Hozef Arif: bond investing during high inflation

Hozef Arif answers questions about investing in bonds amidst high inflation.

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Transcript

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[00:00:00] Jon: Bogleheads® Live is our ongoing Twitter Space series where the do-it-yourself investor community asks their questions to financial experts live on Twitter. You can ask our questions by joining us for the next Twitter Space. Get the dates and times for the next Bogleheads® Live by following the John C. Bogle Center for Financial Literacy on Twitter. That's @bogleheads.

[00:00:22] For those that can't make the live events, episodes are recorded and turned into a podcast. This is that podcast.

[00:00:29] This episode was originally recorded on Wednesday, September 28th. Since then, inflation has come down just a bit with this past Thursday’s inflation report showing 7.7% for the year. And now, onto that previously recorded episode.

[00:00:49] Thank you for joining us for the 29th Bogleheads® Live, where the do-it-yourself investor community ask questions to financial experts live. My name's Jon Luskin, and I'm your host. Our guest for today is Hozef Arif. 

[00:01:05] Let's start by talking about the Bogleheads®, a community of investors who believe in keeping it simple, following a small number of tried-and-true investing principles. This episode of Bogleheads® Live, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501(c)(3) non-profit organization dedicated to helping people make better financial decisions. Visit our newly designed website at boglecenter.net to find valuable information and to make a tax-deductible donation. 

[00:01:31] Mark your calendars for future episodes of Bogleheads® Live. Next week we'll have Annie Duke answering your questions. She's author of, “Thinking in Bets” and “How to Decide.” You can see the full list of future guests at bogleheads.org/blog/bogleheads-live.

[00:01:44] Before we get started on today's show, a disclaimer. This is for informational and entertainment purposes only and should not be relied upon as a basis for investment, tax, or other financial planning decisions. Thank you to everyone who submitted questions ahead of time on the Bogleheads® forum. We might not have time to answer all of them. 

[00:01:59] Let's get started on today's show with Hozef Arif. Hozef Arif is a senior portfolio manager for fixed income strategies at Avantis Investors. Hozef joined Avantis in 2020. Prior to Avantis, he was an executive vice president and credit portfolio manager at Pacific Investment Management Company, AKA PIMCO for 12 years.

[00:02:18] He managed a variety of strategies in global high-yield and crossover corporate credit, including several years as a co-manager of the flagship high-yield credit fund. He holds an undergraduate degree from the Indian Institute of Technology in Mumbai, an MBA from the University of Chicago Graduate School of Business, and a Master's degree in Petroleum Engineering from Stanford University.

[00:02:37] Hozef Arif, thank you for joining us today on Bogleheads® Live. Let's start with a general catchall. What do Bogleheads® need to know about investing in bonds amidst high inflation?

[00:02:48] Hozef: If I can just level set here, Jon, quickly.

[00:02:51] There's two components here. One is obviously your income - your coupon from the bond - and the second is the price change as the bond travels on that yield curve.

[00:02:59] What is a yield curve? Very simply put it is basically a collection of yields for various maturities. As you think about the yield curve, any bond maturing let's say in five years’ time becomes a four-year bond after holding it for one year. So, the yield for the bond which you're holding for five years will change over time as that bond becomes a four-year bond. And if the yield curve is upward sloping, what happens is as the yield of the bond goes down, as the bond moves towards par, the bond price also changes. 

[00:03:29] Usually when you think about fixed income or bonds, there's a broad objective people have had in the last many decades. First of all, it's income generation. Obviously, you have the coupon payments. Also, somewhat of a diversification benefit. And ballast in the portfolio regarding volatility. People think about capital preservation because the principal value of the bond, you get it back when the bond matures. And sometimes also you get capital appreciation.

[00:03:57] Now, today's environment is somewhat different in the sense that you had a series of high inflation prints for the last year or so. And you've seen the bond market undergo a very high degree of volatility which has not been the case traditionally. Typically, you see the average bond volatility at 3% or 4% in the broad US aggregate fixed income market. It's been more like 8% for the last three-month period. So again, highly unusual period for the markets, and a big reason for that is just the inflation surprise the markets have seen in the last nine months to one year.

