Ben Emon, PIMCO

• Zero bound rates are a huge issue and have been a chronic problem for countries like Japan
• The private sector is still deleveraging
  • It’s still with us, and there is still $11.5 trillion in nominal consumer debt
  • We need to increase leverage to increase growth, so we need to decrease rates
  • Will increased rates increase the risk of deflation?
• We have full employment, but what kind?
  • There are lots of temporary workers
  • Many have dropped from the labor force

•  Interest rate outlook: 4% ceiling off of a 0% Fed funds rate
  • 1.0% impact of Fed bond purchasing program and forward guidance
  • 0.8% impact on GDP due to demographics, global debt and political uncertainty
  • 2.2% fair value, fluctuating between 2.5%-3.0% until clearer economic picture evolves

•  Thinks that there will be a 2.5% to 3.0% spread between the Fed funds rate and nominal interest rates for now, with a probable gradual increase in interest rates over time

• Fed’s projection of 2.5% policy rate at the end of 2016 contrasts sharply with the past, which has been nominally faster. The tightening cycle was two to perhaps three to four years. The challenge is how to communicate the change and Yellen may have interjected some uncertainty, and the Fed is not clarifying how it will behave.

• Where to invest?
  • Long U.S. duration not a great place to be right now
  • Overweight European duration may be a better place to be
  • Overweight emerging duration may be better than it was last year
  • Some emerging markets look attractive

Panel Discussion, Different Perspectives: moderated by Paul Doane, St. Paul Teachers’ Retirement Fund; Phil Nelson,NEPC; and Greg Zick, Xcel Energy

• Don’t want to exchange interest rate risk for credit risk
• Monetary policy in the U.S. is diverging with the rest of the world
  • Possible tightening cycle
  • Lots of uncertainty with timing and other factors

•  Increasing rates by the Fed will be data dependent, e.g. GDP level

• Credit spreads are low and credit quality is good, but we are paid on spreads
  • Tail risk with low yielding assets?
  • Many are forced to buy low yielding assets
  • Be wary of bank loans which carry a high yield but people don’t realize they are callable and sometimes sell above par very close to call price so the total return is not great right now

•  Still a place for durations
  • Risk mitigating tool
  • Need liquid, non-correlating assets, especially with equities

• Looking at a range bound market
• Look at total return, be more flexible and nimble and explore variable rate products
• Adding additional diversification via investments in a broader array of bonds and equities can be beneficial in the overall risk / return of a portfolio as evidence by the actual portfolio returns presented.
• It took 14 years to break 4% interest rates in the post WWII cycle, will it take that long this time?

Thomas Coleman, Wellington Management Company:

• As he sees it there are four strategies now

1. Staying the course
2. Shift form interest rate exposure to credit exposure
3. There is a high price for liquidity, and how to use it
4. Being more opportunistic

• Expect low rates or a low growth world.
• Staying the Course
  • Legitimate strategy
  • If rates unchanged, a possibility for 8% cumulative return the next five years
  • Rates abruptly rise, perhaps a negative return in the early years then quickly recover
  • Rates gradually rise and slowly drift higher, comes in at 40 bps /year for this scenario
• Other scenarios
  • Nominal government bonds do well in decreasing growth and inflation
  • Corporate spreads and high yields do well in increasing growth and decreasing inflation
  • Developed market ILBs do well in decreasing growth and increasing inflation
  • Emerging market currencies and ILBs do well in increasing growth and inflation

•  It’s not until the Fed is done tightening historically do markets determine if the Fed has overshot or not, perhaps as long as one year plus after the fact
• Duration hedged credit is like a synthetic bank loan, which can help create a floating portfolio.
• Think like a lender, own what you want to own
• Diversification works, but less so on a market cap weighted basis, equal weighted offers more diversification

Panel Discussion, Investment Advisors: Josh Howard, Advanced Capital Group; Mark Book, Sit Investment Associates; Neil Sheth, NEPC; Justin Henne, Parametric Clifton

• One of the panelists was exploring European middle market lending
  • 30% of loans are funded by banks in the U.S. compared with 80% in Europe
  • More shadow banking in the U.S.
  • Bigger corporations are in the middle market tier in Europe compared to the U.S.
  • Default rates in Europe are less than the U.S.
  • Recovery rates in Europe are better than the U.S.
  • Therefore active management works well here

•  One of the panelists was taking an absolute return strategy
  • Earn more while waiting for rates to rise
  • Use this strategy in conjunction with an existing portfolio, which would include the use of futures and options

• Another used treasury futures most often to remove rate risk and keep credit risk; this can be an advantage in that you don’t have to sell out of the funds you like and incur transaction costs and/or taxes.
• Use a rules based approach, as rates increase, increase duration for example.
• One said the key is how to generate income and return as opposed to gauging the Fed and inflation
• Clients went from caring about mitigating risk to looking for return, with another person mentioning that he’s seen a big shift to that view in the past three to six months.
• Absolute return strategy doesn’t work well in the short term, it takes time to implement

If you are interested in reviewing the slides from the event you can view them here