Expert: Christian Baylis – There’s finally money in bonds | Blossom

Bryce: [00:00:15] Welcome back to another episode of Equity Mates, or should I say. Right. Listen up, your donkeys. Welcome to another bloody episode of Equity Mates, where we're not just cooking up small talk, we're cooking up some serious financial skills. Whether you're an absolute Muppet who doesn't know stock from a stew or you think you're Warren bloody Buffett, I'm here to make sure you're not a total disaster from your first investment to your dividends. New here. Then don't get it. Don't be an even bigger idiot. Savage. Scroll back and listen to the first episode. Well. My name is Bryce. And as always, I'm joined by the equity buddy Ren. How are you? 

Alec: [00:00:51] I'm very good, Bryce. You're Gordon Ramsay. 

Bryce: [00:00:56] You're good at this.

Alec: [00:00:57] Yeah, well, unlike you, I. I've got my finger on the pulse. I'm all over pop culture. Gordon Ramsay's Kitchen Nightmares was a big staple for Rosie and I during COVID. Great show. All of the old episodes on YouTube and. Yeah. Classic. 

Bryce: [00:01:13] Classic show. Yes. Gordon Ramsay. Apologies if anyone found that was a rough way to start the episode. 

Alec: [00:01:18] Yeah, I know. 

Bryce: [00:01:19] But anyway, we are here. We're into it. We've got another cracking interview coming up, discussing an asset class run that we've not on purpose but hasn't been front of mind for the last sort of ten years or so. 

Alec: [00:01:31] Yeah, the returns have been lower than would get you excited. We're talking about bonds, the debt markets that, you know, multiples bigger than the Equity Mates. I think four times as big as the global share market, the global bond market. Back in the day when interest rates were 7%, bonds were a major part of everyone's portfolio, 40th. But since interest rates were 7% in the mid 2000s, we've had sort of 15 years of interest rate cuts. And when interest rates were point 1%, bonds weren't paying enough to be exciting. And so for a lot of us starting our investing in the last decade, bonds just weren't really a part of our portfolio. And, you know, our parents grew up if they learnt about investing, they grew up hearing about 60, 40 portfolios, 60% stocks, 40% bonds. That wasn't part of our investing vocabulary. You can just Google the death of the 6040 portfolio and all of the, you know, Money magazine Fortune, all of them would have written articles about how it just didn't make sense anymore. But interest rates have come roaring back over the past 18 months, and with that, bond yields have come back as well. And now all of a sudden, investors are waking up and saying, hey, there's an asset class here that pays a pretty good interest rate. There's some decent choices there. It's less risky than equities because you're higher up the capital structure. If things go wrong, bond holders get paid back before equity holders. So less volatile so the price doesn't move as much. So there's a lot of reasons why investors are saying, hey, bonds might form part of my portfolio now. 

Bryce: [00:03:15] Yeah. And we've had Christopher Joye on, on, and on the episode in the last six months or so. And today we have the opportunity to speak to Dr. Christian Bayliss, who is the founder and chief investment officer at Fort Lake, and as part of his role, he also oversees all of Blossom's investments. Now Blossom are sponsoring today's episode. We do thank them for their support, allowing us to keep making free content for the Equity Mates community. If you haven't heard of Blossom before that it's an app that allows everyday people to access returns from fixed income bonds, which up until now has been rather unacceptable for retail small dollar investors. But they've done a great job at democratising that with access from as little as five points. They recently increased their target return for their fund to 5.7%. And if you're interested to find out more. Download the app today. We'll include a link in the show notes. 

Alec: [00:04:11] Now, Bryce, before we get into it, we should remind everyone any advice you hear on this podcast is general advice. Well, whilst we are licensed, we're not aware of your personal financial circumstances, so make sure you do your own research. If you're unsure, seek advice. But with that said, let's get to our conversation with Dr. Christian Baylis, the chief investment officer of Fort Lake Asset Management, who also oversees all of Blossom's investments. 

Bryce: [00:04:38] Well, Christian, welcome to Equity Mates.

Chrisitan: [00:04:40] Thanks, Bryce. Great to be here. Really appreciate. 

Bryce: [00:04:41] It. Now, before we kick off, would you rather get the blood flowing?

Chrisitan: [00:04:46] Oh, no. Okay. Here we go. Look out. 

Bryce: [00:04:48] No, it's a good one today because I chose it. Would you rather win the lottery or live twice as long? 

Chrisitan: [00:04:56] Twice as long. For sure. Without a doubt. Without a doubt. 

Bryce: [00:04:59] Why's that? 

Chrisitan: [00:05:00] Oh, you know, I look. I mean, I don't want to get all sort of sentimental, but, you know, I got two lovely young kids, all that sort of stuff. Like, would be great to be able to watch them sort of grow older and do all those sorts of things. So I think that would probably be the biggest reason for so. And you learn so much like, I mean, what I was doing when I was 18 or 22, what I'm doing now is remarkably different. I'd love to say how wise and those sorts of things I'd be with with a bit of extra life in me. So you do learn a lot, and I think that makes your experiences a lot better as you get older. So. So I think that's why I'd love to be able to live twice as long outside of being invisible. 

