Brian Foerster: This is Brian Forester, and welcome to The Active Investor podcast, our monthly look at what's happening across asset management, and how investment leaders at our firm are thinking about markets and opportunities today, as well as strategies that can help investors navigate different challenges.

In this edition of The Active Investor, we are talking about the evolution of fixed income investing, and in particular, a lot of the new challenges investors face around what they consider the core part of their portfolio. The huge move in interest rates starting in 2022 gave a lot of investors in core bonds, often thought of as the "safe” part of fixed-income portfolios, a painful shock that still echoes today.

And that has started to spawn some innovation in the industry. And we'll touch on that in a bit. For this discussion today, we've invited Greg Benz, who is a portfolio manager and managing director here at Lord Abbett and has a specific expertise in credit investing. Greg has been in the investment industry since 2011 and is a CFA charter holder and most importantly has had a hand in managing some of Lord Abbett's most successful fixed-income portfolios. So welcome, Greg.

Greg Benz: Thanks, Brian. Great to be here.

Foerster: So, before we dive into the current state of fixed income investing, and really how some investors are thinking about allocating their portfolios and allocating risk, I was wondering if you could first spend a couple minutes on your background and how you got into finance and investing.

Benz: Sure. And thanks again for having me. Great to be here. Yeah, so as you mentioned, I entered the industry in 2011. I've been here at Lord Abbett since 2016 as a member of the high-quality credit team. I began my career in emerging markets [with] a competitor on the West Coast before coming to Lord Abbett. And I’ve been fortunate to work on a few different teams here.

But I think when I was in school, trying to decide on a career and what would interest me, I knew I always had this interest in finance and investing. Going to a liberal arts school, it hadn't been what I spent all my time in class on.

But I knew I always had this interest. And I think it was really just a desire to learn how things worked and why things happened a certain way and really understand the “how” of situations. So, I think in investing, it feels like there's just always something to learn more about.

There's no endless supply. And there's just also a very quick kind of feedback mechanism about, "Okay, I thought this would happen and it did or did not." And just that chance to keep learning and keep evolving was always really appealing to me.

Foerster: Interesting. And so, you joined Lord Abbett to our fixed-income team I think in 2016?

Benz: Yup.

Foerster: And I think just turning to our discussion on credit, a lot has changed since the global financial crisis [GFC]. There's been sort of this evolution, people have called it, in fixed-income investing, particularly around public and private markets. Maybe you could just spend a few minutes talking about how you view that in particular, then we'll get a little bit more into some of the [potential] solutions around that.

Benz: Sure, yeah. It's a great thing to talk about. I think before you dive into the history of it, I think we've even seen a change in the definition of what is “public” and what is “private” and how do we think about these. And I think there's kind of a long and complicated version, and then I think the quick, shorthand a lot of the market has used for a while now, has just been liquidity.

And in its most basic sense, public equity versus private equity was the easiest thing for all of us to wrap our heads around. But I really think that's begun to change. I think we've heard stories about private equity trading in secondaries [secondary markets], you see this happen in venture capital, with pre-IPO stock trading.

So, I think we really need a new framework or rough idea—rule--to use to different public versus private. I personally like to think about how a transaction was marketed. So, in a public market transaction, you probably went out to a very large group of investors, probably through an intermediary, maybe a bank, and said, "This is what we're trying to do, here's all the information, please everyone, take a look."

On the private side of things, for a variety of reasons, you probably went to a very narrow group. Maybe it's one group, maybe it's one person, maybe it's a couple of investors. But it's probably actually the lender themselves, not through an intermediary, and a smaller group of potential lenders.

So, I think in my mind, these days, that's the biggest distinction between the two. And I think as a result of that, you're also starting to see, as the private market has broadened and deepened, borrowers begin to think about what market they want to issue into.

I think historically, when you look at the pre-GFC period, it was like, "Oh, this is this type of transaction. It should go to this market." Or "Oh, you're this type of company at this given size, you should go to that market." So, I think now, especially if you think post-GFC, a few different crises we've had, including COVID, those have caused issuers to say, "This might not work the same way it was working before, let me look at a wider selection of approaches that might help us."

So, what you've seen is borrowers really starting to look at all the different markets that they might want to raise capital in and create some diversity in how they're raising capital. And then as a result of that, as an investor, you really need to also start looking at all these different markets for where the best opportunity would be.

