Thresher Fixed

“Yeah, it’s all beta but what’s the alternative?” I’ve heard this often in my conversations with institutional investors. Beta drives returns in the core fixed income space. If you want a big institution running your core money that’s by and large what you get. Here’s a chart that helps visualize the problem. The purple line is the excess return of the Bloomberg Aggregate Index over Treasuries. The other two lines represent the excess returns (vs the Agg) of the average core and core plus managers in eVestment over the same period. As you can see, the three lines track each other closely over the 15+ year period. When the Agg generates negative or positive returns versus Treasuries, the average active manager generates negative or positive returns versus the benchmark (source: eVestment and Bloomberg). What does this tell you? Instead of delivering alpha, the performance of the average core and core plus fixed income manager is simply a function of having more risk versus the benchmark over time. In other words, it doesn’t really matter what core managers say or do, the evidence shows they are running strategies that are riskier than the Agg. Bottom-up, top-down, it all looks the same at a high level. We explore this concept in more detail in our “Elusive Alpha in Fixed Income” paper (see comments below for link to paper). 

It’s been an up and down few weeks for the curve. The 2s 10s curve steepened into the volatility of early August where the yen carry unwind met disappointing jobless numbers and was amplified by growth concerns. After almost entering positive territory, the curve flattened as volatility receded. The market was buoyed by the BOJ saying no more short-term hikes, although calling 15bps a hike is a bit of a stretch, maybe a nudge? Still, the BOJ’s dovish about-face coupled with strong retail sales assuaged concerns and the curve topped (bottomed?) out 16bps flatter before Powell’s Jackson Hole pivot. “The time has come for policy to adjust” Short-end rates are headed down and the curve is headed steeper. At least that’s the fat part of the distribution of probable outcomes… As of this morning (8/29) the 2s/10s curve is -2bps. Nominally 6bps steeper than my post on 8/2. If you engaged the steepener amid the volatility expecting the Fed to activate “beast mode” and slash rates you instead got more of the reticent dove and a gentler glide path lower, but still a slightly steeper curve. At least you made some money, right? Well, remember the negative carry of the trade? Net the curve move and negative carry, the trade is down ~6bps (part of the curve move includes a negative roll to the new 2 year). It’s hard to get this right, and remember the Fed is an unreliable narrator. Not purposefully. They are limited by mostly backward-looking data and inherent economic biases. It’s a common handicap of most investment managers when using macro forecasts to make investment decisions. Without a more sophisticated process you could wait for the Fed to actually cut rates before buying the 2 Yr—as I mentioned, it’s a fairly reliable indicator to engage the steepener, at least in the last few cycles. The caveat here is that each of the Fed hiking cycles post ‘99 ended in a crisis that amplified the bull steepener, as rates were cut to the bone (if you think the narrative of a soft landing holds then spend some time forecasting the path of the components of the trade to weigh your carry costs vs. upside): - 2000 to 2001 the Fed cut rates by 550bps, 2s/10s steepened by 73bps 6 months after the first cut. - 2007 to 2008 the Fed cut rates by 500bps, 2s/10s steepened by 96bps 6 months after the first cut. - 2019 to 2020 the Fed cut rates by 200bps, 2s/10s steepened by 5bps 6 months after the first cut. That’s an avg. return of 46bps after 6 months and 113bps after 12 months (source: Bloomberg). Sounds pretty good until you realize that the return was negative in 2020 both 6 and 12 months out. So, engage the steepener, close your eyes and pop your head out on Groundhogs day? Maybe. It’s not the worst trade I’ve seen, and odds are in your favor. The tails are fat, though, and if inflationary data disappoints (geopolitical upward pressure on oil could do it) it’s not going to be pretty. One thing is certain, though, you’ll pay for the privilege of finding out.

2-Year! Yield Curve Steepener! Carry Unwind! Hard Landing! Volatility! Wow!! I feel like this post could just be exclamation points and periods… I wrote the post below (and a piece about the curve and the 2-Year Treasury and risk) this weekend, and it already feels dated.  The 2-year Treasury yield plummeted 38 basis points in just two days at the start of August. Even more staggering? It's down about 86 basis points since late June - a move statistically expected only once every 30 years! What does it mean for: • The yield curve? • Your investment strategy? We've looked at: • The statistical rarity of this event • Implications for yield curve steepeners • How to navigate these volatile markets Spoiler alert: Betting on a steepening yield curve isn't all upside. The costs of holding this trade might surprise you. Dive into the full analysis on our website to stay ahead of the curve (link below in the comments). 

