If you go back to the early 1980s all the way up to the global financial crisis, if you had just blindly bought the lowest quality credit that's out there, proxied by high yield senior secured loans, direct lending, you know, you know, when the index, you would have ended up with only about a half a percentage point of incremental performance versus high quality bonds over the entire period.

And the way it worked was that you made a lot of money, a lot of money, a lot of money, a lot of money. Then you gave it all back. Yeah, you made a lot, a lot of a lot, lot. Getting it all back.

We'd go back to the, you know, late 80s when you had, you know, that period, initial period of aggressive underwriting. You had the savings and loan crisis of the early 90s. You had the ltcM or the Asian financial crisis in the late 90s, then the internet bubble and the telecom issues of the early 2000.

Then, of course, the global financial crisis that was a more normal credit environment up since the GFC, just blindly buying that lowest quality credit on the board, whether it's private credit or lower quality public credit, you generated 7% a year more than high quality bonds. Wow.

And that explains a lot. Not surprisingly, you've seen massive growth in that area of the market.

Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal and I'm Tracy Alloway.

Tracy, you know, we've been doing this podcast for ten years.

I am actually, I am aware, you know, a whole decade and we've been doing episodes talking about big picture things and things that have changed and what's different now in 2025 or 2015 when we started.

We were right in the middle of, like this is a decade or the year or maybe in 2015, maybe at that point the fed had tried to hike one time already, and then the market sort of slapped it down and said, oh no, no, no, no more. We're not ready for more rate hikes, etc.

the rate environment could not be more different than when we first started this podcast. I mean, absolutely.

Can I say one thing about the anniversary? Yeah.

So we started the podcast in November 2015. Yeah.

We were going to celebrate for the month of November, but we're now in December. So are we going to make this a two month celebration?

Well, you know, we're having our ten year anniversary party in December, so I think it's allowed to, you know, it's allowed to bleed the ten years into both months, given that we're formally celebrating in December.

I think this is how I'm rationalizing this framing for this conversation, since, yes, we are no longer we're technically no longer an anniversary month.

I guess it's our party and we can disagree as long as we do it. However we want. But you're absolutely right about the rates of environment.

And, you know, you could see that if you go back and look at some of the old podcast episodes. The other thing that strikes me looking back at the old podcast episodes is how many of them were about shadow banking?

Which of course nowadays we call private crime. Yeah.

And that's another thing that's changed enormously.

So the private credit market now basically rivals the public credit market in terms of size.

And there's obviously a lot of concern about what that means. The outlook.

Lots of differences. Lots of differences. Yeah. Completely dramatic.

And these days of course, we are in the middle of some setting aside the big picture questions.

There are also some, small picture questions, maybe how you put immediate questions. At the time we were recording this, it looks like the December meeting is basically a lock, that there's going to be a cut.

But up until recently, there was a lot of market uncertainty. If we recorded this two weeks ago, it would have looked very different, would have looked very different.

And you know what happens after December? Highly uncertain on many dimensions. The follow through for the rate cutting cycle, there have been, increases in various credit concerns of various sorts.

We've had a few small blowups with, but, you know, nothing that big, but like what Jamie Diamond called the cockroaches.

We mentioned on the show that suddenly people are talking about credit default swaps, uncertain high tech companies, which is very unusual.

But there's a, Star Wars meme. I haven't heard that word in a long time. That's right.

But with the AI build out and how much that's getting financed by various forms of credit, suddenly people are talking about the fact that big tech companies are credits, which we don't really think about very much.

And so there are some big picture things, but also some things happening right here and right now that warrant, further further understanding and further explanation from the people who really understand them. Absolutely.

Well, I'm very excited to say we really do have the perfect guest, someone who we've had on the show before, but someone we love speaking to.

We are going to be speaking with Dan Ivascyn. He's the CIO over at Pimco, which of course, everybody should know about.

So Dan, thank you so much for coming back on the podcast.

Thanks for having me. And congratulations on the big ten year anniversary. It's a it's an honor to be invited back, during this series of, podcast. So thank you so much. Yeah, very kind of you.

To say let's start small picture.

You know, we have this, I think this, this episode will be out before the fed meeting, and the market is saying it's going to be a lock. It's going to be, they're definitely going to cut rates.

But beyond that, when you look into 2026, there's sort of two different questions.

There's the ongoing uncertainty about who is going to be the next, fed chair. And then there's just the the questions about how much appetite this existing committee has to continue a rate cutting cycle.

So I'd love to get, you know, what are you thinking about for the 2026 and what, what we could be expecting.

Sure. So, you know, we do think, the Fed's likely to cut rates, at the upcoming meeting.

We also think that this is a fed that would like to get rates a bit lower, into 2026.

The challenge, of course, is that we expect to see a little bit of re acceleration in the economy, during the first half of the year.

So, you know, we believe this fed when they say they're going to continue to focus on the data.

We do think the data is going to be a bit confusing. The general view, you know, today at Pimco with, you know, significant uncertainty, is that they probably do get rates down another half a percent or so next year, which is close to what's being, you know, priced into the market today.

But again, if you see meaningful re acceleration, in the growth data and more importantly, if you see, even a modest uptick in inflation, this fed, you know, even with a new chair, will likely, you know, be willing to remain on hold.

And then I think the other point, in this came up with, you know, one of your recent guests is that, there's the front end policy rate, and then there's the reaction out in longer maturities.

We do think there's a chance if this fed cuts aggressively into strengthening data, higher inflation, you may actually get, a sell off, in the long end of the curve.

So, that could be a bit self-defeating. And I think, something that will be a topic into next year if we do get that we acceleration that we expect.

There's a lot you said there that I want to follow up on. Just in that one answer, but just very quickly what is the the idea, the gist behind why you expect that Q1 re acceleration. Yeah.

A lot of it's, you know, related to, significant, momentum, you know, in terms of capital investment, you know, associated with AI as well as the delayed the positive growth impact of, the so-called big beautiful bill.