Bryce: [00:05:33] We'll leave that for the next episode. Ren. 

Alec: [00:05:37] That's right. 

Chrisitan: [00:05:38] We'll tilt it that way. 

Alec: [00:05:39] Well, with the magic of compound interest, living twice as long, you basically win the lottery anyway. 

Chrisitan: [00:05:47] Imagine Warren Buffett. 

Bryce: [00:05:52] Nice. All right, well, let's get stuck into it. Today's theme is the forgotten asset class, because we're all talking all things bonds. And it's been a little over two years and 12 interest rate rises since we last had you on the podcast. 

Chrisitan: [00:06:08] Remarkable. On who would have thought. 

Bryce: [00:06:11] So can you tell us the state of the bond market and really how much it has changed in those last two years? 

Chrisitan: [00:06:17] Well, it's changed remarkably. I mean, when you think about the last 12 to 18 months, even the last two years from when I last spoke to you, I mean, we've had the fastest pace of cash rate increases on record. We've had the highest amount of bond volatility on record. We've got central banks who were rocking up with the commercial printing press, buying everything in sight, no matter what the price, no matter what the yield. Central banks just said, I'm going to buy it. And the reason I said they're going to buy it is because they had an inflation rate, their inflation rate. It was at that point in time to inflate our way out of a disinflationary pulse and to ultimately get the, you know, the heart of inflation beating again. And now what we're seeing two years later is we're seeing the polar opposite happen. Central banks are selling at no matter what price. Selling their bonds, divesting. And they're selling to the tune of around 300 billion a month now across some of the G7 economies. So that gives a lot of indigestion issues to people like us who do have a commercial rate, who ultimately have to buy these bonds with a commercial lens. And we have to do it what we call an ex-ante risk adjusted way. I forward looking. Does that make sense to buy that, given the risk that we are taking and that world has changed a lot in two years. So it's a much better world for asset managers. It's a much better world for for people like the Blossom investors. It ultimately now we've got a term structured applied. We've actually got a yield curve to play with. That means that for the risks that you're taking, you're actually getting compensated for it. But what it's also meant is it's it's also meant that you've got this huge amount of bond volatility because if central banks are selling and you've got fiscal agencies or the official sector printing huge deficits, that just increases bond supply. And it means that all of the commercial side of the bond market effectively has to has to swallow all of those bonds. And that's a big, big difference. You know, we've had something like $13 trillion of quantitative easing and we're only 1 trillion on the journey out of that $13 trillion trap that we've effectively created for ourselves. So I call it like the jam doughnut effect is, you know, after you've had one jam, don't taste really good. After you've had two or three, you say that's, you know, that's that's a little bit indulgent. But as you start to get into four or five and six, you could be arched over being vomiting and dying. That's stuff. And that is the journey of quantitative tightening ultimately. And that's what we got to look out for. 

Alec: [00:08:30] I mean, there's so many things I want to follow up there, but let's extend the jam doughnut analogy. Like when you know, you think about investing for the next decade or however long, but is there a chance that we're all over a bean stuffed with too many jam doughnuts? 

Chrisitan: [00:08:50] Well, you know, absolutely. There's a good chance of it, because the one thing we know is we don't have a lot of experience coming out of pandemics. This is not a world that anyone can lay claim to knowing a lot about, is it? It was a one in 100 year event. And the prolonged effects of that type of traumatic situation could be with us for a very long time. And that divestment story of central banks having to leave the party, having to sort of walk back all of that, that that printing of money that they've done, we're only right at the beginning of this Himalayan type climb, effectively getting ourselves back to normalcy. And we just do not know how asset markets are going to respond. But what it means for other asset classes could be pretty profound as well. If you've got more bond volatility, i.e. more discount rate volatility, that means the volatility of your future. Cash flows is also somewhat unknown because you've got this additional bond volatility. So the implications are not just very significant for the bond market, they're very significant for equities and income sensitive assets, which ultimately roll off those discount rates for valuations as well. 

Alec: [00:09:54] Yeah. Now, before we get too far into that conversation, because that is where we want to go and talk about how you invest on the back of it. We should just look back a little bit. This episode we've titled The Forgotten Asset Class, and it really was a forgotten asset class for a bit over a decade. Tell us what it was like then and how much it's changed now. Like, give us a sense of how much you were forgotten and how quickly you have been remembered.

