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Benefitting from Interest Rate Volatility

Join SmartBe Investments Chief Strategy Officer Mr. Gavin Graham for an informative and entertaining conversation about yield curve spread trading with Nancy Davis, Portfolio Manager of the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL – NYSE). Regarded for her asymmetric approach to investing in leveraging opportunity and minimizing risk, Nancy discusses: her background as a “student options trader”, a mother and time at Goldman Sachs and JP Morgan; how to benefit from fixed income volatility, rising inflation expectations and yield curve normalization, and; how IVOL can act as a hedge against equity, bond and real estate pullbacks . All this and more in this segment of the Gavin Graham Show.

About the Speakers

About Nancy Davis, Managing Partner & Chief Investment Officer


Nancy Davis is the founder and managing partner of Quadratic Capital Management. Ms. Davis is the portfolio manager for The Quadratic Interest Rate Volatility and Inflation Hedge ETF (NYSE Ticker: IVOL) and the Quadratic Deflation ETF (NYSE Ticker: BNDD).

Ms. Davis founded Quadratic Capital in 2013. She began her career at Goldman Sachs where she spent nearly ten years, the last seven with the proprietary trading group where she rose to become the Head of Credit, Derivatives and OTC Trading. Prior to starting Quadratic, she served as a portfolio manager at Highbridge Capital Management where she managed $500 million of capital in a derivatives only portfolio. She later served in a senior executive role at AllianceBernstein.

She has been the recipient of numerous industry recognitions. She was named by Barron’s as one of the “100 Most Influential Women in U.S. Finance.” Institutional Investor called her a “Rising Star of Hedge Funds.” The Hedge Fund Journal tapped her as one of “Tomorrow’s Titans.”

Ms. Davis is considered a leading expert in the global financial markets and writes and speaks frequently about markets and investing. She has been published in Institutional Investor, Absolute Return and Financial News, and has contributed articles to two books.

Ms. Davis has been profiled by Forbes, and interviewed by The Economist, The Wall Street Journal, and The Financial Times among others. Ms. Davis is a frequent guest on financial television including CNBC, CNN, Sina, Fox and Bloomberg. She is a sought-after speaker for industry events.

About Gavin

Mr. Graham joins SmartBe with over 30 years of experience in Canadian and international markets. A graduate of Magdalen College at the University of Oxford, Mr. Graham has directed investment strategy at numerous institutions, such as the Guardian Group of Funds in the UK and BMO Asset Management in Canada. In addition to his position at SmartBe, he serves as a contributing editor to The Income Investor, a respected online Canadian investment journal. The Gavin Graham Show is a platform for Gavin to share his wealth of knowledge with the SmartBe community, as well as engage in stimulating conversations with peers and thought leaders.


[00:00:00] Gavin: Welcome to the Gavin Graham Show sponsored by SmartBe Investments. Today we're going to talk to Nancy Davis, founder and chief investment officer of Quadratic Capital. It has a volatility ETF, which invests in changes in volatility and interest rates and expectations about interest rates. Thank you very much for joining us, Nancy.

[00:00:23] Nancy: My pleasure. Thanks for having me on.

[00:00:25] Gavin: So the first question, I suppose, is could you tell us a little bit about yourself, your background, and how you got into this business? Because obviously there are many routes as far as money and finance are concerned, but I think it's always one of the most interesting questions is what got you attracted to it?

What made you interested in doing it?

[00:00:43] Nancy: Well, I do think everybody has their own story and I do enjoy speaking to students and kind of helping as they're thinking about careers and majors. Because it's super important that you do something that you'd love to do, because then it never feels like work.

[00:00:59] I had an academic scholarship to college, which was wonderful. You know, I was kind of on my own when I was in college for the most part. And I had a job that I worked at as well. And then fortunately had some disposable income because I'm a very hard worker and I started investing in options.

[00:01:17] It's a little bit of a fear thing. You know, I also started buying domain names. That was like another thing, but I feel like it can be relatable to today because so many younger people are into whatever meme stocks, or crypto, or whatever I think gets you excited and something you do for fun in your free time is a nice way to sorta figure out what kind of career path you want.

[00:01:41] Gavin: Would one of the reasons you got interested in options was that they were relatively small amounts required to actually get an exposure? A little bit like buying fractional stocks these days or whatever. But the actual amount of money required was not that large, but the possibility for the upside was pretty great?

