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Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Welcome back to another edition of the InsuranceAUM.com podcast. Today's topic is a good one, global fixed income, huge allocation by most any insurance company. We are joined today by Arif Husain, head of international fixed income and CIO at T. Rowe Price. Arif, thanks for being on. Thanks for taking the time.
Arif: Thanks. Thanks for having me.
Stewart: We are thrilled to have you, and I am a card-carrying bond geek and I'm thrilled about this conversation. But before we get going too far, I want to start it off like we start them all, which is what is your hometown, the one you grew up in, your first job, not the fancy one, and a fun fact.
Arif: Okay. So, first of all, great to meet another fellow bond geek. Bond geeks of the world unite. We're going to take over the world one day. I grew up in Manchester, in England, which some people will recognize is both the sporting and music center of the world, but yeah, that's where I grew up. My first kind of wage-paying job, I moved to London for university and realized just how expensive it is, and so my first job was firstly working behind the bars serving beer. Probably my favorite job that I've had, realistically.
Stewart: I can understand that.
Arif: Yeah. And then that didn't quite pay enough, so I then got into a little bit of sales. So, yeah, anything to pay the bills through college.
Stewart: That's outstanding. What about a fun fact?
Arif: Well, considering we're talking to insurance companies and insurance investment professionals today, I actually started my asset management career at a specialist insurance asset manager. It was a really tiny company in the UK called Whittingdale, and it was run by a guy called Patrick Whittingdale. He hired me because, and the killer line that he'd got me, was he told me he was going to not only hire me that day, he was also going to become the sole sponsor of the England cricket team. Now, I know most people listening will not be into cricket, but I was like, "Okay, cool, I'm going to be in charge of the England cricket team." So, that's why I started in asset management and actually spent probably the first 5 years of my career managing insurance money for both Lloyds and then later for bigger insurance companies.
Stewart: Wow, there you go. We have a similar background, not the cricket part, but we have similar backgrounds. I kind of started running money for insurance companies too, but many, many moons ago. Let's start off with global macro, right? So, understanding that you have a global investment mandate, the majority of our audience is based in the US, could we break that up into topics impacting the US and then ex-US, maybe kicking it off with US inflation?
Arif: Yeah. So, it's interesting, we go straight to the high level, but the thing sticks with me from my early days running insurance money is just the value of the basis point. Always chase that last basis point. Well, it's really important to then go and look at the big picture. Never forget that key message, and it's the one that I give to all the people I train and have trained through the rest of my career. So, in terms of US inflation, I'd say it was the big topic for last year and now it's vying for shelf space with the upcoming potential recession, but inflation is still key in my mind. So, inflation is coming down, but that's largely because energy prices have come down.
We're going to split the US versus the rest of the world, but there's a bunch of stuff happening in the energy markets, whether it be global geopolitics, but also just down to the weather. Imagine if we hadn't had such a mild winter in Europe, right? Now, Europe was struggling for energy because of the conflict, the ugly war that's going on in Ukraine. If it had been cold, freezing over Europe, oil prices would not be where they are. So, my point there, and I think this is really important, is inflation is coming down at a headline level, largely energy, but my advice to all investors is just don't bake that in. All it takes is a cold spell coming up a few months from now and we could be right back up to the highs in energy prices.
Away from energy, it's really all about wages. It really is all about wages. Unemployment is a record low, people have jobs, and while the labor market appears to be easing at a headline level, it's still really, really strong. So, while that is the case, and if you had to look at one thing to think about going forward in inflation, just keep an eye on the labor market, and I think this is really, really important. The bar is set pretty high. So, there are rate cuts priced into the market. People are expecting the Fed to start cutting rates later this year. So, we're not just saying, okay, a little bit of a fall in inflation. We're not just saying a little bit of an easing in the labor market's important. Realistically to validate some of those expectations in the fixed income market at the moment, we need the thing to come off really, really hard, and be careful what you wish for, I guess, is what I would say.