[00:04:32] Hozef: The one thing when I always think about inflation and the bond market, I think about there are two components. First is, what is the market pricing in today for the forward expectations of both inflation and interest rates? If you look at the five-year forward expectations for inflation, they have been coming down. I would say the five-year break-evens for inflation, they peaked around March of this year at 3.8% and they have been falling ever since. 

[00:05:05] So, as the market thinks about the Fed's path of interest rates going forward, it also anticipates that inflation will come down over time thanks to those actions being taken by the Fed already.

[00:05:17] The second thing I would say is that it is very important to look at what are my yield curves telling me in terms of what's my expectation for returns from the fixed income market going forward? 

[00:05:28] David (audience): Hello. Thank you for your time today. Number one is do you feel that the negativity that you see in the press around the bond market generally is misplaced? And could you maybe characterize the bond market as a bull market in yield. 

[00:05:45] Hozef: Thanks David. Just talking about the bond market and you said it looks like it's a bull market in yield. That's obviously been the case lately. When I think about longer-term returns in the bond market, they have been a good alternative to cash over longer holding periods. And this includes the 1990’s, 2000’s, the last decade, and until most recently. This year is clearly an outlier. So that's definitely been something to keep in mind for longer-term horizons. 

[00:06:13] David (audience): And then also I remember years ago I read a book, written by David Swenson, recommended that the only bond you really need is a Treasury bond. And that's enough. Take any equity risk in equities and just use Treasuries for the bond exposure. 

[00:06:27] Hozef: The worst returns you've seen for corporates, for example, was in 2008. During that year you had close to a -7% return for the full year because the widening spreads were offset by the yields falling.

[00:06:45] This year you've seen close to a -14% for corporate bond returns. So, it's clearly an outlier year and definitely leads to more interesting outcomes going forward. So, that is something to keep in mind.

[00:06:58] Looking at yield curves is really the most important takeaway from this discussion. Really focus on the yield curve because you have the bond math giving you a good window into what's likely to happen, all else equal, in terms of the cash flows from bonds and how they translate to returns for the next one-year horizon. 

[00:07:15] You can buy a single bond, and hold to maturity and that locks you into that one outcome. But if you think about the yield curve, different holding periods for that same bond can have different returns. Depending on how steep the yield curve is, you may get more return in a certain period compared to others.

[00:07:34] You think about the broad market, it's obviously a very large $40 trillion plus market. Within that, Treasury bonds have been the fastest growing sector given the large issuance by the US government for the 3+ decades. One argument, focusing on Treasury bonds only perhaps does not use the full diversification into the market. If you just look at that as the biggest issuer right now in the fixed income market.

[00:07:58] And Treasury curves right now also are somewhat inverted. So, if you look at short-term yields, they are higher than longer-term yields. So, two-year, for example, is higher than ten-year. Whereas in corporates, you do have higher yields as you go further out the curve. A five-year corporate bond, for example, yields more than a two-year corporate bond. It's like what I say, it's not one size fits all.

[00:08:20] Treasury bonds obviously can be an attractive part of a portfolio, but if you want the full diversification, if you want to capture the most attractive parts of the yield curve right now, being only in Treasury bonds will not give you that diversification or the most optimal outcome for fixed income.

[00:08:34] Jon: Jon Luskin, your Bogleheads® Live host jumping in for a podcast edit.

[00:08:41] Hozef answers David's question with, "You want corporate bonds because they provide diversification." And from Hozef's perspective as a bond portfolio manager, that certainly makes sense.

[00:08:56] To David's case as argued by Swenson, when looking at a total portfolio of both stocks and bonds, you may not necessarily need corporate bonds because the risks and returns of corporate bonds are already available in stocks. To learn more, check out David Swenson's book, “Unconventional Success”.

[00:09:18] And now back to the show.

[00:09:19] David (audience): And then if you could briefly talk about TIPS, I'd appreciate it. Thank you very much.

