Please note: AI generated transcript.
Text on screen: How does a systematic approach to fixed income work? Syed Zamil, Senior Investment Strategist
I'm joined today by Syed Zamil, Senior Investment Strategist at Insight Investment.
Syed is among the incredible investors sharing insights of the Family Office Investment Forum today.
Welcome Syed. It's great to have you with us.
Thank you for having me.
Let's dive straight in. Can you run us through the difference between a fallen angel and a fallen knife and how you can tell the difference when purchasing those bonds?
Absolutely. So fallen angels, just to define what they are first, these are a subset of high yield bonds that were once investment grade. So they're called fallen angels effectively because they've fallen from grade. So these are bonds that were once in investment grade have now fallen into high yield.
Now what's interesting is that this is a misunderstood area because there's so many things that come into play, but a fallen angel effectively are bonds that were once rated, say BBB, the lowest rating in investment grade that have now fallen to BB.
And that's a typical trajectory of a fallen angels that they get a slap on the wrist said, fix your balance sheet, clean up your books, and off we go.
That's the profile we like to see at about 85% of the fallen angel universe follows that trajectory, BB fallen from BBB and that's where it stays.
When that doesn't happen, that's not a fallen angel, that's a falling knife.
So if something more problematic is at hand, it won't fall from BBB to BB. It'll fall from BBB to CCC or something along those lines.
And so those are the ones you need to be careful about because that's not a slap on the wrist. That's something more potentially problematic.
And so effectively fallen angels are bonds that fall from one notch, from BBB to BB, clean up their books, they gone your merry way. The rest potentially more problematic.
And systematic equities have been popular for a long time, but systematic fixed income isn't as popular.
Why is that? And why is systematic fixed income on the rise now?
Yeah, That's a very interesting question.
So the first 20 years of my career, I've worked in systematic equities and I wondered the same thing, but from the outside. Now that I've been working on the fixed income side for seven, eight years, I understand why.
The ideas and factors that you deploy in equities, that's what people have borrowed to build a quantitative processes in fixed income, that doesn't work. You can't take what you've learned in equities and applied verbatim to fixed income.
So for example in equities, very common to take commonly sort of accepted factors like value, quality, momentum, blend them together into one multifactor signal and build a portfolio. In bonds, if you do that, it's not a winning strategy.
And so it took us a while to realize that although the factors are useful, you have to use them in a credit centric way.
So for example, the most important thing in bonds is the left tail, worrying about default. What that means is that you need to worry about the quality aspect first. You can't blend quality with something else because it's diluted.
So apply quality first, then maybe the reach for yield.
So it took a while for the market to also realize that. But the good news is today it is gaining in popularity because there's better data, better understanding, better trading.
And all of these things mean that systematic investing at and fixed income is on the rise.
And what are the benefits then of a systematic approach compared to a traditional discretionary when accessing fallen angels?
Yeah, I wouldn't say necessarily benefits, they're different and they both have a place in the investing ecosystem.
But the biggest difference between a traditional approach versus a systematic approach is one is people intensive and the other is data intensive.
So for example, in a traditional approach, you'll typically deploy an army of analysts who are gonna cover certain segments of the market and they'll do deep analysis on the specific companies that they cover.
But there are some limitations. We are humans, we have biases. We're also limited by how many names we can cover.
So there is some limitations into the breadth of bonds you can cover, but the bonds you do cover, you'll have maybe deeper analysis. So this is probably well-suited for building something like a high conviction concentrated portfolio.
Systematic on the other hand, relies on data, loads and loads of data.
So our approach is to take all the data that we can get for thousands and thousands of bonds that humans couldn't possibly cover and do robust analysis of that data, make intelligent comparisons, and then build diversified portfolios because we may not know each individual company intimately well, but that's more than made up for the consistency of the approach and the application of the models in an unbiased way.
And what technological advancements have allowed you become more efficient and effective in the way that you invest?
Yeah, the biggest technological advancement, particularly in high yield where we focus, has been the advent of better trading.
We call it credit portfolio trading, in let's call it the old days, say two decades ago, if you were to try to buy a single high yield bond, we would say good luck.
First of all, the spread the cost is about 70 basis points. So it's already a very, just put in context, a trade stock is like half a basis point.
So you're already in the whole pretty significantly if you're trying, if you're lucky enough to find the bond, you're gonna have to pay 70 cent premium.
And imagine trying to build a hundred bond portfolio where each one you're paying 70 basis points, just, just not a winning strategy.
So for that reason many people just tended to be very, very active because they said, well, I've got to make up that 70 basis points.
I better hit a home run and go for 2%.
That also isn't a very winning strategy because you have a lot of risk in that portfolio.
Now with the advent of credit portfolio trading, we probably don't have enough time to get into the details, but in short, instead of trading one bond at a time, we trade entire baskets of bonds.
So if we wanna buy 400 bonds, we'll put, instead of trading each one of them one at a time, we put all 400 into one basket.
We carefully curate that basket so that it looks something like a benchmark.
And then we are able to trade that entire basket in one fell swoop at a fraction of that 70 basis points, something more like 20 basis points.
So that advancement has really allowed for better, faster, cheaper trading in high yield.
And tariffs. They're affecting all areas of global markets now.
But is this dislocation a good thing for fallen angels?
Yeah, you know, interestingly, tariffs are are going to be pretty interesting for fallen angels and yes, my sense is that it is gonna be a good thing.
So fallen angels thrives during market dislocations.
So when you have a economic downturn or when you have concerns that prevailing in the marketplace, tariffs for example, what happens, you have companies, big companies like Boeing, like Ford, who all of a sudden have trouble selling their goods.
They have higher costs.
And so what happens, they're more likely to get that slap on the wrist and they're gonna get downgraded.
And when these bonds get downgraded, they have a significant technical sell off.
So as a fallen angel investor, you can really kind of profit from that by capturing that mispricing at precisely the time of downgrade.
So yeah, these tariffs, if they, if they are actually implemented, even if they're not, it's gonna lead to some economic turmoil that's gonna lead to more downgrades and that's gonna lead to potential opportunity for Fallen Angels.
Thank you. Syed. Again, I have to leave it there and get back to the forum.
I really appreciate you sharing your expertise with us today and for being a part of Global Investment Institute's Family Office Investment Forum.
Great. Thank you very much again for having me.