A lot of the corporate, tax extensions happened retroactively, for the consumer or the household. In many instances, you're going to begin to see, you know, the direct impact in terms of positive, you know, refunds, coming into the New year.

So again, you know, plenty of uncertainty, you know, a lot of crosscurrents in this economy.

But we do think there's the chance that you'll get some, you know, moderate re acceleration in the first half of the year.

You know, we're looking at a growth environment, you know, for the next year in the United States at least somewhere in the one and a half to 2% type range.

So again, that that's an environment where from a traditional Taylor rule perspective, we don't think that the fed needs to cut a lot more from here.

Although, you know, we do think that this fed particularly with new membership and a new chair, would like to get rates lower.

Since you mentioned the new chair. This is more of a long term, thoughtful question, but, obviously, for the majority of your career as a bond manager, I don't think fed independence has really been, much of a concern.

Right? We certainly haven't seen the degree of headlines that we are seeing lately with, Kevin Hassett emerging as the frontrunner for the new fed chair position.

How do you, as a bond manager, view that particular issue? And do you have to start handicapping the way you invest because of this?

I think to a degree, you know, I think if you go back several decades, you know, you can question the concept of fed independence a little bit.

And I think even from the perspective of, you know, this Fed's expanded mandate in recent years, what the market's really focused on is independence related to the setting of policy rates.

Which, you know, of course, have a direct impact on markets. So from that perspective, we are monitoring the situation like other investors.

You know, we do think less independent fed has implications, particularly in longer maturities, where you may need a bit more risk premium, when you're dealing with, uncertainty around, you know, fed independence.

But generally speaking, when we think about, you know, who's being considered, for the fed role, including Kevin Hassett, you know, we do think that there'll be a general spirit of independence there.

We still think, you know, the chair is, one vote, so to speak. And we have a committee that will continue to focus on the dual mandate.

So yes, it's a consideration. It's an input into our decisions. It's not a major concern.

We we do think that, you know, the group that's being considered. Are you know, certainly high qualified, or highly qualified and, will likely, you know, continue to take, you know, a sufficiently independent view, you know, regarding monetary policy.

Let me ask you kind of the same question, but with a slightly different framing. It's December 2025 right now.

So we've had like, you know, over four years now, I think over four years now of the fed missing on its inflation, on the two, on getting inflation durably back to 2%.

And if the fed is going to continue cutting as it looks like it's going to do in December, that signals a further willingness to ease policy, even with inflation over its ostensible target.

Setting aside the strict question of independence, do you think the fed, regardless even the current composition and the likely composition going to be forward is just not going to take 2% seriously, as perhaps it might have in the past?

Yes, I think it's a great question. And I think that, in a general sense, the 2% target matters, but not so much the current inflation rate.

You're absolutely right. We've been operating, you know, and living with an inflation rate, meaningfully above their target for quite some time.

But when you look at inflationary expectations, and I think when you talk to central bankers, you know, here in the United States as well as outside, this country, the inflationary expectations piece is what's critically important.

So when you look at longer term break even inflation rates, they've continued to be very, very well behaved.

You saw a bit of an uptick, you know, you know, at the outbreak of the war in Ukraine. And then you saw an uptick around the tariff announcements earlier this year.

But when you look at a ten year tip break even rate, just to use one of several proxies, now the one measures perfect. You know, you're down around 2.25% on CPI inflation.

So to the extent that inflationary expectations remain well contained, we do think that the central bank's willing to look through, some of the more, higher frequency data.

To the extent that you see those longer term expectations become unanchored, we do think that's a risk, for a fed that's, you know, too aggressive in in cutting rates here.

We do think that the mindset will change not only the mindset of the fed, but we think the market reaction, could, be counterproductive not only in terms of higher long term interest rates, but an impact on risk assets as well.

So, you know, the markets have let the fed get away with running fairly accommodated policy, cutting into a 3% type inflation world, because, again, there are a lot of other forces at work that very well could be disinflationary over the long term.

And there still is significant confidence in global central banks and being able to generally keep inflation, you know, close to the target, on a longer term basis.

So, you know, again, so far so good. But you know, this is all going to be a key source of uncertainty, you know, into 26 and beyond.

I feel like uncertainty is constantly the key word on our podcast nowadays.

Since longer dated expectations and yields keeps coming up in this conversation, I got to ask, do you believe in the term premium? Or rather, is the term premium a useful concept to you as a big bond investor?

It is. And you know, when we look at, you know, where would to invest? You know, we like to get paid for, you know, taking more risk.

We do, you know, see an elevated term premium, certainly relative to where we were 5 or 10 years ago.

And that's made longer. Maturity investments a bit more attractive.

With that said, there's lots of reasons why the term premium should be higher. Inflation is one of them.

Global debt levels, U.S. debt and deficit levels, are another and we probably live in a world today, given what's going on in terms of, you know, focusing on, you know, you know, tariffs and bringing back supply chains, you know, to domestic markets, the need for, you know, higher risk premium.

So, you know, as a firm today we, we like longer maturity bonds more.

But we're still, you know, tend to keep our positions concentrated in shorter maturities.

And we would expect over the next few years a little bit of, additional underperformance, in the very, very long end of the yield curve.

So we do think it's important.

It's interesting. People focus a lot on, you know, the deficit situation in the United States as an investor, you know, you don't want, to lead into a perfect high quality credit.

You know, you don't get paid so much to do. So. So in some sense, we want, you know, just enough fiscal irresponsibility where we and our, you know, end investors get paid more to lend, but not so much where it becomes a concern in terms of the overall viability of, of the system.

So we think we're in the midst of that type of market environment today. But things can go a bit too far if we don't get, you know, the deficit or the inflation situation under control over the next couple to few years.