[00:01:57] Nancy: Yeah. I always really enjoyed knowing my downside, you know, so if I was to buy, say, let's just take a simple example. If I was to buy a stock, you know, and it was $140 a share, it could go to zero. So I liked using options because then I knew whether I wanted to be long or short something. I always knew my downside and that I liked a lot because I didn't have a lot of money.

[00:02:20] I didn't, I couldn't incur a lot of losses, but when I was right I had that asymmetric payout. And I think in a weird way that that investing style is very different than many in our industry. Most portfolio managers create a portfolio. And then they use this thing called stop losses. So I hear all the time about people, the merits of their tight stop losses, or how great stop losses are.

[00:02:45] And to me that always seemed backwards for a portfolio manager. First they lose the client's money, right? That's for step one. And then they start to manage risk and you're covering your longs after they've gone up and selling your shorts after they've gone down. So I always just thought that was kind of backwards and wanted to do it differently.

[00:03:04] Gavin: And that's a very important point, I think, in that with an option you know your downside. Your downside is limited to the cost of the option, but you have unlimited upside if things work out as you hope. So that is, as you say, an asymmetric risk profile and an attractive asset metric risk profile. What are your thoughts on selling options? I presume you wouldn't be overly enthused about that because it's the other way around.

[00:03:25] Nancy: Yes. I am not an option seller. There are many people who do that, and I've been asked many times over the course of my career if I would do a, you know, covered calls I don't think are as toxic as other things, but you should be very careful in the very low yield environment.

[00:03:43] There are a lot of alternative risk premia strategies that have grown up and I feel like that's just a nice way of saying selling volatility, short optionality. Because they try to extract the risk premium between implied and realized fall. But I'm not a big fan of, you know, I think all strategies have merit.

[00:04:01] I'm not going to say I don't like that strategy, but for me personally, I don't think the risk reward is as attractive. Especially since we've been in a very low ball environment since the financial crisis for the most, you know, most part.

[00:04:14] Gavin: Indeed.

[00:04:14] Well, I seem to recall when long-term capital management blew up back in 98 and they'd been selling and somebody described it as picking up nickels in front of a steamroller.

[00:04:23] If you are selling well. So you got into options when you're in college and what was your first job and did that lead on from what you've been doing in college?

[00:04:32] Nancy: I started my career in 1998 at Goldman Sachs, and I remember doing a lot of projects on our counterparty risk to them and other things as a young trader.

[00:04:44] But I think it was also something that solidified what I was doing in my personal life. You know, having that positive convexity is really the right risk reward where you know your downside and you have asymmetry when you're right. So it's all a matter of profit taking and seeing that kind of unfold and the demise of that firm and the breakdown and the risk management system

[00:05:05] really, I think, cemented my view that this was a different way of investing. But you know, different can be good. Too many people do the exact same thing in the investing world.

[00:05:17] Gavin: They do. And it's very hard to differentiate yourself just from the point of view of the corporate view. A good place to start off, because it's always fascinating to see things blowing up at what was it?

[00:05:27] Two Nobel prize winners are at long-term capital management and the guy who featured in Liar's Poker, Michael Lewis' original book as the chief trader at Salomon. Really bright people who got it completely wrong. So how long were you at Goldman's for and how did that develop?

[00:05:42] Nancy: I love when you guys say Goldman's. It's so funny!

[00:05:45] Gavin: Sorry, it's a Brit thing. Forgive me.

[00:05:49] Nancy: Just teasing you. I was with Goldman Sachs for about a decade. So about 10 years. After that I joined JP Morgan's hedge fund which doesn't actually exist anymore as a multi-strat. It was kind of blank and how different, you know, they're all privates now. And they closed down the multi-strat, but at the time it was the world's largest hedge fund.

[00:06:12] Gavin: How much in terms of assets under management at its peak?

[00:06:14] Nancy: Small, relative to today. I got the job offer from them, I wanna say it was October '07 and I resigned from Goldman in January '08. Right after bonuses. I want to say it was 38 billion, which is like peanuts compared to the mega hedge funds of today.

[00:06:32] Don't quote me that's off memory and it was a long time ago.

[00:06:35] Gavin: But of course, that was also a pretty interesting time to be investing because you had Lehman Brothers, and Bear Stearns, and the Great Financial Crisis and essentially the biggest financial crash since the Great Crash in 1929. How did the hedge fund work out? How did some of the strategies you were working on work out?