Stewart: It's a great set of facts there. One of the things I guess I wonder is when you see this most recent GDP print of, I think it was 1.1% in the US, I mean, the Fed has got somewhat of a blunt instrument that it's using, right? I mean, it can raise short-term interest rates and we've got an inverted yield curve right now. You've been at this a long time and I have too, and whenever you see that inverted yield curve, it's hard to extend, but oftentimes that's the time to do that, right? So, what's your opinion on the path the Fed is on right now and how likely do you think that we're going to see cuts in 2023 at all?
Arif: I think the Fed has a really tough job, really tough job because there's a bunch of anomalies, a bunch of contradictions happening in the world today that they just haven't had to deal with in the recent history. So, just highlight a few of them. So, the first one I would say is you highlighted the lower real GDP number, but nominal GDP looks fine. Nominal GDP is doing really well because inflation's high, right? If you look at the top-down data, it looks a little soggy, it looks like it's slowing, it's a little worrying, but lockup earnings bottom-up. Things look pretty solid outside the small banking sector. Another big, big anomaly in the economy is the Fed's main tool, as you referenced, is pretty narrow and, really, that targets interest rate sensitive sectors like the housing market and really simplistically it hits manufacturing, but manufacturing is a small part of the economy. The rest of it's service and that isn't very, very interest rate sensitive at all.
So, they're trying to control the whole economy with a relatively blunt tool which affects a relatively small part of the economy. So, they have a really tough job, and that's the case of global central bankers around the world, but that's no excuse. They've still got to get it right. So, I think they're on a pretty good track. I think the mistake they all make is they'll probably hike a couple times too many and then have to end up cutting really quickly when something breaks. The problem is, again, one of these anomalies, if I look at the economy short term, doesn't look great but it doesn't look bad, right? There's a window of pretty good economic performance, but any longer-term, medium to longer-term forward indicator looks pretty terrible.
So, getting that pivot is going to be really, really hard. I don't think they're going to be able to cut rates this year. Given what we know today, given the data on the table, I don't think they're going to be able to cut rates this year, but any day, any month, we've set the conditions for something to break. As a financial system, we may not get an economic recession. We might get a financial market recession. The conditions exist today. Illiquidity, lack of transparency, et cetera, et cetera, anything could break at any point now. So, we're within that window where we could go from the positive window in the short term to that longer-term more dreary outcome pretty quickly, and we all need to be ready for that.
Stewart: That's interesting. It's interesting, I've done a zillion podcasts and I've spoken to a lot of smart money guys like you and the market’s pricing in a cut or cuts and nobody I've spoken with thinks that it's going to happen, which is, I mean, that view is pretty consistent and yet the market's got it priced in. I find that really interesting. I mean, it's one of those things. I've asked that question before, what's overpriced, what's underpriced in the market right now, and it seems like a lot of folks think that cuts in 2023 are unlikely. Is that a fair assessment of how you're thinking about it?
Arif: I think the way you characterize the answers you're getting at is very, very fair. It's hard to find people who think that the Fed are going to cut, but it's priced in. I think there's probably a couple of explanations for that. Well, one is when we started to get those bank failures in March, the market was just really short duration. You just got this massive stop-out covering of deleveraging of positionings and that's led to don't read into, we shouldn't read and say this is what the market's pricing. It's just a product of there having been more buyers than sellers, right?
Stewart: Yeah.
Arif: So, that's a liquidity argument. The other way you explain this is on the balance of probability. So, maybe then a lot of people who have the same sort of thinking as me which is: in the main scenario the Fed aren't cutting rates, but if something breaks and something breaks badly enough, and I'm not talking about small banks, regional banks here, I'm talking about a real fracturing of the financial system, if something breaks that big, then the Fed aren't going to be doing 25 cuts, right? They are slashing rates to 2.5 in pretty short order. So, it's a weighted average of the probabilities. That's how I think you explain that.