Can you talk about the role of bonds in a portfolio? Again, this is something that in 2015, bonds fit beautifully into a diversified portfolio because they were paying something.

But also they had that nice inverse correlation. And so you got that natural hedge etc..

We haven't had that very like that beautiful inverse correlation between risk assets and bonds for a long time, which undermines one of the cases for the diversified investor of having like a big slug of perhaps longer duration assets.

How do you think in 2025, how do you sell the case that diversified investors should still keep some allocation to duration or fixed income?

Yeah. So, you know, it's interesting I know this is a ten year anniversary show. So you know, went back and looked at the performance of bonds versus other things. You know, over the last ten years.

And the divergence in performance over the last decade has been remarkable. And it explains a lot.

If you look at the S&P 500 over the last ten years, in absolute terms, you generated return of about 15% a year, adjusted for inflation. I think it's up close to, you know, 12% or so.

You know, I'm rounding a little bit when you look at the performance of, you know, the the Bloomberg Aggregate Index over that ten year period, the return annually has been below 2% in absolute terms.

When you subtract inflation, you ended up with negative returns, in bonds for ten years.

So not only has the correlation broken down, but you didn't make any money. In owning bonds,

when you look at the starting valuations today, under any type of reasonable longer term valuation framework, none of which have to mean revert quickly. But, you know, you look at, you know, Shiller, you know, p type arrangement or an equity risk premia type argument. You don't need a great correlation on bonds versus equities.

What the relative valuations would suggest is that there's a good chance that bonds outperform stocks over the next 5 or 10 years, or at least have returns on a risk adjusted basis, very, very close to stocks.

So you don't have to start a correlation argument. You know, you don't have to focus on well bonds do well during you know, you know, periods where, you know, people are losing their jobs or, you know, income growth is negative.

You could just from a pure valuation perspective, find, the asset class quite attractive. Absolutely relative.

I think the second point around correlations is that correlations between stocks and bonds will tend to break down when inflation's the primary risk factor today.

Yes inflation's above central bank targets. But there's a lot of uncertainty. You know on the economic side you do have this you know complex economy where you know tremendous value.

You know within the tech sector tremendous capital investment yet lower income households are feeling considerable pain.

If I is very, very successful, an increase in productivity, that could mean significant job loss across key segments of the economy.

So the bottom line is that risks are more balanced. We don't think correlations are going to ever come back to the really, really neat, clean levels. You know, a decade or so ago when inflation simply wasn't a problem at all. You know, across the global economy.

But we have seen correlations improve a bit. And we would expect that to go forward basis correlations, to improve further.

I think it's important again, to look at a global opportunity set.

You know, I think that the correlation arguments are stronger in areas of the world that have the best fiscal position. But in general, you know, not only do we think that the valuations are quite attractive, you know, we do think the correlations will be a bit better, certainly, that we experience coming out of the Covid period.

So in 2015, bonds were an easy sell. It turns out they weren't the best investment 2025 maybe a harder sell. But the math says that now is actually now is actually the time to to expand your exposure.

Well, I guess in ten years when we do the 20 year anniversary, we can see how people tend to judge. But, Dan, you know, since we're talking about why people should buy bonds, one of the surprising things that happened this year was we had the big tariff drama, and we saw markets go down and we saw a bond yields spike.

So everyone was talking about the Sell America trade. So this idea that you didn't want to hold on to U.S assets because of all that policy uncertainty.

And now, you know, in December 2025, yields have come down quite a lot. Although I have to say the dollar is still fairly weak.

You were always, kind of resistant to the sell America idea and you pushed back on it. What did you see that perhaps others didn't?

Well, again, I think a lot has to do with starting valuations.

After a significant period of underperformance, across U.S fixed income or global fixed income, you ended up with a decent valuation cushion.

So I think that's always important in markets. Yes.

There was news that in a narrow sense was negative, for bonds and negative for U.S bonds or U.S assets in particular.

You started with a decent yield cushion. You know, we began the year, you know, with yields, you know, ten year treasuries, you know, up near 5%, a 5% yield even in a 3% inflation. World's not that bad.

I think the second point, though, you know, we weren't, overly convicted in just owning the United States.

And I think if I could, you know, the most important thing I can say today is that global bond investing is back.

For so many years, capital is poured into the US markets. It's poured into the US markets focusing on private credit, you know, which has grown in the most here in this country.

But very, very quietly, you've seen underperformance across the global fixed income opportunity set where today, even, you know, from a US dollar based investors perspective, there's great yield, great sources of diversification.

So it's not that we were, you know, insist on just owning U.S assets. In fact, we've gradually diversified into other areas of the market.

We just thought that there was good value and good yield in the US, a sufficient cushion.

And then by extending into these other markets a great way to generate incremental return by good old fashioned relative value trading in markets today that are less correlated than they were during those years coming out of the, you know, global financial crisis and where you just have a really, really exciting time to neutral dual fashion trading across the yield curves, across markets.

And avoid having big you're what changed because that seemed like, you know, it felt like international investing across any asset class was like a real suckers thing.

It's like, oh, this is going to be the year that we're going to diversify internationally. And you didn't get paid at all for it.

What is the what what switch flipped such that actually both stocks too because international equity markets have done very well and outperform the US, which is kind of surprising in many respects.

But what switch such that now there's been real opportunities to make money looking abroad.

You know again valuations have improved. You know we we talked about you know the real poor performance of the US bond market over the last decade.

As we as we all know, yields were outright negative in many areas of the world. So we talk about low yields.

You subtract that low inflation rate, you end up with a negative number. And big portions of the global fixed income opportunity set. You have to subtract anything.

You started with a negative number. So a lot of this has just been the reprice to get markets that started not only at low levels but negative yield levels.

Then the second piece relates to policy, coming out of the global financial crisis, not only were yields low, but you had such incredible policy activism where on any signs of economic weakness, you had a massive fiscal response, massive monetary policy response, Covid, you know, the ultimate, example of that.