Historically, you could say, "I like this type of thing, this is what fits with my investment mandate, I only need to look at this type of, say, public, unsecured corporate debt," or something. Now you need to look at all the different things available to you.

So, borrowers are starting to look at all these different markets, you're seeing investors as public and private markets become more of a spectrum of opportunities, as opposed to kind of two distinct buckets. As it's becoming more of a progression, you're also starting to see investors think about where in that progression to invest.

Foerster: Yeah, it's an interesting way of thinking about it. And it's almost like if you choose to ignore the private space now, you're ignoring a huge part of the capital markets just within fixed income.

Benz: Well, no, I think that's definitely true. And I think to your point, companies you follow in the public market space, historically forever, that your analyst likes, all of a sudden do a deal in the private space. So, it hits very close to home as well, where you see the companies that you think you should be lending to do a deal in the private space.

And it happens the opposite way as well, and it also recently has really started to happen more across the asset-backed versus corporate space. Issuers that were traditionally only issuing in the corporate space are now issuing in both the public and private asset-backed space. So, it really is this full ecosystem that you have to look at all the options.

Foerster: Right. Okay, so following on that, fixed-income investors I think are rethinking, especially what they consider the core part of their portfolio, or really since 2022 and '23, a lot of the core space, the “Agg”-oriented [toward the Bloomberg U.S. Aggregate Bond Index] portfolios, that a lot of investors thought of as the "safe" part of the market, like “this is what helps me sleep at night,” you lost 10%, 15% potential during that really aggressive rate hike in '22 and '23. And I think that really was a jarring experience. So maybe you could talk about the impact of that experience for investors and just how you're thinking about that.

Benz: Yeah, sure. I don't need to tell anyone listening to this about what 2022 was like. It was obviously a little bit of a shock to the system. I think in October of '22, at one point, year-to-date returns for the “Agg” were over -16%. And this is at the same time when equities were down a bunch.

And you think this should be the hedge and the barbell of your portfolio that's really helping you. So that was a very stark event that I think has people asking a lot of tough questions about their fixed-income allocation afterwards. What is the role that fixed income should serve in a broader portfolio?

And then we think about institutions, they maybe have long-dated liabilities, there's a lot of reasons and a lot of roles that fixed income could play in a portfolio. I think for individual investors, they may be beginning to ask, "Do I have to have this interest rate volatility in my portfolio? Did it have to be down 16% if I owned an ‘Agg’ product?"

If you're outperforming by a couple hundred basis points, but you're still down 13%, no investor is ever happy. So, it's a difficult conversation. So as investors start to really ask that question of, "What is the role of fixed income? Why do I own this?" I think from the conversations we've had, there's been a lot of renewed interest in the “income” of fixed income, especially now with the yields and base rates being so much higher. So, I'd argue that it's the net result of 2022 is pushing people back to this focus on income and another source of return if we did see a negative environment for equities.

Foerster: Yeah. Let's just dig into that a little bit more. So as investors think about the current market environment and a lot of the uncertainty and volatility around rates, credit, macro risk, all that fun stuff, what do we think are the key objectives now for various fixed-income allocations?

Benz: Yeah. So, I think like everything, it's definitely going to be individual, investor specific. But I think there's commonalities between different groups. And I think for individual investors, the opportunity is really on trying to maximize this income piece while managing the volatility piece.

And a large driver of that volatility is definitely interest-rate exposure. And maybe there's an opportunity to trade some of that interest rate volatility for a different type of risk or a different type of exposure that maybe behaves differently. So, could I, instead of taking interest-rate risk, take a different type of risk and broaden out the profile of this fixed income and earn extra income as well?

Foerster: Okay. So, along those lines, with managers potentially having more tools at their disposal today with having more private markets, private ABF [asset-based finance], things like that, and this convergence in public and private credit, how do you, as a multi-sector manager, think about that tool kit and the opportunity that you now have?

Benz: Yeah, so I think the broader opportunity is really to combine these public and private allocations. I think there's definitely a subset of investors who have their own private allocations and aren't looking to commingle the two.

And that's fine. I think that'll always persist. But I also think there's a broad subset that's going to want these two combined. And just as we've seen the public and private markets converge, we're going to start seeing the product converge.

