That tells us this was driven more by liquidity issues and potentially positioning as opposed to larger dynamics that change the fundamental framework. To us, that was an opportunity to be able to take advantage of. And that's how we addressed the volatility in early August.

Joseph: Super helpful. So, I'm going to now jump to Sarah. Welcome to the conversation. We're going to switch gears a little. So, I know for global income, you and Noah talk a lot about, with clients, the power of harnessing multiple levers for performance. So, you clearly have multiple credit asset classes you can call upon, and so I want to get asset-class-specific from the credit side pretty quickly. So, can you share with audience members, Sarah, where are you currently hunting, where is looking attractive right now, and maybe why?

Sarah: Absolutely. So, as one of the sector specialists within the Plus team, European high yield generically is my hunting ground. As a reminder, philosophically, in our sectors, we are looking for idiosyncratic alpha stories. But also, equally important, we're trying to pick our spots from a macro perspective—i.e., where on the credit spectrum offers the most value, what sectors, where on the curve. And so, from a macro perspective, we've had a slight preference to Europe over the U.S. in high yield over the long term on spread differential and hedging costs. But this preference has diminished over the course of 2024. It's also worth noting that we are looking further out the curve for buying opportunities now. And long-dated TMT (technology, media, and telecommunications) is certainly one sweet spot that has materialized in the second half of 2024. We continue to like AT1 (Additional Tier 1), which has rallied quite a bit since the volatility around Credit Suisse, but it still looks to be good value versus Tier 2, which is a big part of the European high yield universe.

Joseph: So, I definitely want to touch on going out further in the curve and some of the default risks that that might bring. But before I do, Sarah, can you talk about maybe some areas where you are hunting, as you said, but where others may not be? So, I guess I'm talking more non-consensus plays.

Sarah: Yeah, absolutely. So, many of our trades have played out quite nicely over the course of 2024, and so we are closer to home at the moment. I feel somewhat late cycle, so we've got transaction activity picking up. Cuspy deals are getting done with high coupons and not rallying. And so, we have chosen to not chase risk and stay disciplined, which is something that we hope will pay off in the long run.

Joseph: So, not chasing risk. OK. Come on, tell us about the default trajectory going forward. Is this keeping you up at night? Should it be keeping our audience members up at night?

Sarah: Yeah, absolutely. And so, investors tend to be very concerned about defaults and for good reason. Losses due to market-to-market volatility can be recouped if your initial thesis proves to be correct. But losses that occur due to defaults cannot easily be recouped. They create a hole in performance that you have to work very hard to fill. I'll take a step back and first say that I believe the high yield market has structurally changed. It is a larger and more mature market with savvier market participants who are more adept at pricing risk and underwriting credits. As a result, our through the cycle default forecasts are lower now than they were 10 years ago. In the short term, we do believe that defaults will pick up but only marginally and from a low base. Macro data is starting to weaken, and while that should spur on rate cuts, it will, of course, start to harm top line for cyclicals. And we are seeing that come through in guidance cuts for H2 in some of the more cyclical sectors like autos. In the event that we're wrong about this—and let's keep our humility here, it can happen—if defaults are higher than expected, we have positioned to be able to mitigate default losses. The best way to mitigate default losses is through diversification. And we certainly have an eye on how we size positions for risk management purposes when we are sizing high yield positions in the strategy. No one position going wrong will make a significant dent in performance.

Joseph: Thank you, Sarah. The high yield market is structurally changed forever. Definitely something I'm going to remember from this. So, we're going to switch credit asset classes pretty quickly. Back to you, Noah. I want your thoughts on securitized. So, I must say, Noah, from my seat, I see a lot of clients favoring securitized right now. Do you as a team agree? And if you do agree, can you explain why the market appears to like this asset class so much right now?

Noah: Sure. Yeah, we actually do agree. And there are times when consensus is right. We're not going to take an out-of-consensus view just for the sake of being out of consensus. I think at a high level, this is a time when a consensus is likely right. But there is some nuance here. And I think that nuance is very, very important. Particular areas of securitized that we like may not be the same as what all investors are favoring right now. Securitized has different components. Broadly speaking, there is securitized credit, if you will, kind of non-government types of securitized exposures that have more credit risk, oftentimes don't have as good of liquidity characteristics. Sarah touched on spreads and valuations. And we are in a period mentioning potentially some late-cycle types of behaviors. You don't want to be reaching for yield. And so, at a high level, securitized does offer some higher-quality opportunities. But within this securitized space, we actually like the agency mortgage bond sector within securitized. So, this is U.S. agency mortgage bonds. They do have the support of the U.S. government on these exposures. So, very, very limited types of credit risk, but also very important, it is one of the most liquid fixed income sectors globally. And so, you're getting some relatively attractive carry. The spreads are at a reasonable level, not only compared to their own past, but compared to some of these other lower-quality credit sectors. And they also offer quite attractive liquidity. So, a number of factors that we see relative value within that sub-component of the securitized space.