But in the meantime, and I think this is really, really important, inverted curves are highly destructive. You're a fixed income nerd. A lot of the people listening are going to be fixed income nerds. We all know that carry is our best friend in fixed income. Negative carry is highly destructive. You wake up each morning, you have to dig yourself out of a hole, right? All an inverted curve is, is negative carry. We don't buy credit with negative spreads because... why would we, right? But we're buying inverted curves. That is a really tough environment for investing fixed income.
Stewart: Just straight sincerity here, that was a really insightful explanation all the way around. I mean, that helps me get a handle on how the yield curve can be shaped the way that it is, which is really helpful. So, let's switch outside the US. What's your primary market view on countries in Europe, Japan, China? Can you talk a little bit about the ex-US market?
Arif: Yeah, it's a cliché, but each of those is a different place. So, Europe, I've heard some people characterize it as the US light by 6 months, many of the same problems. I'd say there's a very big difference between Europe. One is the energy issue that I highlighted earlier. They just don't have enough energy if and when they need that energy, if it gets really cold. And the second is Europe tends to be a lot more unionized. I'm generalizing here, but it makes those wage settlements that are coming through a lot less sensitive to demand and supply of labor.
So, potentially Europe may have a bigger inflation problem than the US, maybe, maybe. So, maybe not that an attractive place to invest in the short term, but longer term I think Europe's becoming a pretty attractive destination for fixed income, much higher yields, long gone are those negative yielding markets, and during COVID we saw the early signs of Europe coming close together. Yeah, my words no one else's, right? Instead of being the European Union, imagine what would happen if we had the United States of Europe where they neutralize their debt. They've got a monetary union, what about a fiscal union? A long way off, but it certainly makes Europe an interesting investment choice over the medium term.
China, China's interesting, a lot of factors going on in China, biggest one being they exited their COVID lockdowns a lot later than other places. From an economic perspective, they're getting that big post-COVID bounce still, but they didn't write anyone a check. So, it's a later bounce and maybe not as big. Also, a very, very complex economy at the moment trying to go through big transitions, centrally managed. And then the external perspective on China's really important. Whether it's through ESG or geopolitics, it's affecting capital flows, et cetera. So, really interesting place.
But I think probably the place most people have forgotten about because it's been the opposite of interesting for a long time as an investment is Japan. Japan's zero rate yield curve control, it's sort of fallen off people's radar. I'd urge everyone to start listening more to the Bank of Japan. They are probably the last anchor of quantitative easing, the last anchor of mass, huge easing out there, and if they abandon yield curve control, that's potentially kind of the San Andreas fault of monetary policy. It's really important. Why do I say that? Well, Japan has the biggest pool of private savings in the world, and most of that, a substantial amount of that money is outside Japan. If they make it much more attractive to repatriate their money, that's got profound impacts on everything that your listeners are investing in. Really, really important.
Stewart: That's a great point. How should investors think of China? In your mind, is it an emerging market or is it a developed market as far as fixed income goes?
Arif: So, I think there's a number of ways to approach this. I'm going to go back to the bond geek definition.
Stewart: Welcome.
Arif: So, for me, emerging markets and developed markets have very set characteristics. So, an emerging market fit bond, you wake up in the morning and it's dropped four points, massive volatility, big gap risk. When equities sell off, it's correlated, right? Those are your typical emerging markets. Developed markets tend to do the other thing. They tend to be safe haven, lower volatility. I know some of these kind of stereotypes are breaking or have broken recently, but if I place China on that continuum, Chinese government bonds, Chinese fixed income has had some of the lowest fold of anywhere in the world over the last couple of years, which is really interesting.
Within our investment process, we look very globally. We have analysts focused all around the world looking for opportunities, and actually when building a fixed income portfolio, China has been what we define as a hideout. It's been somewhere to hide out from the big losses in treasuries and all the volatility that's happening. So, it's almost played the role Japan used to play, just boring stability. Now, that hasn't been the case in a lot of the corporate sectors in China. China housing bonds have been particularly egregious to a lot of investors, but the government bond sector actually has been kind of interesting.