[00:06:51] Nancy: I couldn't buy enough Volkswagen. I remember running around the whole firm because a lot of places. Especially the converts portfolio is very short Volkswagen and I was, like, the fall is, you know, it's like free. It's cheaper than dollar yen vol.

[00:07:05] It's crazy. Like everybody should convert their shorts into books so I can option. It's like, whether you're a longer start, it doesn't matter. And so that was I'd say one thing that I was, like, felt very passionate about and being long vol in something like that was a good call. But I think it's kind of a story of my life.

[00:07:22] Like I always like to look for that cheap misprice convexity. And I remember having a conversation with another PM. So I had my own books. I couldn't buy enough of it for my book, but at some point you hit your risk limits and I was trying to get other people to enjoy what I thought was a great risk reward.

[00:07:39] And I remember one person was, like, well I just borrowed it from the prime broker. And I was like, well, you're short the stock. And if you're right the charge from the prime broker is going to go higher and you're going to lose alpha on that short idea, you know? And I remember being like, why wouldn't, you know, it just seems so obvious to me.

[00:07:56] Gavin: Because you didn't have that risk with the options that you, effectively, the price would not change from when you bought.

[00:08:03] Nancy: The implied vol was super low. I remember it being cheaper than dollar yen. Single digits at the time, but still the realized vol was lower than the implied vols. So some people get really hung up on, oh it's trading at a premium to realize. It doesn't matter where realized is. If it's a cheap vol that you can buy what you're anticipating is going to happen in the future, it's not today. And implied volatility always should be over realized volatility unless there's some kind of, like, something crazy going on where the market's pricing in that volatility will fall in the futures. You know, I'm not a stock person at all. Like I'm a macro person, but I just saw that in our screening models.

[00:08:41] And I was like, wow that's crazy cheap and a good risk reward.

[00:08:46] Gavin: Really that's the important point that if your analysis shows that something is cheap, you should buy it regardless of what particular vehicle it is. As you say, you're not a stock person per se, you're a macro person, and you're playing with the volatility that is expressed in the options on things like a dollar yen, but when it comes to an individual stock and it's cheap it's still a good deal. So that was an exciting time. You then actually, am I correct, took a little time out to actually start a family?

[00:09:14] Nancy: For very personal reasons. '08 was, you know, really wild year for the markets. And I was very fortunate to have left Goldman at that time because I probably wouldn't have been paid anything if I stayed at Goldman, you know, probably honestly speaking just cause it was a tough time for, you know, Wall Street firms.

[00:09:32] My kids were both little. You know, I had a baby and a toddler and I decided that the best risk reward as somebody who to buy optionality was to really just be a stay at home mom and let things settle down and wait. You know, it's like all investment horizons too. And, you know, I thought like my best return on investment was that zero to three period with my kids, rather than plugging it out as a long vol world and a long vol in a short vol world.

[00:10:02] Gavin: That's a great way of putting it. I mean, again, you were using the same risk reward analysis in your personal life and your personal capital, so well done you. And then you decided to come back once that risk reward balance had changed and the kids were a little bit older.

[00:10:16] Nancy: It was a nice time in a way, being a stay at home mom to kind of check yourself. To be, like, do I really love what I do?

[00:10:24] Is this something I still enjoy? And I remember, I'd always been a little bit of a different person. Like some of the things that my friends enjoy are, like, tend to be different than me. Especially my stay-at-home mom friends at the time. Like a lot of them were into doing yoga or a pickle ball or meeting at Le Pain Quotidien for coffee.

[00:10:44] I used to go to the Greenwich Library, where they had Bloomberg terminals for anyone to use. And I would trade structured products in my, you know, precious two hours when the kids were in preschool. So it was sort of in a way, a nice like head check. I actually really like this, this is something that I'm doing for personal pleasure in my free time.

[00:11:05] So I think it was a great way to be, like, I'm not doing this because it's a job I'm doing it because I like it.

[00:11:11] Gavin: And you enjoy it. And with you're very limited free time, that's what you choose to do in your limited free time. You must really like it. So well done for recognizing that. Quadratic.

[00:11:20] How did that start? And how long has it been going for?

[00:11:23] Nancy: So we've been up and running almost 10 years. I founded the firm in 2013. You know, really exciting journey being an entrepreneur. And I think because I have such a different investment style than most people using a long convexity. You know, most people love to sell options. Not buy them.