Joseph: So, I'm going to keep you on your toes, Noah. Going to jump from securitized to EMD (emerging markets debt). Clearly, quite a big lever you can pull for client outcomes. So, are you pulling this lever right now in EMD? And have you had any change in your allocation over the last year in 2024?

Noah: We are and we have. And I think this also does a really good job of kind of showing the value of being more nimble and looking more broadly. EM, in similar ways to securitized, there are quite a bit of differences when you take a little step further into that sector. There's EM credit where default risk is a bigger issue, but there's also EM local government bonds where the bigger issue is currency risk and inflation and monetary policy. On EM credit, there we are, again, seeing some tighter spreads. There are some idiosyncratic opportunities that our research platform is discovering in EM that provide some better value on the credit side, but more recently, we've actually been finding some good opportunities within the EM local government space. And one in particular is in South Africa. There were elections in the summer here of 2024. We think that's a situation where political risk is not just as the risk factor but also as political opportunity. You had a relatively favorable political outcome in South Africa that we think is going to lead to some positive reform dynamics that is going to be good for inflation, good for productivity longer-term growth trajectory, and, ultimately, we think can lead to the risk premium in those bonds coming down. So, some South African local government bonds we also think provide some attractive opportunity here moving forward.

Joseph: So, I've certainly heard you speak a lot here today about elections in EM. Have we got any more to go or are you finally over that election hump?

Noah: Yeah, the bulk of the election uncertainty in 2024 in emerging markets and really more broadly in developed markets outside of the U.S. is in our rearview mirror. I mentioned South Africa as a place where it was a positive catalyst. In France, you talked about the Olympics earlier, right? There was a negative catalyst with early elections being called there that caused some of their bonds to underperform. So, it can go both ways. There is quite a mix. But really now, looking forward, most eyes are focused here on the U.S. and the elections that are coming in November 2024.

Joseph: So, I'm going to pivot topics completely, and let's tackle the important topic of differentiation. So, global income clearly operates in a highly competitive marketplace. I don't think any of us would deny that. So, what elements of your differentiated process do you believe the Plus Fixed Income process offers relative to peers? And Noah, I'm going to stick with you there first.

Noah: Yeah, absolutely. And we mentioned a few of these things earlier, but those key differentiated pieces are our outlook. So, we have a six-month outlook. We talked about being more nimble, more opportunistic, more agile. And I think that six-month outlook is critical in being able to do that. It allows us to take advantage of those shorter-term volatility episodes, like we talked about from earlier August 2024. But it also allows us to get more rapid feedback in our investment thesis. So, there's a risk benefit, as well. That six-month outlook is a benefit compared to competitors, particularly the larger competitors. It’s a very, as you mentioned, competitive landscape that tends to take a bigger, longer-term macro or secular type of outlook. So, we think that's an important differentiator. The second one is this idea of multiple levers. And already here in this conversation, we've talked about European credit. We've talked about investment grade. We've talked about high yield emerging markets. We've talked about some government bond opportunities. This idea of a really diversified set of opportunities. There is always something going on somewhere. And I think that's a really good way to build a portfolio to get that diversification but also to be able to seek those opportunities. And we're able to really look for those opportunities wherever and whenever they crop up. And the last aspect is the markets in fixed income right now, we would argue, are very, very attractive. We have yields that are at historically high levels in what we've seen over most of the last couple of decades. We think it's a good time to be a global fixed income investor. But relative value and risk isn't the same everywhere. And we touched on this with spreads being relatively tight in a number of credit sectors. There is risk out there. And so, we like this unbiased approach. This idea that you don't just always have a set risk exposure or factor within the marketplace. You want to be nimble. You want to be dynamic. You want to adjust those. And we talk about that as an unbiased approach to portfolio construction that we think is really important.

Joseph: Fantastic. I saw lots of nods from Sarah. But Sarah, I'm going to ask you, anything you want to add just in terms of this vital topic of differentiation?

Sarah: Yeah, absolutely. So, Noah covered it very well. It is worth me stressing that this strategy is run by one integrated team. So, taking a step back, generically speaking, there are two ways to approach an unconstrained bond strategy. And it really depends on how your fixed income business as a whole is set up. It can be siloed and you sleeve off your allocations to different fixed income sub-asset classes run by different teams, which is absolutely not how we do it. Or it can be done collaboratively within one integrated fixed income team, which is, in our view, the right approach. When I'm selecting securities for high yield, in the back of my mind, I have our team’s top-down view and ensure that not only do we buy high yield credits that have an idiosyncratic alpha component, but also ones that fit into our top-down view that have been heavily debated and agreed upon within the team. The risk you run with a siloed approach is, for example, you may have an investment-grade team that is super bearish on the consumer and tilts their allocation as such and a high yield team that is super bullish on the consumer and tilts their allocation as such. And so, they sort of cancel each other out. You want to avoid these unintended risk positions and we do that by employing this novel strategy called talking to each other.