Now, the question is how do you fit it in within a more global portfolio and whether other markets are much more interesting because certainly for people struggling with rising rates and the Fed and the ECB rising rates, one of the simple ways we've been thinking about it is rather than trying to pick the top of a rate cycle, rather than sitting around in countries that keep raising rates, that keep having high inflation point prints, et cetera, go find a country that isn't raising rates, where rates have peaked and they're starting to cut, or even somewhere where they're actually thinking about cutting rates, right? Using that global opportunity set I think is a tool that not enough investors are thinking about. We're all focused, tend to be focused on the same things. Use the world. It's a big place with lots of different bond markets, and that's really kind of the heart of what our process is trying to highlight.
Stewart: That's great. Okay, so changing gears just a little bit, right? We did a couple of podcasts this past week about CRE, and it turns out that I learn a lot when I get to do these because I talk to smart people, and one of the things I picked up is that about 60% of the bank-owned commercial loans on real estate reside in the regional banks, right? Credit Suisse caused quite a market stir in March. We all know what happened with SVB. Is this a temporary market blip or is it more symptomatic of what lies ahead in banking, for example?
Arif: So, I think it's symptomatic. So, we've gone from a world of quantitative easing to quantitative tightening. We've gone a world from low rates to high rates. Most importantly for banking, we've gone from a world of positive yield curves to inverted yield curves. That's banking 101, right? Borrow short, lend long. It doesn't work in an inverted curve. So, I think we're seeing, we're effectively seeing the natural consequences of what has been going on in the world. We saw it in the UK pension schemes, now it's come home roost in to the regional banks in the US. What I would probably say though is while it's important, cannot underestimate it, I can't help but feel that we've seen this movie before. I feel like authorities, the alphabet soup of regulatory authorities have this under control. They've got a playbook. They might need to rewrite a few chapters of the playbook, but they know how to deal with banks.
What worries me is the real push post-GFC has been disintermediation away from the banking system. So, there is a ton of non-bank leverage in vehicles or areas that are unregulated, more opaque, a good degree of financial engineering exists, illiquid, pick your term around this, but that unknown worries me a little bit more than the known of banking crises. I think inevitably more, but I think there's a playbook to deal with those. So, what we're watching is for something to break somewhere else, and there is no backstop to that that we know today, right? So, that I think is the most important thing.
Stewart: It's really interesting you say that because I've kind of broached that topic prior and nobody really wants to talk about it, but there's a lot of loans that would have historically resided on bank balance sheets that are now on insurance company balance sheets and the quality of that underwriting, I think the jury's out on what the quality of that underwriting is. So, I share your view there. So, after a decade or so of limited fixed income market volatility, do you view the current volatility environment as the new market normal going forward?
Arif: 100%. Simple question. After the quantitative easing response post-GFC, which asset went up? And the simple answer is every single one of them. Bonds went up, equities went up, credit. We even invented new asset classes like crypto, and they went up, right? Everything went up except volatility. Volatility collapsed across asset classes. So, as we've gone from a QE to a QT environment, I think necessarily that we're going to be in a higher vol environment and that's then backed up as you think about the demographic transformation that the world's going through, the social economic, work from home, geopolitics, everything leads me to believe that we're in a structurally higher realized volatility market. Well, whether that translates through to implied volatilities, that the jury's still out there, but I do think all conditions exist for much, much higher volatility.
Stewart: And so, as you've mentioned earlier, our audience is predominantly insurance investors who are focused on yield, investment income. Where in your mind do opportunities exist for income improvement, both in investment grade and below investment grade as you look out across the globe?
Arif: I think firstly, there's a lot more yield out there. So, we should all applaud and be happy. The flip side of that is we all have to ask ourselves why there is more yield, right? The yield is there for a reason. It could be government yield to a premier. It could be credit risk premier, default risk premier. That's a big deal for most of the people listening here, but it could also be compensation for that volatility, right? So, you buy a corporate bond, you're selling volatility. That's the way it works. So, wherever we look generically, we've got to be looking and thinking, "Why am I getting paid that yield?" It's been a while since we've had to have that deep conversation about getting paid for a reason, but we need to have that. That's imperative.