[00:11:41] So I think it was because I do something really different it was fun to build a firm around, you know, a different way of thinking.

[00:11:49] Gavin: And how much do you have in assets under management as we speak?

[00:11:52] Nancy: A little over $2 billion, about 2.3.

[00:11:56] Gavin: And that's in real dollars. That's US dollars.

[00:12:00] Nancy: Yes. We do actually have a lot of Canadian investors who use, you know, the Canadians seem to be much more derivative focused.

[00:12:08] I would say. Like sometimes some of US wealth management platforms get a little freaked out. Like one of our funds has the name volatility in it and we're long vol. And I see that as like, that's a great thing. Why would you not want that? But the Canadians are actually very early adopters of our strategies, so it's pretty cool.

[00:12:25] Gavin: That's very interesting because of course, could you then tell us what your principle product is designed to do, how does it work? And we can go on from there to say what's been happening recently and how it's been affecting it.

[00:12:35] Nancy: IVOL, which is the quadratic interest rate volatility and inflation hedge GTF.

[00:12:40] It is an inflation strategy, but instead of using, you know, some people use equities or commodities or other things, other asset classes to capture inflation. We focus on the interest rate markets. So it's been pretty popular in Canada as a replacement for US TIPS. TIPS are treasury inflation protected securities that are issued by the US Treasury.

[00:13:03] And the big problem that many of our investors, be them US, Canadian, or other parts of the world see is that the only way that TIPS measure inflation is one index. Single index. And that 's consumer price index, right? Nobody would buy, you know, one index to calculate, like say you wouldn't buy the Dow Jones index and say, ta-da I have US equities.

[00:13:27] Why would you do that with something as big as inflation? So core TIPS portfolio and enhance it with another measure of inflation, which is where lenders lend money, the interest rate markets.

[00:13:38] Gavin: The construction of the CPI. One could talk about this for ages, because of course it's not regarded as being a particularly accurate reflection.

[00:13:45] I think what a third of it is, owner's equivalent rent, which is both a lot lower than you actually play in rent. And secondly, it has a big time lag. One of the things we can maybe talk about a little later is the fact that there's some built in inflation coming down the track, simply because of that owner's equivalent rent element of it.

[00:14:01] But in essence, as you say, what I've always designed to do is to give you a much better exposure to inflationary pressures, or rather I should say protection from inflationary pressures. So you're essentially using corporate lending on top of it.

[00:14:14] Nancy: We actually used the OTC interest rate markets. The reason that we do that is we don't want to just use... Like US dollar, Canadian dollar.

[00:14:22] There are lots of different levels of interest rates, right? The central banks always set policy rates. And then there, you know, SOFR replaced LIBOR. There's treasuries. There swaps. We like the swaps smart. Because that's where every global bond issuer, whether it's the Kingdom of Saudi Arabia, or AstraZeneca, or Sony, or, you know, any corporate in the world when they issue bonds in US dollars, they hedge their rate risks with the swaps market.

[00:14:49] They're not, you know, they're not sitting there being like, geez, I hope, you know, Powell doesn't hike rates. I hope interest rates don't go lower or higher. They all hedge it. We see it as a more market-based measure for US interest rates and more global measure than just using the treasury market which, you know, here we are, February 22nd. The Fed is still buying bonds.

[00:15:11] They're tapering, but QE is happening right now. And our balance sheet is almost $9 trillion. So I just don't think the treasury market is necessarily the best measure of, you know, markets. Right? It's not as free moving as one would like.

[00:15:28] Gavin: No, indeed. Obviously government intervention in those markets by buying loads and loads.

[00:15:32] I think Fed has doubled its balance sheets since COVID started two years ago. A mere four and a half trillion dollars worth. But as you say, you've got the swaps market for corporates. How big is that? Is that a very liquid market? And at the same time, I think you said, you mentioned elsewhere that there may be some inefficiencies in it. That there is actually mispriced vol in that.

[00:15:51] Nancy: Yeah, it's a very big market. It's obviously hard to measure, but you can look at it at various things from like the BIS they put out some on the second page of our IVOL fact sheet, we have a table from the BIS, which estimates that the OTC rates markets in US dollar is about five times the size of the US stock market.

[00:16:11] You know, it's, it's kind of a lick your finger, hard to thnk, hard to say. But that's one data source that you can look at. But I think the thing that's unique about our fund is that it's, you know, it's not another stock based strategy. It's not another buying cash bonds, whether they're investment grade, high yield, or treasuries. It was something a little bit different.