And today, you know, with debt levels and deficit levels where they are policy makers don't have that flexibility.

So you're you're back to an environment where markets increasingly have to stand on their own, stand on their own based on fundamentals.

And that's just an exciting time. It means more risk premia in markets, more term premium, higher yields, with significant valuation cushion absolute and relative to what look to be, you know, quite expensive equity markets and then just less correlation.

You have situations even over the course of the last couple of months where a political surprise in Japan or France creates lots of local volatility in those markets.

Uncertainty in French politics impacts UK politics because they have similar challenges in terms of getting their, you know, deficit situation, in, you know, under control and economic productivity higher.

So it reminds us a lot more like the mid 90s. You know, back before you had this massive volatility suffocation from policymakers.

And again with deficits where they are with inflation where we're where it is today versus central bank targets, it's likely that over the next several years, you know you're going to continue to be in this type of environment.

Good value good relative value. And then much less correlated markets, which, you know, lead to, you know, some some good opportunity to generate, incremental return above starting yield levels.

Well, we wanted to talk about private credit as well, because as we said in the intro, this is one thing that has changed quite a lot since 2015.

People obviously have different characterizations of private credit, but I'm curious how you think about that space and how you would define, you know, or how you would measure things like transparency and opaqueness and customization in the credit waterfall and things like that.

Because again, one person's extremely transparent market can be another person's opaque morass of potential defaults.

Not much of this is new. You know, when I joined Pimco back in the late 1990s, I spent the good portion of my initial time at the firm focusing on the underwriting of private assets.

You know, we call them pure privates, but these were, you know, foray to privates that were created as part of the Securities Act of 1933. 144 eight privates, which are quite popular.

I think the first one was issued back in 1990.

The technology that's being utilized to fund, AI infrastructure today, some of these off balance sheet contingent or cold guarantee type frameworks were around in the mid to late 1990s.

The difference today is that you have this massive capital investment need. So the deals are larger. But a lot of the technology has just been, you know, dusted off, so to speak, for, for the new era.

I think the other point that's important. And when we're talking about historical returns, you know, I think this explains a lot, is that what's been so unique in terms of credit asset performance in general has been the post global financial crisis period, where we haven't had a sustained period of economic weakness.

In fact, one of my favorite, you know, data series is looking at how lower quality lending performed since way back during the Michael Milken days.

You know, when he helped to create that market. If you go back to the early 1980s all the way up to the global financial crisis, if you had just blindly bought the lowest quality credit that's out there, proxy by high yield senior secured loans, direct lending, you know, you know, blend the index, you would have ended up with only about a half a percentage point of incremental performance versus high quality bonds over that entire period.

And the way it worked, was that you made a lot of money, a lot of money, a lot of money, a lot of money. Then you gave it all back. Then you made a lot, a lot, a lot, lot gave it all back.

We go back to the, you know, late 80s when you had, you know, that period, initial period of aggressive underwriting. You had the savings and loan crisis of the early 90s. You had the ltcM or the Asian financial crisis in the late 90s, then the internet bubble and the telecom issues of the early 2000.

Then, of course, the global financial crisis. That was a more normal credit environment, since the GFC, just blindly buying, that lowest quality credit on the board, whether it's private credit or lower quality public credit, you generated 7% a year more than high quality bonds.

And that explains a lot. Not surprisingly, you've seen massive growth in that area of the market. Now, you know, weaker credit tends to perform well when stocks go up 15% a year.

But again, you know, that's where we are today. I hear all the discussion about God, you know, underwriting is worse than the public side versus the private side.

The reality is when you've grown this much, when you've lent so much money to weaker quality borrowers, when covenants have weakened, when spreads are tight, when equities have gone up consistently as much as they have, you're going to have challenges, in these markets.

So when we think about credit, we look at it under sort of two Continuums one liquidity.

Certain assets are completely illiquid. The only decision you have to make is the purchase decision. So you better be right.

And then at the other end, the extreme, you have very, very liquid assets where you can change your mind, on a regular basis.

And then you have economic sensitivity. You have assets that are very insensitive to the economy, that are very, very high quality.

Then at the other extreme, you have assets with a tremendous amount of economic sensitivity, a tremendous amount of sensitivity to AI related disruption, other forms of economic weakness, unanticipated competition.

And you just want to make sure you get paid enough. And with stocks near all time highs, with spreads tight, with covenants weak, there going to be problems.

And I think as an investor you just need to acknowledge that you're not getting paid. What you got to take that risk 5 or 10 years ago.

And you just want to be defensive. You want to be skeptical. But it's not so much private versus public.

I think it's just thoughtful underwriting and just understanding that we're at a time where, given the strong historical performance, given the fact that we haven't had a sustained period of economic slowing for a long time, some complacency has worked. Their way into these higher risk areas of the market.

Well, talk a little bit more about competition in private credit, because I imagine it's good to be Pimco when it comes to sourcing, deals and maybe negotiating the terms.

But does even someone like you, a truly big bond manager, have to deal with competitive pressures where if you don't agree to one bond term, someone else will swoop in and agree to it and take it away from you?

Absolutely. And again, I think the other point about public and private markets is that they're well integrated.

You know, we could talk about convergence, you know, a bit later, have had some views there.

But, you know, when an issuer looks at, their options, they're going to test the public, option. They'll test the private option.

And there is a lot of competition, a lot of competition for market share.

When you look at a lot of the managers, particularly in the private credit space, they announce very, very aggressive growth assumptions.

You know, as an investor, sometimes, you know, I wish in certain quarters people would talk about, you know, if we could find value for the end investor, we will grow this much, all too often, you know, after a pretty bullish environment for for credit, it's we're simply going to grow a lot.

So, you know, we do see time and time again situations where you start the underwriting process, you get down to the point where it's time to get into a final round, and you don't get the terms that we feel we need as extenders of credit in this marketplace.