From 2006 to 2023, the average core fixed income manager generated 57 basis points of annual excess return. Only 14% of the average manager’s excess return was alpha. 7 bps. That’s it. It’s a brutal punchline and, unfortunately, the joke was on me for a long time. Alpha and excess return are easy to confuse in fixed income. At bottom, alpha and beta are just parts of excess return. Alpha is the return due to a manager's idiosyncratic skill. That's special and worth a premium. Beta, on the other hand, is a manager's exposure to the market. That’s not so special. Attributing return in fixed income is a bit of a bear.  Excess return is easy. Either you generated it and beat the benchmark, or you didn’t. To get to a meaningful alpha (or beta) number you need to separate out the risky part of the benchmark from the non-risky part. The non-risky part, Treasuries and the risk-free rates they set, drives most returns for investment grade bonds. Looking at excess return beta helps remove the white noise the treasury component generates. Without doing that you have a beta close to 1 for almost every core manager – not that informative.    It’s true that in the real world, it’s the bottom line, the excess returns, that keep the fees rolling in. This means managers don’t spend a lot of time thinking about alpha versus beta. Excess return = fees.   Excess return is nice but it’s common and overpriced in active fixed income. Why should investors pay a premium for beta when it's readily available at a fraction of the cost? Instead of deliberating over which manager to select, the decision could be simpler: how much exposure to the Agg do I want? How about the AGG at 3 bps? Since 2006 the Agg has generated 37 bps of excess return over treasuries. Need more excess return? Buy more. Of course, it's not quite that straightforward. Implementation considerations are more complex and nuanced. But, at a minimum, investors should scrutinize the quality of managers' returns. They should seek managers who generate alpha. We dive deeper into active fixed income excess return in our piece – Elusive Alpha in Active Fixed Income. See the link to the full paper in the comments below. A quick note on AI and people ... Thresher is a systematic manager. Our framework is a blend of quantitative and fundamental analysis, and we expect the ratio of quant to fundamental to shift in quant’s favor as AI becomes better and more accessible. That said, creative, smart people remain indispensable. We took a crack at creating the comic with AI and were pleasantly surprised. But, the final version, pencil and paper, was far and away the best – (thanks Teresa L.).

Time flies. One moment you're changing diapers, and the next you're going to college graduations. One moment you’re sitting in front of a screen with lots of numbers and the next you’re sitting in front of a screen with lots of numbers, just somewhere else… It's been a while since I left Jennison to start Thresher and a lot has happened. People often ask me what I'm up to, so I thought I'd post a brief update. I built a career at Jennison by tackling challenges and solving problems. I started fresh out of school, no finance chops but a mean hand at the bridge table. Useful when the guy who hired me wanted to play with clients. Over the next twenty-six years, I learned to code, traded bonds, earned a CFA, became a PM, met with clients, built solutions in the LDI space, and ultimately became Co-CIO, overseeing a significant portion of the fixed income business. My job was mostly great. The work could be interesting, challenging, and rewarding. However, I became increasingly convinced that the industry was on the cusp of a transformation. I watched the pace of technological change accelerate and it spurred me to think hard about what it meant for asset management. Quantitative approaches to asset management on the buy-side have long been piecemeal. Quant has evolved, but it remains just one of many offerings at the alpha buffet for most portfolio managers. With tools to integrate fundamental and quantitative analysis becoming more accessible, I began to envision creating something unique, a dynamic asset manager that could more efficiently allocate resources and leverage emerging technologies. Driven by this vision I ventured out on a different path. Building something from scratch is an incredible challenge, and I have immense respect for anyone who has done it. I started with deep experience and strong convictions about what I wanted to build and the kinds of people I wanted to work with. And that and a couple of bucks will get you a coffee (maybe)... I spent a lot of time thinking. I enjoyed more time with my family. I walked the dog. I swam in the ocean and spent more time thinking. I had a clear idea of what our investment engine would look like and what it would not look like. I did not want a beta factory, the prevalent excess return model in fixed income. I started with the core space and built and rebuilt that thing I had in my head until I had a workable alpha generator. Bharadwaj Kavuluru joined in the fall of 2023 and by the end of the year we had refined and optimized our investment engine, discovering we could generalize our engine across asset spaces. So where are we now? Three strategies up and running. An office in Boston, two interns and more ideas than we know what to do with. Not to mention a burgeoning relationship with Hurricane Capital that will help us scale faster and launch an exciting new fund. There's much more to come, but for now, that's the update. Stay tuned for more news as we continue to grow.