[00:16:29] Gavin: As you say, what five times the size of the US stock market? That's pretty remarkable. But at the same time, even being that big there are still pockets of inefficiency that you can exploit?

[00:16:39] Nancy: Yeah. You know, especially to your audience, if you have a lot of Canadian viewers. Real estate, right? Real estate is a big market. And a lot of people have a lot of their net worth tied up in real estate. If you just take a step back, IVOL doesn't have anything to do. We have no real estate in the portfolio, but because we use interest rates it could potentially be a nice diversifier for real estate holdings too. Generally interest rates and real estate,

[00:17:05] you know, you either need inflation, right? To have, you know, higher wages or you can afford less money. Like if we just don't go up and you're borrowing money to buy a home, your monthly payout is going to be capped if interest rates go higher. So I think it's a nice diversifier and we have had a lot of investors who focus in the, you know, most professional real estate investors do hedge share rate risk. But most regular people don't. We're pretty excited about, you know, trying to democratize markets and give access to another asset class.

[00:17:39] Gavin: Because this is not obviously a market which individuals can access easily, if at all effectively. Would it be fair to say you're one of the very few vehicles to be able to allow individuals to do this?

[00:17:48] Nancy: It's not even individuals, many institutional investors don't have access to this market. It's a pretty, I like to say I'm a super specialist, you know. Asset allocators, they have to look at the forest and \figure out which tree to look at. You know, we're not just focused on one tree it's specific cypress trees.

[00:18:06] I know we do have some institutional investors in Canada and they just don't have the capability to book these or monitor the OTC Greek risks. So even on the institutional side we do have Canadian institutions.

[00:18:19] Gavin: No, that's obviously a very important point because effectively, if you are the specialist in the space then firstly, you've got the size, you have the track record. And secondly, it's virtually impossible to replicate. So why would you even bother? Why wouldn't you just actually go to the shop that knows what it's doing? And on that, and we were talking about the possibility of rates increasing, it does seem likely going forward that judging by the rhetoric from Mr. Powell and the Federal Reserve that they will be raising rates, whether it's four times, five times, seven times this year. And we already are seeing what the Bank of England's raised rates twice within a month, which I think the first time in about 15 years. And even the European Central Bank is muttering that possibly it might end quantitative easing and, oh my gosh, even raise rates by the end of this year. So would it be fair to say that rates are going up?

[00:19:05] Nancy: Well ethey're definitely priced to go higher on the short end. But interestingly the long end isn't really buying that, you know, just take the US ten year treasury right now is, you know, 194, right? I don't think CPI is the only way to measure inflation, but just say you believe, you know, 2% inflation is realistic.

[00:19:25] You're not getting compensated in real return space for buying long dated interest rates. But interestingly, the short end is fully priced for all these hikes. So just this year alone, 2022, I see, you know, on my Bloomberg terminal behind you. Fed funds market, or you can look at the Euro dollar market.

[00:19:45] It's priced in 150 basis points of hikes this year alone going into the US midterms and a potentially geopolitical situation as well. Plus there are even more hikes priced in, in '23. And I think that's the thing that I really like about IVOL is you don't have to take a bet about the level of interest rates.

[00:20:03] You're not saying, I think grades are going to be 2% or 3% or 0% or 5%. You just want the spread between short and long dated rates to widen. And the interesting thing about that is it happens in different times. You know, if we had say a risk-off environment, like say, I don't know, something bad happens, new variant, Russia/Ukraine heats up, something, you know, some kind of bad scenario. Those hikes are just, you know, it's just Powell using his words.

[00:20:33] Like, I feel like this is like, when I was a stay at home mom with my two kids and my toddlers. And I'd be like, don't fight, use your words. Right? It's the same thing. He isn't hyped at all. You know, he's, they're going to hike in March for sure. But he's with forward guidance already talked in seven and a half rate hikes that have fully been priced into the market.

[00:20:54] So it's very easy to have the, you know, expectations for hikes falling, which potentially benefits IVOL from a steeper yield curve. Or we have more of a risk on inflationary or potentially stagflationary environment where global investors are going to say, holy cow. I'm going to demand more than 1.94% to own US dollar denominated debt, especially with the budget deficit and the amount of fiscal spending that we're doing in this country.