And that's just, again, symptomatic of the fact that there's a lot of demand for these assets. And, there's a lot of demand relative to the supply across many segments of the market.

And that's true not only of, below investment grade risk, but it's very, very true of certain transactions, with an investment grade rating, at least from a, from a rating agency.

So, you know, given tight spreads, given, the competition, you just have to say no.

And I'll go back to that. You know, by my earlier point, what's so exciting about this market today is that you do not need to take on aggressively underwritten credit to generate return the high quality area of the market, especially if you expand globally, if you take advantage of liquidity, which typically means flexibility for end investors, and you can have a high quality portfolio where you don't have to sacrifice return very different than where we were ten years ago.

But again, pretty exciting. Now we can go up and quality without again giving up return and in some cases, ironically, you know, picking up, expected return.

I want to go back to something you said, and I didn't quite get it, but I think it's important. And of course, it's very interesting to our audience.

You talked about the AI financing. I think you said something contingent make whole guarantees.

I don't, tell us your what is the history like. Tell us about these financing as you see them.

And what is the history, how novel are they relative to past financings or how much is it that these are structures that were very much in place for something else, are now being re proposed into, into this new, into this new, exciting area?

Yeah. So I'll start with, with what's new, which is, you know, lending to support the growth in AI and related infrastructure.

They're, you know, you're talking about several trillion dollars of investment need. So that's what's new.

But you know, what's, not so new is this idea that companies would like to keep a good portion of their debt off their balance sheet, or come up with structures that limit their overall financial liability, or give them some flexibility to manage that liability over time?

And as an end investor, you know, looking to lend to those companies, you know, it's important to acknowledge that lending against tech firms, lending against AI infrastructure, lending against AI chips, is risky.

That could be a real good investment if you own the equity may not be a great investment. If you own the bonds, where at most you get your coupon and you hope to get PA back at the end of the day.

So a lot of the underwriting of these transactions and there have been a lot and we expect a lot more to come, over the course of the next few years is to understand the form of that guarantee and understand the entity that's providing that guarantee, whether it's in the form of lease payments or other type of make hole type arrangements.

And these types of structures are what have been around for many, many years. You know, back in the mid and late 1990s, you know, a lot of times these were would be done by Wall Street financial institutions.

Sometimes across a segment of their business where they would use a corporate guarantee to arbitrage a bit. The rating agency frameworks and other times, these deals were backed by, you know, large, you know, ships, equipment, other areas of the market.

So it was the same type of analysis, the same type of underwriting, checklist, which involves a lot of lawyers, to ensure that you understand the guarantee, what you how you have to realize on that guarantee.

And that's not so different today.

Just to be clear, the guarantee we're talking about here is. Okay, here is, a hypothetical SPV that owns a data center, and it borrows money and it finances, etc..

And the guaranteed question is, how much will the tenant of that data center, which didn't want to have all that debt on their books, maybe like a Facebook or one of the hyperscalers?

How much are they actually committed to being a tenant for the long term? They're basically that's what we're talking about. Absolutely correct.

And why it matters here is you're typically talking about investment grade rated counterparties on these transactions, where the infrastructure itself, the assets that are partially backing the deal on a standalone basis would achieve a very, very low rating.

So how do you create a structure where you improve the credit quality, while meeting the needs of those that are looking to borrow, within this market.

So again, the whole key is to make sure that, something that the rating agencies may assign, investment grade rating to is in fact investment grade from a fundamental credit quality perspective.

And I think that's another theme. You know, in talking about private credit, you know, there are more economically sensitive, lower quality loans.

And then there's that a lot of growth on the investment grade side. It is very, very dangerous to assume something has an investment grade rating just because the rating agencies assign a rating to it.

It's critically important that you do your own credit work today. All too frequently.

You have, an investment grade rating from one entity. And again, market participants for years have always joked if you could only find one investment grade rating, it's pretty fair to assume everyone else's below investment grade.

So in the bottom line is that there's been a lot of aggressive, underwriting going on, even with instruments that carry an investment grade rating at least from one entity.

And again, when spreads are tight, when documentation is relatively weak, it's just critically important that you do your own fundamental credit work.

I do think Pimco has some advantages in that area, both in terms of experience and resources.

But it's super important because you're not always getting the terms that you want. When you do, you can unlock tremendous value for your clients.

But this is an environment, where we have to be really, really selective as a, as a bond investor at least.

Yeah. When I think back to, the 2015 environment, I remember a lot of people were writing stories about the triple B bubble in investment grade.

So triple B is the lowest tier of investment grade. And that had been absolutely exploding post financial crisis.

And everyone, not everyone. A lot of people expected that to end in tears. And instead it ended with all those like Triple B's getting upgraded and a lot of junk getting upgraded as well, and having a bunch of rising stars, which I don't think a lot of people were necessarily expecting.

But talk a little bit more about the rating agencies. What are the pressures that you think are perhaps driving them to, rate some of these structures higher than they otherwise might be?

Well, again, there are multiple rating agencies that have different philosophies, to how they arrive at a rating.

And, you know, there's, there's, there's going to be, you know, understandable disagreement, you know, within markets.

But issuers are quite shrewd. You know, they're going to go to where they get the most favorable, ratings treatment.

And this has always been the case. And I think the important point, you know, to note is that when stocks are going up 15% a year, when the economy's growing, when you don't have a sustained period of economic weakness, even poorly underwritten credit, well, mature.

We experience that in an extreme sense. You know, during the 2000s, what we try to do as active, investors is to underwrite, to weaker economic environments, environments where, you know, those underlying entities or the infrastructure, you know, that you that you're lending against go into a period of weakness.