[00:09:26] Hozef: Treasury-inflation protected securities (TIPS), they give you an expectation of inflation and what that translates to in terms of real yields. Whatever the market is currently pricing in for the next two years, five years, ten years; that will be reflected in the TIPS pricing today. But obviously the actual scenarios and the outcomes can be quite different than what is priced in. So then, TIPS can give you more or less returns depending on how the inflation expectations shape up from this point on. 

[00:09:52] This is why I said in the beginning that, while the inflation prints have been fairly high this year of late in June and July, and again in August, if you look at the TIPS inflation break-evens, they have not been going higher. They actually peaked in March of this year close to 3.8% for the five-year TIPS, and they have been falling ever since. And that's basically also a function of the nominal yields rising as the Fed hiking gets priced into the bond markets. Right now, the Fed forward funds rate gives you a terminal rate of around 4.5% by March of next year. And, the forward five-year TIPS gives you an inflation rate break-even of 2.4%.

[00:10:34] The market's saying that, yes, the inflation is fairly high, but then going forward is supposed to come down as per what's priced into the markets today. Now, that may happen, that may not happen. We don’t know. It's very hard to forecast bond markets. But that's what the market right now, the TIPS market, is telling.

[00:10:49] Jon: You mentioned break-even inflation. For those folks who aren't investing nerds, can you tell us a little bit about what that means? 

[00:10:57] Hozef: You think about interest rates, two components. There is the inflation premium built on top of what we call the real yields. Let's say you have a five-year yield of 4%. If you had inflation of 2%, you had a real yield of 2%. Because four minus two is two. 

[00:11:16] When you buy a TIPS bond, what you're getting is the real yield, which is after inflation. And the TIPS principal will adjust higher or lower depending on how the inflation prints shape up going forward. 

[00:11:31] Jon: Here, Hozef mentions the word principal. Let's break that down for those who aren't bond investing nerds.

[00:11:39] Principal means the value of the bond. And with TIPS bonds, they adjust the principal for inflation. As inflation increases, so does the value of the bond.

[00:11:54] Hozef: What happens is, as you see inflation expectations rise, the TIPS yields will fall more than Treasury yields. Which means the gap between the two becomes higher, meaning the inflation expectation from the TIPS market also becomes higher.

[00:12:11] Primarily it happened last year during the third quarter and the fourth quarter, also during the first quarter of this year. But then they began going hard because of what the Fed was doing. They were hiking rates in March, again in May, June, and July.

[00:12:25] So as the Fed hikes began to get priced into the markets, at some point the market begins to price the inflation lower and TIPS real yields begin to rise more than Treasury nominal yields. What's happening right now is the yield between TIPS bonds and nominal Treasury bonds has begun to compress, meaning converge.

[00:12:47] And that difference between the two, which is what we call the breakeven inflation, has begun to come down. So mathematically what you're seeing is the market thinks that, because of what has happened so far in terms of the central bank’s hiking path and quantitative tightening (QT) and all those things, the market expects this difference between the nominal Treasuries and the TIPS yields to compress even further. That is why over the next five-year period, the five-year TIPS right now is giving you an implied inflation expectation of 2.4%. 

[00:13:17] Jon: What should folks be considering in making a decision to purchase TIPS or a plain vanilla Treasury bond?

[00:13:25] Hozef: TIPS really help you more than Treasuries when there is a surprise in the market more than what's priced in. So, the inflation forecast for the next five years for buying five-year TIPS, if the five-year inflation forecast began to creep higher compared to what was priced in today, then the TIPS will be a better outcome than Treasuries, for example. But if the five-year inflation forecast stays the same or keeps falling, then the TIPS outcome will be probably worse than Treasuries, all else equal. 

[00:13:59] So, it all depends on your personal opinion and view and if it’s higher or lower than what the market is pricing in. Because, like I said, when inflation comes more of a surprise to the market like it did last year Q3, Q4, even parts of Q1 this year, TIPS do quite well. But then inflation gets priced in. The question becomes at that point, do you expect a further surprise more than what's currently implied by the market yields?

[00:14:24] Jon: I like how you said it, it depends on your view. That's to say, if you think all the investors in aggregate are wrong about expected inflation, then perhaps buying TIPS makes sense for you. If you think there's no way inflation is going to be as low as everyone thinks it's going to be, then purchasing TIPS might make sense. 