So, with that in mind, when I look around the world, I'm actually really using a pretty simplistic view which is go to the places where the reason for that higher yield is most transparent. So, maybe an underinvested asset class amongst insurers is the emerging markets at the moment. I certainly am seeing lots of people interested in emerging market corporates, particularly on the IG site. Gives you some great diversification, but you're also getting the yield, and almost simplistically, we know why we're getting paid that yield. It's emerging markets, but there are some great companies who can build a great portfolio. We're seeing a lot of insurance companies turn to that and doing it very, very successfully.
What started as “Oh, I'm getting nothing really, no yield in the US or Europe, I'm going to go look elsewhere,” is actually becoming a really interesting asset class in itself. A high yield, looking pretty attractive, some really nice yields, available, pitch spots. And then the other place where there appears to be great liquidity premier and you seem to be getting paid more for that volatility is the securitized world. So, there's plenty of places to go. Again, though, my view is: understand why you're getting paid. Is it liquidity? Is it volatility? Is it a default risk premier or a downgrade premier? So, we got to be really careful.
Stewart: That's a great explanation as well. If I'm a CIO today, should I be moving out of floating rate exposure and locking in fixed rates right now? What's your view there?
Arif: That's a great question and really depends on the nature of the CIO's remit. What are the liabilities? But I'm running the P&C, if I'm the CIO of a P&C company at the moment with relatively short-dated liabilities, I'm staying floating rate for the majority of my assets. I think there are probably better ways to get protection against that recession than buying duration at the moment because the bond market with the inverted curve has a pretty dreary outlook already priced in. Not saying it couldn't get any worse, not saying yields can't go lower, but I think there are other better ways of buying protection to that recession as you structure your portfolio. There's simply just lengthening duration. Again, that's pretty costly, that inverted yield curve.
Stewart: So, at the risk of putting you on the spot, and we don't typically cover particular strategies here, but you are the lead portfolio manager on a number of strategies for T. Rowe Price, one of which is called the Dynamic Global Bond. 2022 was brutal for fixed income by any standard, and yet you were able to deliver positive absolute returns. Without a sales pitch, if you will, how'd you do it?
Arif: Well, thank you for raising that. I read in the press that we were the best performer or one of the best performing bond funds in the world. I think how we do it, it starts with philosophy. That is a strategy that is built to avoid losing money. So, think of it more in either in your fixed income category or liquid alts, but the philosophy is: don't lose money and behave as a diversifier. Provide those old-fashioned characteristics that people used to buy fixed income for. We did exactly what we said we were going to do. We were one of the best performers in Q1 2020 when COVID was kicking off as well. We're designed to perform well when the going gets tough.
So, the other side of it was I've got a ton of really, really good analysts at T. Rowe, just such a thoughtful team, such a large team, such a global team. We managed, just as I said earlier, we managed to stay away from those kinds of negative returns by thinking globally. We were short duration. We've got a great active duration management process going, and we largely stayed out of loss-making countries. So, taking a global perspective, being a little bit more nimble really paid off for us.
Stewart: Wow, that's great. That's a great story. Last question. So, maybe you remember your first day of a job, like post-college and your first real job in this business, what advice would you give a 21-year-old Arif Husain today?
Arif: I'd give myself the same advice I give to all the grads and all the juniors that are coming through and developing and that is really simple which is: you'll get to where you deserve to be. People have your best interests at heart, and if you work, if you go over and above, you will end up getting to where you deserve to be. It will just take a lot longer than you ever hoped it would. So, be patient, don't worry, focus on today.
Stewart: I love it. I've learned a lot. I really appreciate you being on air. Thank you so much.
Arif: Thanks for having us today.
Stewart: Absolutely. We've been joined today by Arif Husain, head of international fixed income and CIO at T. Rowe Price. If you like us, please rate us, review us on Apple Podcast. We certainly appreciate that. If you have ideas, please email me at podcast@insuranceAUM.com. Thanks for listening. My name is Stewart Foley, and this is the InsuranceAUM.com podcast.
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