And I think that's where, you know, good fundamental credit work in this type of environment that we're in today. That's very much driven by rating arbitrage, you know, seeking out investment grade ratings, you know, for an **保险公司资产负债表**（Insurance Balance Sheet: 保险公司记录资产、负债和所有者权益的财务报表） or a **再保险公司资产负债表**（Reinsurance Balance Sheet: 再保险公司记录资产、负债和所有者权益的财务报表）, as an example, you know, can lead at times to aggressive, decisions.

So it's just a nature of the fact that you have multiple agencies and some will be more optimistic in certain areas than others.

But you know, that's great. You know, if we didn't have those sources of disagreement, there wouldn't be opportunities to generate, incremental return, you know, versus passive alternatives while we're here on credit, actually, you know, I was pro about a month ago or a month and a half ago.

That's when we were getting all those headlines about Tree Killer. And that was when, Jamie Dimon made the sort of famous crickets thing I was getting. Really crunches. Cockroaches, cockroaches.

I hate cockroaches, and I like crickets, so I want to make that clear. Crickets are lovely. You're right.

I should not associate them with credit. Blow up. That's completely unfair to cricket. It's fair to cockroach.

Jamie Dimon made those concrete. I was getting worried. I saw all these other ago. Another entity took a hit on. There's another entity.

I was like, oh, this is very familiar. I don't like I don't like how many times the same company appears in the headlines, but we haven't gotten that much since then.

It's not like there have been five more of those. I'm just sort of curing it.

Setting aside some of the data center, the sexy private credit stuff that everyone's focus on, do you think over the last several years, was there some systematically bad underwriting going on, especially over the last few years, or was it could were there isolated cockroaches, the first cockroach before they had a chance to lay eggs and make babies?

The lonely cockroaches. Yeah, yeah.

So look at again because there's been so much growth in, in, in, in lending to, to lower quality, you know, companies.

And again, the last major cycle was lending to lower quality, households. You know, there there's going to be areas of, of excess.

And I think, you know, people are focused on these areas. But but again, when you look at, you know, the, the cumulative, you know, delinquencies and losses.

Yes. They've, they've increased a bit over the last few years. But these situations have been relatively, isolated.

But again, anytime we've had this much credit expansion, you're going to have challenges in these challenges are happening in a relatively strong economy.

So we don't think this will be a catastrophe. The word I've used is that there's likely going to be disappointment in certain areas of the credit markets that have performed exceptionally well over the last 10 to 15 years, but that it shouldn't be viewed as an overly controversial statement.

That's how markets work. You know, credit was very cheap 10 or 15 years ago. High quality bonds were very, very expensive.

Today, credit spreads are near all time tight, equities are near all time highs in value add high quality bonds looks reasonable relative to their history.

So you know starting valuations tend to be pretty big drivers of future returns. If the economy continues to grow.

If stocks keep going up 15% a year, yes these will be, you know, relatively isolated situations.

But if you get into a period of economic weakness, losses will go up and they'll likely be some disappointment. I think that's the best way to categorize it.

And then I think the second important point, when you look at markets in a longer term historical context, is that regulators hate bailing out the same sectors twice.

Back during the GFC, it was lending to the consumer. It was excessive lending from the banks that caused all of the problems, almost took down the financial system and not surprisingly, the regulations towards the banks and towards consumer lending was massive.

And today when you look at the world, the household balance sheet, certainly middle income and above cohort groups, hasn't been stronger this strong in several decades.

This record amounts of borrower equity in these areas of the market have been very, very strong.

From an underwriting perspective, the areas that escaped the scrutiny the last time, you know, a lot of lending to **非金融企业**（Non-Financial Corporates: 不从事金融业务的公司）, a lot of, you know, this, this, this **中型市场私募贷款**（Mid-Market Private Lending: 向中小型企业提供的私募贷款） that came out of that period relatively unscathed from a regulatory perspective has grown a lot.

So I think a lot of this just relates to longer term cycles. Pimco was talking in a much different way back in 2005 and 2006, where we were screaming from the rooftops saying that, you know, what was going on was so irrational that there were major problems ahead.

That's not what we are. And that's why I sometimes sound a bit more negative that we are.

I think that the idea of disappointment, is the way people should think about some of these areas of the credit markets.

And the good news is you don't have to accept disappointment. You can, you know, simply accept the fact that you had a great performance run and that by going up in quality, expanding into a global opportunity set, that hasn't been sufficiently embraced just yet, perhaps owning a little bit of non, you know, dollar exposure could get you the same place with much more resiliency, much more downside protection and a lot more liquidity or flexibility to change your mind in the in the future as well.

Since you brought up household balance sheets, can you talk to us a little bit about your housing outlook?

Because I believe Pimco has been pretty bullish on mortgages recently. But at the same time, we've seen a slight slowdown in the housing market.

But then again, we still have long term structural, tailwinds such as a massive undersupply of homes in the US.

Where do you see that going in the coming years particularly? You know, if we were to see inflationary pressures start to pick up and those longer end yields start to rise?

Yeah. So we are very bullish on housing related investments, in the United States as well as, you know, in other areas around the world, agency guaranteed mortgages, still trade at very wide spreads.

Relative to corporates. Even in an absolute sense, we think it's a very high quality liquid area of the market.

That, again, makes a lot of sense, to own across a variety of, of different mandates.

We also like lending, in the non-guaranteed area against the House, simply because borrowers have record amounts of equity.

Pimco just loves collateral. That's what it sounds like. You love collateral?

Yeah, we like the documentation. And good, good, good collateral. You know, at least, all else equal.

But, you know, it's not a major bet on the directionality of homes when you're lending against, a household that has 70 percentage points of of borrower equity, your home can go down quite a bit and you're very well protected.

That same dynamic exists, you know, over in the UK, across Europe, you know, and even in other parts of the world.

So you know, again, regulators don't like bailing out the same sectors twice. That's pretty good asset allocation advice.

It's quite straightforward. But also you know you have much better fundamentals across household.

But to your specific question around housing you know it's a tough situation. We do think that homes are going to remain elevated from a valuation perspective, and affordability is going to remain quite constrained because there's no easy answer.