Chrisitan: [00:10:20] Well, we were rightly forgotten. I mean, it was it was the disgraceful asset class. When you think about why was it the disgraceful asset class? Because you had central banks rocking up with a printing press saying, oh, I'm going to buy every single government bond that I can find, no matter what the yield, if it's negative, who cares if it's got a negative real yield, even better, let's buy it. And that was the thinking of these inflation sensitive central banks. So everyone just got on the vortex of those central banks and effectively bought for price accumulation or price gains. And so it was this greater fool type of argument is as long as you're buying after the central bank and prices keep going up and yields kept going, well, you will make money in the bond market. And that was the rationale. You didn't have the thinking behind it saying, well, what are the yields of these bonds? And does it make sense, given the volatility that I'm saying? You had central banks squashing volatility, squashing returns, and therefore the only ones that should have been occupying that asset class were effectively the central banks. And people like us should have been taking a step back. And retail investors and the mums and dads out there who would typically be investing in those types of assets rightly put their money in other places. And that's why you saw all of these other assets go up. So it was it was it was the disgraceful asset class, but it has changed so much in such a short period of time. Literally in the space of 24 months, it has gone the polar opposite way. And all of the things that I've just said, the counterfactual now. Now we have huge amounts of bond volatility. We've got huge amounts of bond losses. Bond investors have been in a lot of pain because as yields go up, prices drop. But for people coming into the asset class now, you're getting very well rewarded for that risk. And it's getting harder and harder to lose money in the less risky parts of the bond market, i.e. the government bond market. And the reason for that is because the central banks are divesting their government bonds and that is creating this accentuated type of volatility in the least risky part of the market. And so everyone like us is going, God, okay, all of these bonds are coming out. All of these really high quality bonds are coming off central bank balance sheets. I'll buy those. And, you know, and I'm getting much more volatility as a result of it because of all of this divestment. I'm getting much better yields. And then the corporate bonds over here really aren't offering huge amounts compared to the government, the government bond sector. And that's not something we've seen since early 2007 when we had really good looking yields in the government bond space. We all know what happened in the mid part of 2017. The corporate bonds, which traded what we call, you know, try to be very tight in terms of their spreads. There wasn't a lot of compensation for default risk, You know, that ended up blowing up. And what we see today, not to been alarmist, but we do see similar types of things. We do see that there's not a lot of compensation for corporate risk. We haven't had really any corporate deaths for four, three odd years because we've been living off of the mother's milk of financial repression, negative real yields, fiscal largesse, everyone's been getting transfer payments, these sorts of things, and no one's denying the logic of those actions. But the reality is it became very hard to stuff things up because you were always sort of lifted off the floor before you would scrape, you know. And so there hasn't been a lot of psychological scarring in our markets or the Equity markets or risk markets in general. 

Bryce: [00:13:32] So given that over the last ten years or so, it's been an asset class that we haven't paid a lot of attention to for those that are just joining the Equity Mates journey. Can you help us understand just how the bond market is made up and sort of the big sort of components or parts of it and then where you're saying a lot of the deal flow and money going at the moment? 

Chrisitan: [00:13:50] Yes, I think I think, look, in terms of the simplistic sort of break up is you've got your government bonds and that's obviously issued by, you know, like the Australian government, and then you've got your sovereign supra nationals which is issued by your big official sector authorities that typically have some type of remit like the World Bank or something like that. They're there to help develop markets and they will issue bonds to do that. Then you've got the corporate bond market and then you've got things like what we call the structured credit or the asset backed market, which is like securitisation, which is basically banks wrapping up all of their mortgages and selling them out as securitised assets to a range of investors like us in order to fund their mortgage books. So they're probably the core major parts of the market. But one thing that's changed a lot since the financial crisis is that banks are no longer the conduits for risk taking in the economy. Me anymore. That's a big, big difference. So banks used to buy a lot of bonds off people like us and a bit like a bit like a supermarket. They were like the shopping aisle for all of these types of different bonds, like the ones that I've just mentioned, the different categories. Now, what you're finding is that they've got limited capacity to purchase those bonds because the capital regulations have gone up. They don't take much directional risk anymore. And a lot of these regulations that were imputed upon them have really changed the way that they interact with the economy. So they're like regulated utilities now. And what that means is that liquidity in the bond market and all of those categories of bonds that I've just bought is probably not as good as what it was back in 2007 and 2006. So so we have to be very mindful when we're when we're in this asset class that whilst it is typically seen as a low risk asset class compared to equities, the bizarre fact is that where did corporates go to raise money during the pandemic? They went to the equity market. If you think about Ramsay, you think about Cuba, you think about all of these corporates, they couldn't actually get their bond issuance. Why they actually went to the equity market, which was bizarrely more liquid. The reason for that is because there's no balance sheet typically tied up like there is with the corporate bond side. And the weirdest thing of all is that you could go to, you know, a National Australia bank and get a corporate loan for one of those corporates. No problem there. But as soon as you come to the bond market, you get a totally different outcome and a totally different response from the investment community because it's a different part of the balance sheet which gets affected by regulatory capital. So there's a lot of these odd things that affect our effect, our market effect, our liquidity effect, you know, the different categories of bonds and those sorts of things. And what it what it all means is that you've ultimately got to have, I guess, a good northern start to know where you're going, like where is it, what parts of the market make sense to invest in, What parts do you want to avoid and what are the risky sort of, you know, mousetraps that you that you desperately want to avoid as well, which is something that we saw during the GFC with all of the acronyms like the CDOs and the sales and those sorts of things. You know, so it's it's it's a very big broad willy type of asset class and it's different in every economy, in every geography almost as well. And so it is a little bit treacherous. 

