DoubleLine’s Jeffrey Sherman Captivates at Aston Research Symposium
Jeffrey Sherman, portfolio manager for multi-asset strategies at DoubleLine Capital LP, capped off the day long 2014 Aston Research Symposium on May 6 in Chicago with a rousing talk on the current state of fixed-income markets. Sherman was the final speaker at Aston’s research event held for investment professionals interested in learning more about Aston and its lineup of funds managed by institutional-oriented subadvisors.
Sherman began his speech by noting that despite optimistic forecasts from the governors of the Federal Reserve Open Market Committee a look at the data doesn’t paint a rosy picture of economic activity. As measured by real U.S. Gross Domestic Product (GDP) growth by decade, the 2000’s and 2010’s (an average of 2010 thru 2013) have produced the worst growth since the 1930’s. The velocity of money (i.e. the frequency with which money is put to work in the economy) has deteriorated sharply since the late 1990’s despite record low interest rates and numerous rounds of so-called quantitative easing (QE) by the Federal Reserve. Velocity has reached a four-decade low as banks have failed to do what they are supposed to do to keep money circulating in the economy, especially since the end of the 2008-09 financial crisis.
GDP is driven by capital. Stagnant employment since the financial crisis plus the 40-year trend of falling wages/salary as a percentage of GDP points to the lack of capital being generated. This is echoed by U.S. inflation measures that have remained at low levels the past decade and the lack of any expectation for inflation currently priced into the US Treasury market. Reports of consumer deleveraging have been overblown as total household mortgage debt has declined, largely through defaults, only to be replaced by an increase in consumer credit, with total household debt only marginally lower than its 2006 peak.
All of which prompted Sherman to ask and answer a very important question, “What did QE get us? … Increased risk.” Total household wealth has soared above pre-crisis levels in the past year, but at what cost. The Fed couldn’t spark a rebound in housing prices, instead it fueled a massive rally in stocks. Nor did QE do much to improve real economic growth. The $1.5 trillion in quantitative easing since its implementation by the Fed roughly equaled the five previous years of real GDP growth (Dec 2003 to Dec 2008). With a cumulative increase in the Fed’s balance sheet of $2 trillion (from $1.5 to $3.5 trillion) the economy only got a one trillion dollar increase in aggregate GDP.
While QE clearly worked for stocks, the picture is more nuanced for bonds. QE increased yields for government bonds early on but had diminishing effects over time. Overall, the performance of 10- and 30-year US Treasuries has been positive during the QE era, despite rumblings of a “bond rout” since the Fed began talk of tapering its asset purchases last June. By that time, few serious bond investors (other than the Fed) had a significant trade on in relatively low-yielding 10-year Treasuries, and as Sherman noted, “Who owns the 30-year?”
The so-called “taper talk” did take a serious chunk out of US Treasuries since the beginning of 2013, but other fixed-income securities suffered significantly lower drawdowns than Treasuries, with US Corporate bonds, US High Yield, Mortgage-Backed Securities (MBS), and Bank Loans back to or nearly at December 31, 2012 levels by the end of April 2014. Indeed, the recovery has been such that few bargains stand out at the sector level.
In a revealing series of slides highlighting opportunities in various sectors of the fixed-income market, Sherman stressed the importance of valuation in analyzing bonds. Investment-grade Corporates are two standard deviations more expensive than Treasuries (over a nearly 30-year trend). High-yield bonds are even richer. Yes, Treasuries are cheap, Sherman noted, but also the lowest-yielding sector of the U.S. fixed-income market.
He reserved his deepest scorn for Bank Loan securities, however, saying that, “Bank Loans scare us to death.” Sherman pointed to inflated valuations, the highest relative to 1-3 year Treasuries since January 1999, but also a shift in the structure of the marketplace for Bank Loans. Flows into open-ended Bank Loan Funds have soared since the beginning of 2013. Dedicated Bank Loan mutual funds now represent 35% of the ownership of the securities, up from less than 10% in 2009. In addition, lending standards have declined, with covenant-lite leveraged loans representing 63% of issuance compared with 25% in 2007. During the financial crisis, Sherman said that trade settlements for Bank Loans were as long as 75 days, making the current situation scary on the liquidity side, even more so as he noted that “there was no upside left.”
Where Sherman was “super bullish” was on Emerging Market (EM) debt, “one of the cheapest asset classes.” He noted specifically that yields on EM High Yield debt were high merely for having a bad address, with notably less interest-rate risk than comparable term Treasuries and Investment Grade bonds. Indeed, Sherman pointed out the relative attractiveness of EM debt to potentially less-stable peripheral European BBB-rated (investment-grade) Sovereigns such as Spain, Italy, and Ireland.
A Piece of Advice
Sherman ended his talk with a bang saying, “If you’re investing in bonds, I don’t care if you buy our funds or if you buy our competitor’s funds. Buy whatever you want. But don’t buy the Barclays Aggregate Index.” The duration (a measure of sensitivity to moves in interest rates) of the index has lengthened more than a year to greater than five years. Treasuries are the lowest-yielding sector of the entire U.S. fixed-income market, and now make up a larger portion of the index. Finally, on a yield-to-duration basis (which he called the “Sherman ratio”) the Barclays Aggregate Index is near its lowest level since inception, and by far its lowest level since 1976.
(DoubleLine is the subadvisor to the ASTON/DoubleLine Core Plus Fixed Income Fund)
This article is a summary of information contained in a speech made by Jeffrey Sherman of DoubleLine Capital LP. (“DoubleLine”), a subadviser engaged by Aston Asset Management, LP (“Aston”), on May 6, 2014. DoubleLine is not an affiliate of Aston and their views do not necessarily reflect those of Aston.
This material is not intended to be a forecast of future events, does not constitute investment advice, and is not intended as a recommendation to buy or sell any security. Investors should consult their investment professional regarding their individual investment program. Since the date of this report, economic factors, market conditions and DoubleLine’s views of the prospects of any particular investment may have changed. Investors should consider the investment objectives, risks and associated costs carefully before investing. Forward-looking information is subject to certain risk, trends, and uncertainties that could cause actual results to differ materially from those predicted. Past performance is no guarantee of future results.