You know, you bring the mortgage rate down, the home price goes up. You know, affordability doesn't change in a meaningful sense.

What we really need, in this country and other parts of the world are more homes, more housing units.

And again, because of a lot of the, you know, post global financial crisis regulation, it's been real hard to build new homes.

So our base case view is that home prices are going to moderate here on a national level.

You could see, at least in real terms, you know, some steady, declines over the course of the next several years in certain markets, that are a bit overextended, you know, a bit more volatility.

But we do think that, you know, home prices are going to remain elevated, from a historical perspective, just because of the fact that people have locked in very, very low mortgage rates, 30 years, you know, not just 5 or 10 years, you know, which which were, you know, mortgage durations, you know, popular pre GFC.

So, you know, you're not going to see, you know, too much turnover. And unfortunately that means that homes for, you know, a lot of younger Americans are going to remain out of reach.

But but again maybe some incremental benefit, maybe, you know, this administration get mortgage rates down a bit, through some creative policy the next couple of years, by the way, would like that, given Pimco's current positioning.

But again, but again, without without building new homes, which are going to take, you know, many, many years, you know, there's no easy solution.

I want to go back. You mentioned this idea. There's there's an optimal amount of fiscal profligacy from the perspective of the bond investor.

Maybe you want them to push it a little bit because then you could pay a little bit for taking on, but obviously you don't want them to push so forth where you get some fiscal dominance spiral leading to higher and higher inflation.

You want to find that sweet spot. You know, I mentioned we're talking a little bit about politics earlier about whether an independent central bank can be sustained.

But when you look abroad, you know, it seems like in a lot of pretty major, we're not the only country that's having political volatility these days.

People are concerned about, the approach that the new Japanese PM is going to take. And so we know that rates are higher in Japan, France, very indebted country.

They seem to have like a new government every two weeks. I like lose track of all the times their government collapses and so forth.

The UK very indebted country. The moment anyone takes office, their approval ratings plunge to -30 or whatever.

There's a lot going on on the political front, and that sort of determines whether countries or even it's even possible to run. What might be more responsible fiscal policies is that something that, I don't know, keeps you up at night is the right term, but is that something that's a big part of your work is trying to understand, especially when you think abroad, understand the political dynamics and all these countries that are happening right now?

Yeah, absolutely. And, you know, we we get together, you know, once a year, you know, talk about the outlook for economies and markets over a, you know, five year type timeframe.

And, you know, whenever advisors I think put it well was that, you know, we used to live in a world where, you know, economic outcomes would drive politics, if economies were strong, you know, politicians usually ended up in a, in a good situation. They would stay in office.

Today, it feels like it's a bit reversed where political priorities, geopolitical tensions, are driving economics.

And I think you see that to a degree with **关税政策**（Tariff Policy: 政府对进口商品征收关税的政策）, you see it, you know, to a degree with with various forms of **回流**（Reshoring: 将海外生产或业务迁回本国）。

You see it in terms of these **民粹主义倾向**（Populist Tendencies: 政治上强调普通民众利益，反对精英阶层的思潮） across markets.

So they're all very, very important and a lot more important than they were in the past.

And I think it takes a lot of humility from someone like myself, and others that grew up, you know, doing, you know, **折现现金流分析**（Discounted Cash Flow Analysis: 一种估值方法，通过折现未来现金流来估算资产价值） and, you know, **衍生品定价**（Derivative Pricing: 确定金融衍生品价值的过程）, as opposed to understanding the **政治经济学**（Political Economy: 研究政治与经济之间相互关系的学科）。

So, you know, we think that that's important both from the perspective of gaining an edge in markets, but also understanding that, sometimes we'll be wrong.

And when you're running the debt levels, that countries are running or your deficits in overall debt levels, there's going to be some unpredictability.

And that's why this idea of, looking to exploit a global opportunity set **审慎多元化**（Prudent Diversification: 谨慎地将投资分散到不同资产以降低风险），targeting some countries outside the US that aren't running, you know, 6 or 7% deficits.

And there are high quality countries out there, Australia being an example, Germany being another example.

Even the United Kingdom, although they have a lot less, policy flexibility than we do, given that there were smaller, you know, open economy with their own currency offer attractive yields.

So this is less about picking your favorite country. From our perspective, it's more looking to take advantage of attractive opportunities around the globe with some tilt towards those countries that are balancing their budget and that do have a better overall fiscal picture.

And we haven't talked about **新兴市场**（Emerging Markets: 经济发展中且具有增长潜力的国家市场），但那里，你知道，有一些新兴市场，在这个周期中领先于通胀。

That have been in some sense more fiscally prudent than their developed market counterparties and that have very, very high yields, even adjusted for inflation rates.

So even some diversification in some of the higher quality areas of the emerging markets, you know, from our perspective, represents real good value or real good sources of, diversification in return versus, some of these assets, you know, here in the United States that have performed real well, historically.

But where when you look at, you know, the likelihood for forward, performance, just just look a little bit less interesting.

Actually, this reminds me, thinking back to 2015, 2015 was actually a big year for Pimco because it was your first full year without Bill gross, right.

Who left in late 2014? That's right.

Can you talk to us, perhaps how the culture of Pimco has changed over the past ten years, and how you would describe that evolution?

Because I imagine it's been a long time. It must have shifted a little bit. Yeah.

Look at, you know, the way Bill left the firm was an ideal, to say the least.

But, you know, Bill left us in, you know, an incredibly strong position. You know, he created a lot of the frameworks that we still use today to make decisions.

You know, Bill was a strong personality, but he believed in teamwork, and believe that investing was, a team sport, you know, so to speak.

So from that perspective, there didn't need to be a lot of change or certainly not radical change.