Joseph: Talking to each other. Plain and simple. OK, I should really ask you now about the election. But I keep delaying the inevitable. I'm actually going to go completely off-topic as today, we've clearly gotten to know you a little bit more about your process and your market views much better. And now it's time to get a little bit up close and personal. So, we have a PM Spotlight available right now for our audience members on the website. A chance to get to know both of you a little bit better beyond the PM desk. And I've managed to get my paws on one of these PM Spotlights. And Sarah, I'm going to pick on you. So, I've read, within the spotlight, you famously said you'd like to be a PM early on in your career, which is great, but I believe you said you'd like to be a PM in any other asset class but fixed income. So, explain this hilarious story to our audience members and let them know what's in store for them on the website.

Sarah: Yeah. So, this is true. And it is on the internet, and if it's on the internet, it's out there forever. But I think when I was starting my career, I had this misconception that fixed income was separate to companies. And where I really love to and how I love to think about the market, where I love to invest is thinking about companies, company strategy, what makes companies successful, and what makes a company unsuccessful. And so, high yield is actually the perfect asset class for someone with that mindset. When you're at university, you're only really told about the equities part of investing. And so, I'm very grateful to have found my way into high yield because it is the perfect fit for me.

Joseph: Perfect. Read more on the website for sure. OK, so we're nearly at the end of the podcast and we haven't yet mentioned the Fed (Federal Reserve) nor the elections, but we're going to go there, of course. Noah, I know within your global income solution, you do have a very wide bandwidth to operate a pretty significant duration position, zero to six years. So, can you tell our audience members what you've recently done from a rate perspective in 2024? And how do you anticipate the big U.S. presidential election? How would that likely affect your views? And I appreciate this is quite a tough question, Noah.

Noah: Yeah, certainly. So, you're right. There is a lot of flexibility on the overall interest rate risk that we can take in the portfolio. It can be beneficial in a portfolio. You want to have a little bit more duration when you are in a later-cycle environment. We do have a little bit more duration than we've had in the past five years because rates are higher. The value is more attractive and we think that we are in more of a later-cycle environment. So, we do have a little bit more duration in the portfolio. We think it makes sense at this time. But that stands in stark contrast to where we were, let's say, in 2021 and 2022, when it was really the opposite end of that spectrum. Looking forward now into the end of 2024, obviously, the elections we did touch on. It’s an important event coming up that’s going to impact not only markets toward the end of this year but into 2025 and beyond. And the way we would characterize the elections and how it could impact the markets is really kind of twofold. One, there is incredible uncertainty, right? I don't think there's a lot of conviction from a lot of investors in exactly how things are going to shake out. So, there is a lot of this uncertainty, but I think that the next step in the analysis actually is possibly even more interesting. And that is, while there's a lot of uncertainty, we actually have quite a bit of conviction that while we don't know the exact makeup of what the government's going to look like after November 2024, we do have more conviction that it is going to be some form of gridlock. You see in the Senate, it is very likely going to tilt toward the Republicans. In the House, more likely than not, it's going to be Democrats. And then, you have a 50/50 proposition for the presidency. It is very likely that you're going to have some split government coming. And that is, ultimately, we think, going to result in gridlock. That means we're not going to see significant changes in the fiscal trajectory going forward. And so, we see a relatively limited risk of fiscal-driven rates sell off here moving forward into next year. So, again, we think it's a good environment to be a fixed income investor and that we think that the elections are unlikely to really alter that trajectory here moving forward.

Joseph: Fantastic. And definitely expect to hear more from SpringTalk as this pivotal event gets much closer. So, today, we've been going beyond boundaries on all edges of the credit markets, across all areas of the globe. And to wrap up, I'm going to give you both the tough task of condensing today's fantastic content into one or two key takeaways for our audience members. And Noah, I'll ask you to begin. Any thoughts?

Noah: Yeah, absolutely. So, I'll just kind of continue from where I left off. We do think that where yields are today, investors have been looking for these more elevated yields for a long time. We are at the precipice of the Fed here, likely in September 2024, embarking on an easing cycle. So, we don't know how long those yields are going to be around. So, we think it's a good time to be a fixed income investor here. But there are risks. And we talked about valuations, potential late-cycle behavior. So, we think that you want to have a nimble, active, opportunistic approach that really looks broadly for opportunities and doesn't just set those portfolio exposures in one particular or to be able to perform in one particular environment and then leave it. So, it's an exciting time to be a global fixed income investor and we're looking forward to the balance of this year and 2025 moving forward.

Joseph: An exciting time to be a global fixed income investor. Sarah, I'll ask you to bring us home with your key takeaways for our audience members today.

Sarah: So, Noah covered it beautifully. I will pull out three words that he used to describe our approach and just repeat them: Nimble. Opportunistic. Responsive.

Joseph: Nimble. Opportunistic. Responsive. You heard it here. So, thanks again, Sarah and Noah. Thank you, as always, to our listeners and indeed viewers across the globe. You've been listening to SpringTalk. Always a pleasure, and we will see you next time.