Alec: [00:16:50] Yeah. Yeah. For people who are new to the bond market, it is worth just pausing on the size. It's four times bigger than the global equity market. 

Chrisitan: [00:16:59] And to be exact, I would assume it's something along those lines and it's only getting bigger because we've had you know, we've had fiscal deficits hand over fist. Everyone was living off the juice of negative real yields. And it was a great time to basically go out and borrow and raise is back in and sort of wish for the best, though that is changing, though we haven't talked about credit worthiness for such a long time because we've been assisted for so often and sovereigns haven't talked about credit worthiness since, since Greece, where, you know, sovereign credit worthiness used to be a really hot topic. You know, they used to be a huge amount of focus on fiscal conservatism and balancing the books and balancing the budget. And you used to hear politicians saying we've got to, you know, reduce our debt to GDP and our debt load because we do not know when we're going to need it. We need a buffer. And we just haven't heard those conversations for such a long time. And I think the reason for that is because we've had central banks over here effectively buying off of that. You've had the official sector and the fiscal authorities over here issuing all the debt. And it's been this very cosy relationship where they've been keeping their yields low and been effectively supporting them the whole time through these sort of questionable financial decisions. No one denies the logic of them, but in hindsight, some of them probably weren't all that well thought through. But really, when you think about it, with the things that they were doing, that should have been an environment where you had much higher yields and much greater risk in the asset class and it was quite the opposite. The reason for that was because central banks were buying all and sundry. So it's a big impact. And I guess what's exciting now is it's all reversing, so it throws up a lot of opportunities. 

Alec: [00:18:33] Well, we were speaking before we got on it, we turned the microphones on that. We have a mate that works in bond sales and I'm on his email distribution list and we've seen some ASX listed company bonds come through that are now paying more than 10% yields, which is incredible. Like that's equity like returns. And I guess, you know, that becomes a question of, you know, the markets waking up to credit risk and default risk and stuff like that. And it's just, you know, interest rates are going higher as well. So everyone's got to keep issuing bonds at a higher price. How do you think about investing in that part of the market where you're getting, you know, north of 10% for a bond and also, you know, for where mainly equity investors, How do you think the the flow on effects of something like that where a company's cost of capital is getting more and more expensive? 

Chrisitan: [00:19:25] Yeah, well, it has huge implications for corporate profitability. The cost of capital, which you typically want to exceed in terms of your return on invested capital raises, is becoming harder by the day. And you've sort. I've got to wonder about these type of high yield investments. If you haven't got yourself out of the high yield naughty corner, after all these years of financial repression, negative real yields and all of this fiscal help from the government. What is the fundamental basis of your business model? I why do you have such high yields? Why do you still have so much debt? There was no better time for effectively deleveraging. There was no better time for getting your house in order with all of that assistance. A lot of corporates did that. But now what you've effectively been caught in this, this, this trap that all of a sudden interest rates have turned on you and if you've got a lot of debt, you're still probably living off the liquidity buffers that were afforded to you from these fiscal policies and those sorts of things. But it does mean that the environment is much more risky for you. And you do have to wonder what is going on here when you've got yields at 10% and we still don't have any corporate defaults. And I compare it to wearing a jumper in a sauna. Is it everyone sitting in there? You know, we see everyone sweating from the brow and going, wow, it's really hot here, but no one's really coughing and taking the jumpers off yet. And so everyone's putting on a really brave face. But I think there is actually a fair bit of heat exhaustion going on underneath it all. And that ultimately what you might actually find is that all of a sudden people rapidly start to change the way that they're dressed in the sauna and ultimately start to, you know, think very differently about, you know, how comfortable they are being in the sauna. And at that point in time, what do they do? Do they go to the equity market and effectively try to deliver? Because that would be a good thing to do right here, right now, given where equity prices are. So you could effectively go out, raise equity at a reasonably good price and pay down that debt. If you're listed. If you're not listed, you've typically got to go to your banking syndicates and try to get a better rate or a of a better yield from them and pay down your public market debt, which I think a lot of a lot of corporates would be looking to do. And then you've and then you've got to think about, well, what happens if I can't roll over that debt as well? Something that's changed since the financial crisis was that we turned out all of this debt, debt issuance that used to be one two year type paper or a 1 to 2 type market. You now have been able to issue for five years. That could have made people a little bit more complacent as well. They're probably sitting there going, Well, I've still got three years to go, no problem. But we do have this big refinancing hump coming up in 2025 where you've got a big bulk of all of these issues like the ones that you're talking about that you have to refinance. And that's where the rubber will hit the road, I think is is they are going to you're going to see the whites of the eyes of these business models. You're going to see some of them scrambling to the equity market. And then, you know, we have to factor in what could go wrong in between now and then as well, if the economic environment isn't what we think it is and we do have a bit of a hiccup and and ultimately the the economy is not there for your type of business model, because what's very evident at the moment is we are not seeing any clear pattern across any particular industry. All we are seeing is idiosyncrasies within each industry. But it's not like one industry is totally struggling. You just see a bunch of poor performers and it's pretty sort of patchy across all of these different industry. But there's no clear signs that there is systemic stress in a particular industry. The only place that I can sort of allude to is obviously the commercial property market, where they did have a slightly higher debt load, but even they learnt the lessons from the GFC and their debt loads are pretty conservative. But if I was comparing it to a sheet of ice that I had to run across the sheet of ice, the or the part of that that sheet of ice that concerns me the most is is the private credit market, because that has become the place or the area that I call the fish that John Lewis rejects have all gone into the private to the private credit market because the banks have effectively changed the way that they deal in the economy. Now they've they've given all their their loans or their not so good loans off into the private credit space. The private credit space has been the biggest beneficiary of that. We've had a huge amount of capital going into that market as a result. But you haven't you don't have you have you don't have the type of deal flow that you probably need. So you've had something that started as a cottage industry in 2007. 2008 is a huge, huge industry now and that has been welcomed for the banks because they don't have the regulatory environment that the banks do and they've absorbed a lot of this paper off bank balance sheets. But we are seeing a few questionable underwriting decisions in that part of the market.