[00:21:24] Gavin: So in other words, as you say, it's not a particular level of rates. It's the spread between short and long rates. And secondly, that spread might actually widen if the fight to safety trade continued with the geopolitical excitements we're seeing in Russia and Ukraine or whatever. You might actually have that as long rates going down, which would in turn widen rather than short rates going up. Which has been the case so far for the first couple of months of this year.

[00:21:47] Would that be an accurate statement?

[00:21:49] Nancy: So with IVOL specifically we went lower front dated yield expectations or hired long-dated yield expectations. So the lower front end typically happens in a risk-off environment where the expectations for the number of hikes decreases or the Fed hikes, and maybe they don't hike as much. Or the long end goes, yields go higher.

[00:22:10] So it's either one, which is why I think it's really nice because you don't have to necessarily have a crystal ball to know what's going to happen in the future. You can just say, you know, there are not many things in the fixed income market that you can buy today that are trading at say 20 year lows.

[00:22:26] And the yield curve is one of those, and it's not the treasury curve. A lot of people get hung up by looking at the treasury markets. It's very easy to see, you know, I can pull it up on my iPhone. You know, you can go to YouTube. We're using the forward swap curve because our options don't expire today. They expire in the future.

[00:22:44] And so just looking at the Bloomberg screen right now, the one year forward is negative four basis points. So anything bigger than 0, 1, 5, you know, 200, whatever it is. So it's a pretty, pretty great risk reward. In my opinion, given that we are at an inverted curve right now.

[00:23:03] Gavin: So the forward curve is inverted effectively.

[00:23:06] Is that correct to say then we should expect an economic slowdown? Is it the fail-proof forecaster of what's going to be happening in the economy, which a lot of people claim that whenever the yield curve inverts, then you're going to get it at the very least a slowdown, if not a recession.

[00:23:19] Nancy: Yeah, no, the rates market has priced that in the rates market is saying the fed is going to hike and it's going to be a disinflationary outcome. And so I think it was Warren Buffet who said you actually make money when you buy a security. And that's why it's such a nice time I think for adding inflation in the United States, at least. Because the rates market doesn't believe it's going to stick around.

[00:23:41] So it's pretty cheap because everybody's lulled into this, you know, the fence going to hike, it's going to. You know, stop all the inflation. But to me, I think a lot of the inflation has been driven by things that are pandemic related, whether it's a labor market shortage, or supply chain disruptions, or Canadian truckers not working.

[00:24:02] Like whatever you want to point your finger on a lot of those are like, would higher policy rates help alleviate those pressures? You know, I don't think so.

[00:24:12] Gavin: And then of course, and it's something we're going to be discussing with one or two of our other guests who also have a fairly bullish view on the outlook for raw materials, commodities, or whatever, simply firstly demand coming back after the pandemic, but also things like the green revolution, where if you're going to be moving to a carbon-free world, you're going to a whole bunch of stuff out of the ground to actually build all these batteries, or electric cars, or whatever else might be the case.

[00:24:36] And then of course you have the geopolitics on on top of that where possibly you might have less secure supply. You don't necessarily have to agree with all of that, but your feeling is, and what the market is saying is, or what I've always positioned for, is that there will be more rather than less inflation for whatever reasons.

[00:24:52] Would that be an accurate statement?

[00:24:54] Nancy: It's not necessarily just inflation too. Like I think having the Fed hikes being priced into the curve make it a pretty attractive carry trade as well as equity risk off trade. I mean, if you just take a step back and you're like, why do people bother with fixed income at all?

[00:25:10] I see three reasons people buy fixed income. The want monthly distributions. They want something that's going to diversify equities. And they want something that's going to be non-correlated. I think we check those boxes. I've always distributed a minimum of 30 basis points a month since the fund started paying distributions in July 2019.

[00:25:30] We actually sometimes pay out more. Like in December we paid out 47 basis points. In December 2019 we paid out 50 basis points. So monthly distributions check. Also having that diversification for equities. Having all these Fed hikes priced in means that that hawkish positioning could just unravel, especially if something really bad is going to happen. Not like a little equity sell-off, but like a big, you know, IVOL had positive performance in March. 2020. Whereas TIPS alone were down even though 85% of our portfolio was that type of treasury. TIPS were down about 175 basis points. We were up in that month. And that's when the lower Fed hikes really kicks in to give you that low ball tips fund potentially. And then owning interest rate volatility I just think is a nice non-correlated strategy. It's something that, you know, a lot of our model builders like it. Inside the portfolio, especially if they have core fixed income. Perfect income tends to be benchmarked to the Barclays agg index, which a third of it approximately is short volatility from US mortgages. Because in the US homeowners can prepay.