And it's going to be high-quality credit, investment-grade credit, as opposed to public and private and the line will be a little harder to distinguish. So, if you think even bigger picture, the basic premise about a core-plus fund is, let's start with the “Agg,” which is really three things at the end of the day--Treasuries, mortgages, and investment-grade corporates--and let's start introducing other types of assets that will increase the overall excess return per unit of risk of the strategy. I think at its core, that's where core plus really emerged from.

So, this is just another step in that evolution. There's no free lunch. We're not adding a bunch of excess spread with no other risk.

So, you need to think about the risk you're taking. Part of that is a liquidity risk. So, you need to make you don't have any asset-liability mismatches. You've made sure that you're being very thoughtful about the price you're giving away liquidity at.

But introducing this additional asset class is going to push out the efficient frontier of the broader, multi-sector suite of products. And then additionally, we've talked a lot about how it is a convergence between public and private and we're seeing this as more of a spectrum.

There still are issuers and transactions that lend themselves particularly well to one of those four quadrants. So, if you are introducing direct lending or asset-backed finance with a more public credit or public asset-backed portfolio, you're naturally going to get some diversification benefits.

You're getting access to a whole host of issuers and probably transaction types that you don't currently have represented in your portfolio. So, I think it's also really helpful to think about it as an additional source of diversification.

Foerster: So clearly what you're referencing is a strategy that we now manage at Lord Abbett. And there's been a lot of product innovation in the industry around this idea of combining public and private or tradable and illiquid assets. You've even seen firms partner with one another to come out with innovative products. Maybe you could talk a little bit more about that strategy, the sectors you're allocating to, and how that could be a unique solution or unique set of outcomes for investors?

Benz: Sure, I'd be happy to. So yeah, there's this broad trend right now that is [potentially] going to lead to some great outcomes for investors, this combination of public and private assets within a given strategy. That being said, a lot of our conversations following up on 2022 and the volatility we experienced were focused on the objectives that investors were trying to achieve from their fixed-income portfolios, and the thing we kept hearing was, "How do we earn the high income we're looking for while minimizing some of this volatility?" And "We're okay taking some credit risk, we're okay giving up some liquidity, but how can we still earn this income while managing our volatility profile?"

So, it was important to us to meet those needs. And what we decided was, “what if we build a strategy that focuses on those outcomes, those objectives, instead of a category or a benchmark?” I feel like a lot of times, people lead with a benchmark and a category, but let's focus on the objectives. What would that look like?

So, in doing that research and having those conversations, we ended up settling on five building blocks that we think could be the key foundational pieces to achieve those objectives. So, on the corporate side: public, investment-grade corporates; public high-yield corporates; and private direct lending.  So really the full gamut.  And then on the asset-backed side: both private and public [financing vehicles] there as well.

So, by combining these five things, we think we can meet those objectives, and we think that the diversification benefits between the three and the different risks that all of those bring to the table will help us manage the volatility profile.

So, I will say we've also, given that a lot of the feedback was around it being okay to give up some liquidity, we felt comfortable introducing the private [vehicles], but we needed a structure that would map that as well. So, you don't want that in a daily liquidity type vehicle. So really considering all of those things, putting them together to create a strategy that we think would meet these investors' needs.

Foerster: Right. So, if you're willing to give up a little bit of liquidity, if you don't need your core money at 4:00 every day and more like a quarterly liquidity type of approach, you can get these intended outcomes. And I think if I'm hearing you correctly, the intended outcomes are something along the lines of having the income profile of higher-yielding asset classes, the interest-rate profile of short duration, and the credit profile of investment grade.

Benz: Exactly.

Foerster: Awesome. Good stuff, Greg. Very helpful way to think about this evolution in credit markets. And with that, I think we'll wrap things up and I'll just say thanks again to Greg Benz for joining the podcast. Some really great insights today across public and private fixed income. And it seems like it's only going to continue to evolve. Definitely look forward to having you back again. Thanks for joining us.

Benz: Thank you. It was great being here.

Foerster: Great, thanks Greg. And for listeners wanting to learn more about Lord Abbett's views on the markets, please visit the Insight Section of LordAbbett.com. We have a number of papers on credit and fixed income investing that touch on a lot of what we discussed here today.

And lastly, we'd also like to hear from you, our listeners. If you have any comments about today's podcast or ideas for a future podcast, we welcome your thoughts. Just email podcasts@lordabbett.com. So, we'll leave it there. This has been Brian Foerster with The Active Investor podcast. And thank you for listening.