Alec: [00:24:08] Is that so? Private credit includes mortgage backed securities.

Chrisitan: [00:24:12] It can. It can, but it's effectively stuff that's not from that is not in the public markets and doesn't get, let's say, the pricing transparency of the public markets. 

Alec: [00:24:22] Because I was going to say what you just explained. This seems like a lot of the steps of the 2008 crisis in America. You know, people pushing risk off their balance sheet into a private credit market where underwriting standards are worse. 

Chrisitan: [00:24:35] Like, yeah, and worrying me, I know I didn't want to be the the Grim Reaper here, but you do see, you know, I mean, look, I was recently in Europe talking to a lot of the Nordic banks and the French banks and the European banks in general. And talking to a. All of their Sappho's the one thing that became very apparent is they were all looking at their balance sheets saying, look, we think there's a problem. We think there should be a problem. We know interest rates have gone up a lot, but we can't find a problem. And you sort of and they're sitting there scratching their heads, the CFO saying, well, we want to put provisions through our balance sheet and we want to do the right thing and we want to effectively allow for a rainy day by putting these provisions in because we feel that something should be going wrong because of all of these huge increases in interest rates. But there's just not. And then they turn over to the corporate balance sheet and they look at the corporate lines that they've got and go, oh, you know, that's a bit of a problem. They're all in pretty good health as well. And they don't have a lot of commercial property on their balance sheet, a bit like, you know, which is very different to how banks were caught out during the GFC. So you look at the banks, the commercial banks globally and particularly in Europe, and they're in really good health. And you go, well, where has it all gone? 

Alec: [00:25:42] So the problem is there is no problem. 

Chrisitan: [00:25:44] Well, there's no problem there. So you sort of say you have to ask. It's a bit like Whac-A-Mole when when you work it, when you're whack a mole, the head pops up somewhere else. And my view is and I'm not saying, you know, again, I don't want to be alarmist, but if there was a part of that sheet of ice that you want to step around, that would probably be the part at the moment that you would step around. You wouldn't you wouldn't skate over that part of the ice. There's other assets that you'd probably go to. There's probably other parts of the market you'd grow to. And it's not to say that they should all be tarnished with the same brush. It just means you want to be trading up in quality in that particular part of the market. There's going to be really good asset managers in that particular part of the market who do have really good underwriting standards. But we are seeing what we call ball washing going on in that part of the market where we've got people buying really high risk stuff off bank balance sheets. It never gets marked. And so there's no volatility and it looks like you're buying those really high returning assets with no volatility. But it's a fool's paradise. It's a mirage. And what will happen as soon as you get redemptions in those types of funds, you will get this mass exodus and then it'll be a bit like Queensland. Beautiful one day, terrible the next. So that's what you're going to say, I think. And that is and typically this comes back to human behaviour. All of these things sound great, but we are the final nail in the coffin with these sorts of things is how are people actually going to behave and how they're going to respond. And that tends to make it self-fulfilling is that all of these things can be going on. But if people sit there blissfully ignorant about it and blissfully unaware about it and keep acting as if, you know, we're back at the zero rate, the zero rate world, this could go on for a little bit longer than what we expect. But if people wake up one day and all all of a sudden have an attack of the nervous Nellies and they want to take all their money out of these funds, all of a sudden we do have we do have a potential, you know, potentially a dangerous situation where we start to get all of this volatility and it starts to feed on itself. So that's what we've got to be mindful of, at least our job, which is always the glass half empty asset class. 

Alec: [00:27:45] As you can tell, that is something we notice that a lot of fund managers. 