[00:26:40] So they have G-rated names for short vol they call it. Negative convexity or convexity correction or prepayment risk. But all of that is just a nice way of saying they're short options because the homeowners long the option. The owner of the mortgage is short the option. So I think it's been attractive as a non-correlated strategy.

[00:27:01] Our clients are already short, fixed income volatility. This is a nice way to try to at least neutralize it.

[00:27:07] Gavin: And the correlation number with other asset classes, I presume, it's pretty low then?

[00:27:12] Nancy: You know, correlation is always one of those things that can change, right? It's just the history. But, you know, if you go to our website, pull up our FAQ sheet, it's on the front page since inception. Which is not quite three years. We really have no correlation to most common asset classes.

[00:27:30] You know, a lot of that is US focused. We did US equities, the Barclays agg, gold, high yield bonds. It's just something different.

[00:27:37] Gavin: So you'll be a very good diversifier in people's portfolios. As you say, people putting factors into models go, oh, this is a really neat way of reducing overall volatility. And, oh by the way, as you say, you get the distribution.

[00:27:49] What would that be equivalent to as an annualized yield? If you're doing 30 beats a month, would that be 3.6? Is that a simplistic way of putting it?

[00:27:56] Nancy: So our FCC 30 day yield is really high right now. It's 8.1% if you look at our FAQ sheet, I don't think that's a sustainable number. So I kinda downplay that. I think it's more realistic to think about a distribution of around 30 beats monthly, which would be 3.6. But it changes.

[00:28:16] That's because TIPS are also a variable yield product, right? They reset with CPI. So it's not a lot of TIPS. Funds didn't pay out any monthly distribution in like, if you look at some of the big ETFs, they paid out nothing until the fall of 2020. For eight months, no distribution at all. Whereas I've all continued to pay a distribution.

[00:28:37] So I would say it's smoother as well, potentially.

[00:28:40] Gavin: That's right. And then of course with CPI, was it seven and a half percent was the most recent number? Presumably there's going to be some flow through there, both for the conventional ETS but also for IVOL as well.

[00:28:50] Nancy: Yeah, we do our own TIPS. So.

[00:28:52] Gavin: Yeah, you will get that benefit.

[00:28:53] You are a diversifier. You pay a monthly distribution, which is sustainable. You are not correlated with virtually any other asset class. And you've been doing this-

[00:29:03] Nancy: With every asset class I think it's different than what people tend to have in their portfolio. I mean most people tend to have stocks, bonds, and real estate, right?

[00:29:13] If it's not any of those three things it's something different. But I wouldn't say any asset class. I haven't looked at everything. I'm sure there's certain things that are also non-correlated.

[00:29:24] Gavin: And you have been doing this for almost 10 years and you have a 2.3 billion in assets under management. So it's evidently been a very successful that you've attracted a lot of attention, as you mentioned, not merely from individual investors, but also from institutional investors. Not merely in the US but from Canada.

[00:29:39] Do you have any non-North American investors? Do you have Europeans buying because you are listed?

[00:29:44] Nancy: Yeah, the really neat thing about being a 1940 act fund is we trade on the New York Stock Exchange and anybody who can buy, you know, a stock that trades on the stock exchange or a ticker on the NYC can buy our fixed income funds.

[00:29:58] We have investors all around the world. It's amazing. I know we had a big institutional investor in Switzerland become an early adopter of IVOL. We have investors in South Africa, in Singapore. We even have Australian investors using the funds. So it's really global.

[00:30:16] And I think that's one of the neat things about this strategy. And we also have South American investors. So, you know, any place that can buy a US listed security can look at IVOL.

[00:30:27] So that's a very broad range of potential investors. Are there any other areas that you're looking at in terms of tweaks or a slightly different path as far as using some of these same strategies? Do you have other products that might be of interest?

[00:30:42] Yeah, no, we would like to get a dollar hedged version going of the strategy because we do think a lot of the foreign investors don't necessarily want the dollar exposure. So that's one thing that we're excited to hopefully pursue to give, you know, something that doesn't have the US dollar exposure.