[00:14:49] But if you think that TIPS are overpriced because everyone and their grandmother is terrified of inflation, then perhaps purchasing those regular plain vanilla Treasuries may be appropriate in your circumstances. Again, it depends on your view, how you think the market has priced in inflation, and if the market is wrong or right about that.

[00:15:08] This one is from user name ‘drumboy256’, who writes, "How can you convince someone that bonds, even in a target date fund that is 30 years out, are worth holding in a well-rounded portfolio?"

[00:15:22] Hozef: Like I said in the beginning, bonds really serve multiple goals – objectives - in any diversified portfolio. They give you income. They give you that portfolio ballast or hedge against economic slowdown. They give you, sometimes, capital appreciation based upon the yield curve. And they also effectively give you a way to preserve capital. 

[00:15:42] In general, if you look at longer time periods, the last four decades, and despite we have seen multiple bouts of inflation, we've seen several credit crises, we've seen several different regimes in the last four decades. Bonds have been a positive contributor for the long-term to portfolios. I would say from that perspective, bonds do serve an important role in any fixed income portfolio. 

[00:16:06] Jon: I think about an individual that I worked with last week. This was a younger gentleman who was targeting FIRE (early retirement), and in our engagement together, I noticed that he had a 2050 target date fund in his Facebook 401(k).

[00:16:21] And I mentioned, “if you're targeting FIRE you might want to consider something with an earlier target date fund such as 2040, for example.” And his question was, “can't I just reevaluate that later?” And the answer is yes, of course you can. You can certainly in eight, ten years, as was his question, look at that again. But the catch is, in the time between then and now, if stocks underperformed over that next decade, then you would've been better off with that more conservative portfolio that had more bonds. So, certainly you can reevaluate this later, but you risk underperformance in the meantime.

[00:16:59] Hozef: Your portfolio composition can also decide the impact of fixed income on that particular situation. If you look at the equity versus bond mix in a portfolio, depending on equity versus bond, what your mix is, your fixed income may or may not have a big enough impact on the overall portfolio volatility. 

[00:17:17] Because equity volatility is higher than bonds, if the portfolio is somewhat more equity-heavy, the fixed income you have will not really impact your overall portfolio volatility as much compared to, let's say you had a more bond-heavy mix in the portfolio. In that case, what type of fixed income you choose - how risky it is, what kind of allocation of fixed income you have - that will have a bigger impact on the overall portfolio volatility and outcome.

[00:17:47] Jon: Here, Hozef makes the point that stocks are more volatile than bonds. That is, normally stocks are going to change in value much more than bonds will. But he goes on to add that if your portfolio is mostly bonds with just a little bit of stocks, at that point the volatility - or the changes in price - of the bonds in your portfolio can make a much bigger impact to your portfolio returns than the changes in price of stocks. 

[00:18:25] So, if you have a bond-heavy portfolio, you want to be thoughtful about the types of bonds that you choose, and the accompanying volatility or the changes in price you can expect from those bonds. Because that's going to have a much bigger impact on your total portfolio investment returns. 

[00:18:44] This one is from username ‘er999’ who writes, "what is the proper duration for bonds?"

[00:18:55] Hozef: Duration, just to level set, think of it as when you expect to receive the cash flows for that particular security or that particular sector.

[00:19:05] Now as the question of what's the right duration to own? It again depends really on someone's personal situation. I would say here the most critical thing to keep in mind is, the right duration to own, the answer is probably not the same for every sector.

[00:19:24] So, if you ask me what is the right point to be on the curve for Treasuries, I would say probably a bit shorter given how the curve looks today. If you ask me what's the right point to be on the curve for corporate bonds, it would probably go a bit longer because of how steep those curves are even in the intermediate maturity. So again, you have to really look at what are you investing in - what sector of the fixed income market - because there is no one size fits all.

[00:19:50] I think if you own a home which has multiple rooms, you would not really want to furnish every single room – be it the living room or the bedroom, or the kitchen - the same way. You'd have different items in those rooms. 