Chrisitan: [00:27:49] That we do not rate off positivity. So we have to stay negative. Otherwise we lose our job. So it comes comes with the turf. So, you know, we have to be mindful of that situation for us because I always say that, you know, we live in this miserable parallel universe where we only get the downside. We don't make ten times on our money in our asset class. We're not going to make a ten bag. I like the equities can. We're not going to win. We always get is, you know, potentially losing 50 to 60% on your money and you've only been making a few hundred basis points on the top. Like we, we typically know our prices always go back to 100. That's typically our world. They don't go to 300, they don't go to 400 like what you see in equities. So we have to unfortunately apply this miserable type of mentality to the way we look at things and make sure that we're incredibly conservative about what we get because we don't get a lot of upside for getting it wrong. So unless you're a distressed netballer, which can be quite fun when you're buying Argentinean bonds and this sort of stuff, then it gets interesting. But that's not the world. 

Bryce: [00:28:47] We're all Christian. With inflation falling at the moment, plenty of investors are getting excited about the opportunity presented itself in the bond market. So the question is, is now the time? And I think more broadly, how would you help us think about looking at the headlines around inflation and what's going on there and just timing investment in bonds? [00:29:06][19.9]

Chrisitan: [00:29:07] Yeah, well, the good news is that the real returns are getting better because as inflation comes down, people's real returns are getting higher. So interest rates have gone up, inflation is coming down. That is a really good thing for bond investors or income sensitive investors even. It's a really good thing. So what was really painful was if we go back to, you know, when the interest rate hike started, we had whopping high inflation, near double digits in a lot of developed economies, and we had zero rates. I mean, that's negative seven, negative eight, -9% that people were getting on these income sensitive assets. So it was a disastrous situation and it ultimately couldn't last forever because the flipside of that is the people that are. We're showing that stuff, eh? Making out like bandits. So. So there's always a winner and loser in this world with. With this stuff. And that is why it's so important for central banks to get inflation under control, get it back to the 2 to 3% target, because that is the world that we know and feel comfortable with. And that way we can start to plan and start to shore up our business models around a sure fire inflation target. 

Bryce: [00:30:11] We were talking the other day on a recent episode how some central banks around the world seem like they're just going to adjust their ban from 2 to 3% to 4 to 5% in a day. 

Chrisitan: [00:30:20] Well, it's interesting because it wasn't so long ago, about 2 to 3 years ago, that everyone was saying go the other way and dropping it from 2 to 3 down to 1 to 2. And so, you know, this is a lazy person and monetary policy is not you got to stick to the target. You've got to have Mario Draghi approach whatever it takes and you have to take a firm bat to it. And you and you need to leave people in no doubt what your goals and objectives are and what you're out there to do as a central bank. Because if people are very clear about what your goals and objectives are, they can plan around that. And that will ultimately change their consumption and their purchasing decisions as well. So if people think, Oh my God, Australia's become like Argentina, we're going to have 100% inflation and this sort of stuff, all of a sudden that changes the way people interact. And then you've got a situation like Argentina where you go in one day, you've got nothing on the shelves, you go in the next day, you got nothing on the shelves. Everyone is just scrambling to buy things. And we had a taste of that during the pandemic. You know, you go into the shopping, the shopping centres and you could not get things because there was a supply shortage. And that's exactly what you've got in Argentina. But it's become so pronounced and so disastrous that it's feeding on itself and it has got away from the central bank and you know, they've got a lot of other issues, but that's just one example of some of these economies who have really got their policies wrong. And we're nowhere near there, obviously. But that's what value looks like. We have a successful regime and we should stick with it. And what has driven that success has been ultimately central bank communication targets. Getting inflation under control and consistency over time allows people to to make better financial decisions. And it's really important we stick with that format. Do not change something that has worked for you for the last 30 years.

Bryce: [00:32:01] Just like no rate rises until 2024. 

Chrisitan: [00:32:05] Yeah, I know, definitely. I think growing the day that they that they said that or at least didn't nuance it a little bit. So I think but that is just a great example of how important communication is. When you say something as a central banker, you are in such a privileged position that everyone listens to you and people go out and make decisions on the back of that. And in the end, if it proves to be wrong, people get very, very cranky and rightly so. So, you know, the way to communicate in a very uncertain world is to say, look, this is something that we do not have a lot of experience with. We do not have a lot of experience coming out of pandemics. The world is highly uncertain. The best thing you can do as a consumer or or or a mortgagee is to be incredibly conservative with your assessments of the future economic outlook and factor that into your financial decision making processes. That would be the better thing to say, as opposed to maybe selling a little bit of false hope and getting people sort of lulling them into a false sense of security. That's what you don't want and it's not the time. I mean, I always say that, you know, when you are in a really uncertain environment and if you are talking to an index listed company, the last thing is, say a CEO is going to come out or should or should not come out and do is double down on giving people certainty in a really uncertain trading environment. The last thing you want, you'll have class actions all over you. It will be a disaster. And central bankers should abide by the same policies as well. When the world is incredibly uncertain and the distribution of possible outcomes is incredibly broad. That is when you retreat into your shell a little bit as a central banker and you give people lots of information, but you do not provide certainty. Certainty you nuance your communication appropriately. And I think I think that's the lesson learnt from from this crisis. And, you know, I look at everyone, it's a learning experience, but I think, you know, it just it just ultimately reinforces how, you know, how much communication actually means. 