But, you know, over the this period, you know, markets have become, you know, so much more specialized, client needs, have evolved, you know, over time, the introduction of a more sizable private opportunity set, has been important, technology, big data, using, you know, trading techniques, portfolio trading and other automated, you know, type, you know, trading strategies are all critically important.

So, you know, we're a much more specialized firm today, which is a function of, again, you know, evolving client needs, but also just, you know, the realities of this world that we live in today where data is abundant, much less expensive to access.

So from that perspective, we've needed to adapt. We've become, you know, even more global.

So, you know, we tend to, you know, utilize regional committees and in regional, decision making structures.

But, you know, a lot stayed the same. At least in terms of mindset.

And we try to really leverage, you know, the history and the experience the firm has had managing and navigating through more challenging markets.

22 was rough, you know, for both stocks and bonds. But, you know, in general, you know, the environment's been reasonably forgiving, but you can always get into these, you know, you know, tougher periods and, and again, we, we try to use these structures that, you know, Bill put in place.

And Bill deserves, a tremendous amount of credit for it.

Funny, in your last answer there, there were like five things you said that could merit full follow ups or even full follow up episodes, like about changing client needs over time, or what happens when the cost of data goes from costly to, fairly affordable, etc. all those sort of interesting things, but just the my last question and it sort of relates to technology, you know, when it comes to AI in investing.

We've talked a little bit more on the short term, like high frequency side and the sort of models that they use and the signals that they use and, how that sort of relates to AI and their application.

But for in a, for a firm like Pimco and when you're thinking about longer term holding periods and, you know, you want to have a good collateral and good documentation, etc., currently today, have you found ways to apply cutting edge AI technology to the the, the the process of good securities selection?

We have, and we're finding ways to utilize the technology at an accelerated rate.

You know, we do some of this in some of our, you know, more **量化策略**（Quant Focused Strategies: 依赖数学模型和统计分析进行投资决策的策略）， you know, where we look to use AI to actually drive **阿尔法**（Alpha: 衡量投资组合相对于基准指数的超额收益）。

But just AI is a tool to drive efficiency. Has been will be, critically important, to, managing, an investment platform.

Just the ease in which you can access data, that you can use AI to help support overall analysis.

Both at the, you know, company level, the individual investment level. But even, you know, coming through economic history and understanding some of these geopolitical trends and themes that are hard, you know, at least intuitively, to grasp, are going to be critically important.

In fact, before our discussion today, spent, you know, considerable time, you know, with our head of technology and, our head of, implementation talking about various firm wide initiatives.

And I the only other point is, you know, my own use of AI, both at home and at the office has gone up almost exponentially over the last year or two.

And I'm the last person you want to, you know, rely on it to understand this technology.

It's the younger folks that we hired over the last year that are helping us with a lot of this, perspective.

So this is, going to be quite disruptive, probably **提高生产力**（Productivity Enhancing: 能够提高工作效率和产出的）， you know, at the, at the, you know, economy wide level.

But it's also going to lead to considerable disruption. And it's important that, we don't get disrupted and that we use this technology to drive client returns.

But, you know, it's going to be important, in so many ways. And we're really, really embracing it here, here at Pimco.

Dan Ivascyn thank you so much for coming on Odd Lots That was a fantastic conversation.

Really appreciate you taking the time. Thank you guys.

Tracy I thought that was great. I really I really enjoyed talking to Dan. Fantastic overview.

Yeah. So a couple of things stood out to me. So number one, the idea of no more free lunch and credit, although people have been talking about that for a while now.

And obviously with the rate environment changing, you can see that argument.

The other thing that I really liked was, his description of policymakers don't want to bail out the same thing twice.

Yeah, that's an interesting framework or way to think about it. Yeah, absolutely.

And it kind of reminded me of, there's another person in credit who, used to tell me, a line about how he invests, which is follow the bad guys.

Right. So, like, the guys that blew up in one part of the market, usually, you know, start doing something new, they're going to get there.

Wait, are you saying they're going to get their act together? No, they're going to do something. Oh, I'm saying move to the new thing. And then that blows up.

And so if you can just identify the bad guys and just follow their career trajectories, just short everything the bad guys do, I love that.

I love that take, you know, it was really I had not realized that stat, he said about how little you got paid for taking for buying poor credit up until the GFC.

Yeah. And then post GFC, it's just totally flipped that you just got. You should just go as far out on the credit risk curve as you possibly can.

And you've just walloped, anything safe. And I knew that, I guess on some level.

But the extreme of that statistical divergence. But, you know, you have to think we had that. Well, it was more than a hiccup in 2020, but we did bounce back very fast from it.

So really what we're looking at is, you know, well over 15 years now of the lines just going up.

And you have to think about what are the things that accumulate over that time, are the patterns that accumulate or the habits, etc..

And this idea that there is a lot of safety at the far end of the risk curve and that people don't care, and that maybe, you know, some of the the perception that they're safety at the far end of the risk curve and how much that's been, burnished into people is very interesting.

Absolutely. The other thing he said that I thought was very poignant was the idea of, you have all these private credit firms starting up, right, and promising these astonishing returns for investors.

And he made the point that, like, you can't just say you're going to make all this money in private credit because like, those deals might not be out there and available to you.

You have to do it on a risk or value adjusted basis. And as as I say that, I see, a headline in Bloomberg about Capital Group getting into private credit as well.

So so this is the thing like it's a booming market. There are a lot of competitive pressures, both on the lender side and also on the credit rating side.

And you can see people really scrambling to get into the market and accumulate as much as they can.

And so the temptation, of course, is to, you know, accept lower terms, accept lower quality.

Totally. All right. Shall we leave it there?

Let's leave it there. This has been another episode of the Odd Lots podcast.

I'm Tracy Alloway. You can follow me @TracyAlloway and I'm Joe Weisenthal.

You can follow me @thestalwart. Follow our producers Carmen Rodriguez, @carmenarmen, Dash Bennet @ Dashbot and Cale Brooks @calebrooks

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