[00:31:00] Gavin: Do you have any thoughts on the US dollar? Again, predictions are difficult, especially about the future, but with the possibility that the rate hikes, which Mr. Powell has mentioned not necessarily being either as high as, or as rapid as anticipated, do you feel that that might be a negative for the US dollar?

[00:31:15] Nancy: Well, it's tough to say with FX. Because it's all such a dollar versus what? Like dollar versus CAD, dollar versus Euro, dollar versus yen, dollar versus real. It's hard to make broad statements because it also really depends on rate differentials between the various countries and also the level of real yields.

[00:31:33] So I don't really know about whether the dollar is going to be strong or weak. I don't really have a view on it, but I think for our investors who think, you know, say you believe that the US is going to have a sustainable inflationary environment. A quick way to get out of inflation is to appreciate your currency.

[00:31:52] Right? So reasonable to at least offer that, you know, depending on what. I think that's a nice thing I really like about being a product is it's not what we think. We're building tools for investors to express their view. And it's interesting over the years, we've had some new major hardcore deflationists who have, you know, 99% of their portfolios set up for deflation.

[00:32:18] They still own IVOL because it's not what they already have. So I think it's neat to be able to give a product to people to say look this is a tool for you and you can express whatever view you want.

[00:32:30] Gavin: No, that's a very important point because as you say, in the end, it's down to what the investors are trying to do.

[00:32:35] And also of course, what exposures they already have, whether or not they realize they have those exposures. And I think your point about real estate to return to that, effectively, every homeowner is obviously long and has a vested interest in that. Every mortgage owner has a vested interest, whether they realize it or not. We've seen some extremely rapid increases in real estate prices.

[00:32:54] Again, not asking you to say is that likely to continue, but if you don't believe that the interest rates will go as high, is there the possibility that real estate could be affected by that?

[00:33:05] Nancy: It's so hard to say with real estate, right? Especially in Canada, it's been like so many people have wanted to say the end of the Canadian real estate market for years, kind of like the bull market for bonds as well.

[00:33:17] You know, it's always hard to call tops and bottoms, but I think at the end of the day, people need a place to live, right? That's the, you know, that's not really necessarily an investment, but I think most professional real estate investors, do try to hedge their rate risk. And I think giving access to this market as a way to say, look, you could potentially add this as part of your diversified portfolio.

[00:33:40] I've read stats that 80% of global net worth is in real estate.

[00:33:45] Gavin: That's a pretty large number. Obviously it's very widely spread cause you've got an ownership ratios of sort of mid to high sixties in most Western developed countries. So there's an enormous amount of capital and of course, an enormous amount of emotion tied up in what's happening with house prices.

[00:34:01] The UK is even worse than Canada, as far as focus on a house process. But at the same time, if rates are going to be going higher and certainly with what's priced in, you'd have to think that mortgage rates at least are going to be somewhat higher in the next 18 months. Presumably it's not unreasonable to expect that that would dampen down some of these cause what, what of house price has been running?

[00:34:21] US and Canada, it's 15, 20% increases in the last 12 months?

[00:34:24] Nancy: So that's where going back to kind of, I think of, you know, your personal balance sheet, right? A lot of people, whether their view is a disinflationary outcome or deflationary outcome or inflationary outcome, it doesn't really matter because at the end of the day, if we don't have, you know, especially if you're not working, right, you're not going to benefit from the wage inflation.

[00:34:45] You're just going to hit with a higher cost of living, whether it's interest rates or other goods and services. So that's why for a while is inflation transitory or not? When Powell kept talking about and using that awful word. I'm like, it doesn't matter! It doesn't matter whether it's when you are at risk, whether you like it or not.

[00:35:04] We live in a real world, not a Barbie world.

[00:35:07] Gavin: That's a pretty good note to finish up on . Thank you. That has been absolutely-

[00:35:10] Nancy: Probably haven't had anyone say that on your podcast before, right?

[00:35:14] Gavin: I don't think Barbie has come up before. Anyway, that has been exceptionally interesting and entertaining. Very insightful. Obviously IVOL has been a tremendous success.

[00:35:24] So we just like to take the opportunity of congratulating you and hope we have the opportunity of getting your insights in the not too distant future. Thanks very much, indeed.

[00:35:32] Nancy: Thank you for having me. Great to discuss today.

[00:35:41] Gavin: Thank you very much for listening to The Gavin Graham Show sponsored by SmartBe Investments. If you would like to learn more about the subjects discussed today, please go to our website at or @smartbeinvestments on any social media platform.

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