Alec: [00:33:57] Yeah, well let's take it from the, the big sort of bond market and a bit more just to like how we as individuals can participate in the bond market and invest in it. And I think one of the big challenges that I see when it comes to this is just how the high minimums and, you know, bonds normally trade in half a million dollar parcels. Are you saying at a minimum sort of $50,000 parcels? So for people like Bryce and I that don't quite have that capital behind us yet, it makes it so positive. It makes it hard to get into the bond market, at least directly. Yeah. So for people like us, what are our options? 

Chrisitan: [00:34:40] Yeah, well, I think that's the good thing about, you know, things like what Gaby and the Blossom team have done and, you know, trying to create a market for people who ultimately don't want to. I put a mortgage sized investment into a single bond. You know, that's not the way assets should be structured for investment, particularly when they're such an essential part of the financial fabric in the economy. Why is it that it's $500,000? Yeah, great question. Well. 

Alec: [00:35:02] It's well, it's crazy. 

Chrisitan: [00:35:03] It shouldn't be that way. And it shouldn't be expensive to to effectively go and support corporates because corporate corporate bonds and those sorts of things are above equity in the capital structure. It shouldn't be. 

Alec: [00:35:13] This expensive to take less risk. 

Chrisitan: [00:35:15] That's right. And I do always sort of puzzled at why it is so inaccessible for the least risky asset class and why the barriers to entry are so high. You scratch your head, you sort of say, why does it have to be this way? It doesn't need to be this way. I mean, I think the US does a really good job of making it much more accessible. You know, they've got a much more developed market and they accommodate a larger variety of issuers and a larger variety of buyers. And I think that's a great thing. And Australia should obviously look to the US as a role model for our fixed income market and try to be as innovative as what they have, not too innovative sometimes. Sometimes we get over skis on innovation and we get the well known sort of GFC type events where we take innovation a little too far and we slice and dice things too much. There's a good balance somewhere in between and that's what we've got to try and find. I think that's what the regulatory community needs to try and find and we need to try and support, I think, investments and firms which are trying to open up these markets and do the sensible thing, giving people access to these types of these types of choices. So I think, look, the ASX obviously has listed bonds, but it's still very illiquid, it's still very expensive. What we call the Basel spreads are very wide. Just because there's not a big uptake, there's not a big mass market in there. And what you need is you need mass, you need mass support and you need lots of liquidity to close down those Basel spreads. And that comes back to marketing, that comes back to, I guess, telling people the benefits, the pros and cons of the asset class and getting people comfortable with the asset class. So they might actually want to reallocate away from equities and say into these other markets that are now on the ASX. And so I think it will take time. It's a long journey, but I think government support can help. There's a variety of things that the Government has done in the past and is and is currently working on. But I think I think we're still not there yet and we we just need to, you know, and Australia is just one of those markets. We're very equity focussed. You know, it's not a huge allocation decision or it's not a huge allocation in people's super funds or portfolios. 

Alec: [00:37:26] Well after property and the share market. Like there's not a lot of money left. 

Chrisitan: [00:37:31] No, that's, that's right. And, and look, that's where probably people's thinking needs to change a little bit now because given the risks that are in the equity market, given the things that I've talked about, you know, now we've had we've got this really good cosy yield environment where government bonds and pretty low risk types of bonds or yield type investments are giving you a pretty decent return for not a lot of risk and a lot of that. We can thank the central banks because they're selling them hand over fist and they're selling them at really, really cheap prices and they're selling them very quickly because they have to because they've got these inflation rate needs. And as a retail investor, you can go out and take advantage of that. And I would certainly recommend people start to consider things like government bonds and those sorts of things because they are good investments now. They were terrible investments two or three years ago, but the world has changed so quickly and that is one of the silver linings of higher interest rates is that you can get low risk bonds at pretty decent yields, typically with a triple-A rating like Australia's sovereign riding. And, you know, and they will provide you a lot of comfort when things go sour as well. So yeah, so that's a very different world to what we've seen for a very, very long time, probably back to 2007. 

Bryce: [00:38:41] So bond funds are something that is an option for retail investors. So can you help us understand, I guess, the difference between investing in a bond fund and investing in bonds directly? 

Chrisitan: [00:38:51] Yes, I look at the benefit of investing in a bond fund is you get instant diversification, obviously. So you put if you put $1,000 in or you put in $50,000 or whatever the amount is, that will be spread across a full, diverse portfolio. And that's really the key benefit and that diversifies away a lot of your risk. And you heard what I said at the beginning about we live in this miserable parallel universe where we only get the downside in our market. That's the reason why you won't have a lot of diversification, more diversification in a fixed income portfolio than what you would want in your equity portfolio. And the analogy I would give is if you had a corporate a corporate treasurer from a from a large major bank come out and say, I guess what, I've got all these great chunky exposures to Centro property groups, ABC Learning Centres, you know, and they're 10% of my assets, you'd run them all the same, should apply to a fixed income fund or a bond fund because you do not want large single name exposures, you want to be diversified, you know, to the extreme, I would say. Because you get all of that downside. And that is why you need to also be very mindful of single bond investments as well, because buying a single bond, we all saw what happened with Virgin Airways and we also saw what happened with a lot of those investors that went out and bought those Virgin Airways bonds. Had really good yields look really good. But we all know what happened. And all of a sudden you're caught up in a very voluntary administration. And, you know, you're fighting you've got, you know, legal fights going on and all this sort of stuff for a very long time. You're trying to scrambling to get cents back in the dollar and this sort of stuff. That is what can happen if you take the treacherous step of doing this yourself and just going on one or two bonds. Best you get good advice and and maybe even think about going into a bond fund or something like what Blossom does, where you get a significantly diversified portfolio of bonds that sit behind a reasonably short up yield. All of these sorts of things I think are probably better decisions to make than going out and doing this yourself and buying one or two bonds. 

Alec: [00:40:52] Yeah. So let's turn to your funds. So you run for like asset management and then you oversee Blossom's investments as part of that. Yeah, you have a little bit of a different investment philosophy to many of your bond investor contemporaries. Yeah. So talk to us about how you say investing. 

Chrisitan: [00:41:11] Yeah, well, look, we are not a garden variety fixed income manager. That's not what we set the business up to do. We want it to be a satellite diversified, alternative type of asset manager using the fixed income universe as a conduit to generate financial returns. And I guess the reason why we did that was because we felt that the best parts of the asset class weren't brought to the forefront of the investment choices, particularly here in Australia. If you go to the US, there's probably a few more asset managers that do things more like the way that we do them. But here in Australia we felt that that type of offering really just didn't exist at all. And given the breadth of our market, the geographical dispersion, every market you go to pretty much has a different microstructure. There are huge, huge, huge opportunities out there. There's also huge risks. So we see ourselves as an asset and asset allocator within a complex asset class and we have to make those decisions on behalf of our investors and navigate them through the sort of the winding forest pathway to ultimately try to get them there to a better ultimate risk adjusted return. And that's what we're trying to do, is use the best parts of the asset class, not the more mundane, simple parts. We see ourselves as knowledge workers, not labour hire workers. So ultimately I always say, you know, if you're coming to us, you're not coming to us. For a thousand people printed on a glossy slide deck, you're coming to us because you want someone to navigate or help you navigate through that complex world. And that's why we see ourselves as offering a knowledge service, because we've had to unfortunately live and breathe through that world for so long that we know the pitfalls of the particular areas and the particular geographies and the trap doors that can occur in particular parts of the market. And we want people to come to us as custodians of their capital to help, you know, to help them sort of find a path through it. So that's how we see the universe, that's how we use the universe, very different to just going out and buying a few bonds. 

Bryce: [00:43:03] So, Christian, that brings us to the end. I thank you so much for your time. We do have one final question. Each year we run the Equity Mates awards and it's an opportunity.

Chrisitan: [00:43:12] For us to address this.

Alec: [00:43:13] Getting. 

Bryce: [00:43:14] Already. I'm getting we have an expert of the year award where our community vote on an expert who's come on the show that they feel it's really contributed to their investing journey throughout 2023 and you're automatically in the running for being here today. Are you able to leave them with a piece of advice and actionable insight or perhaps just a content recommendation for our audience today? 

Chrisitan: [00:43:36] Yeah, I think avoidance is not a strategy. You can take advantage of things that seem a little bit scary in what was otherwise seen as a a terrible asset class or terrible market. So don't avoid the fixed income universe any more. Treat it like it's an opportunity because interest rates can be very bad for a particular cross-section of the community, but they can also be really good for a particular cross-section of the community. There's, you know, there's 3.3 million households out there with mortgages, but there's 24 million people out there that probably benefit from higher interest rates. So open your mind up to the asset class, open your mind up to getting some decent advice about the asset class because there are really good opportunities in the asset class as well. So definitely start to look at this as a potential investment destination. It doesn't always just have to be in one particular asset class. I know it's more equity focussed here, but really this could be, I guess, a great thing for you to be invested in. If the equity market has a turn for the worst, this will provide you optionality. It will provide you fresh capital to invest in the equity market when that inevitable drop happens and you'll be able to draw on those funds if you invest well across this asset class to make better equity. Decisions as well. So that's far outside. 

Alec: [00:44:50] Well, Christian, after a decade of being the forgotten asset class, we're back with Goodbye. I hope you're enjoying your time in the spotlight. I hope some of your most dire predictions don't come true. But it was great to, I guess, get your perspective on it all and to continue our journey of learning to understand this asset class. And one day we'll have the $50,000 minimum possible size to join you in investing. But until then, it's great that there's bond funds that give us access to this asset class. So thanks for joining us today. 

Chrisitan: [00:45:20] Thanks, Alec. Thanks. Really appreciate it. Cheers. 

Bryce: [00:45:23] So if after that conversation, Equity Mates, you're interested in finding out more about how you can get access to fixed income bonds, check out Blossom who are giving everyday people like you and I access to that asset class that has for a long time now been out of reach for many of us. They give access from as little as $5 and they have recently increased their target return to 5.7%. So download the app today. Information will be in the show notes.