[00:20:02] So, same thing here, but you have many different sectors in the fixed income market. It's almost like a bouquet of flowers. You think about for each particular sector, you have a unique set of outcomes, which is there in that sector’s yield curve. So, once you have that distinction available to you, you can really figure out what's the right duration for me, for every sector.

[00:20:24] If I had to give one answer for the broad market in general, if you look at the US core fixed income market today, the average duration for that market is about 6.5, in that range. So, that is what the full market is. But again, within that the proper duration probably for the Treasury market is perhaps 2, 2.5. Corporates, perhaps a bit longer. But again, that is what the market duration is and depending on the various outcomes for each sector at the right point would be different for every single bond. And that's key to keep in mind, in my opinion. 

[00:20:56] Jon: This question is from username ‘phoroner’ who asks about factor tilts and bonds. How should an individual adjust their bond portfolio based on equity factor tilts such as those that Avantis uses?

[00:21:13] Hozef: To me the overarching factor really is how much equity allocation you have to begin with. More than just the tilts, it's about the sector beta in general. As you know, equity volatility and return potential, they're both higher than fixed income over long periods of time. Typically, equities have yielded about 9%, 10% returns with 16% volatility over many decades on average. 

[00:21:39] With that in mind, because fixed income volatility and returns over longer periods obviously are lower than that, it becomes a question of really how much weight do you have in equities compared to fixed income? That to me is the bigger driver of the portfolio outcomes than any tilts within that. 

[00:21:56] If your portfolio, like I said before, was more equity heavy, then your ultimate volatility or the overall portfolio outcomes will be driven more by equities, not so much fixed income. So, the flavor of fixed income you have in the portfolio – be it riskier or higher quality, duration-wise, longer, shorter - those particular tilts or those nuances of your fixed income portion will not have that big of an impact on an equity-heavy portfolio. Whereas if you had a more conservative allocation in terms of being more fixed income centric and less equity heavy, those portfolios, yes. The type of fixed income you have - short duration versus intermediate versus long duration risk, how much credit you have in the portfolio – yes, all those factors will obviously have a bigger role to play in terms of deciding the overall outcome for both volatility and returns in the portfolio. 

[00:22:52] And we have run various back-tests on this and looking at the last four decades or so, and see the max drawdowns in a portfolio. Really whether you own just a short-duration portfolio versus a full-market core fixed income ‘agg’ universe, those really don't make a big difference on your max drawdown if your portfolio is more equity-heavy. If it is less, if it's more fixed income tilted, then yes, those differences do have a bigger contribution to your max drawdowns.

[00:23:21] Jon: Said differently, when you have more bonds in your portfolio, the type of bonds matters more. 

[00:23:28] This one is from username ‘typical.investor’ who writes: “I see now that the five-year real yield moved recently from negative to 1.5%. Yet the five-year treasury is only 3.7%. With inflation measured at 8.5% how can all this be?”

[00:23:47] Hozef: What the market's saying is inflation is fairly high right now, but it's expected to come down to that 2.4%, 2.5% level over the next five-year horizon. If you look at the ten-year horizon, even longer for that period, the breakeven inflation forecast is even lower. It's at 2.3%. For better or worse, the market right now believes that CPI prints being so high is a temporary phenomenon. Again, given what is currently priced into the bond markets going forward.

[00:24:18] Now, the market obviously can be wrong. Could be higher, lower inflation. We don't know that.

[00:24:23] By March of next year, if you look at the forward fixed income, that is being priced into the bond market and that gives you that inflation being lower. And why is that lower? Because the market is expecting the Fed hikes to cause the inflation to come down over time.

[00:24:38] Jon: I think part of the reason we've got some confusion about inflation and the five-year yield is that that 8.5%, that's going to be one-year inflation for last year. But that five-year bond, that five-year Treasury, that's paying that 3.7% for the next five years. That's to say, to your point Hozef, that investors in aggregate don't think we're going to see this type of inflation going forward.

[00:25:04] This question is from username ‘AlwaysLearningMore’ who asks about municipal bonds:

[00:25:10] “Does Hozef have any opinions or insights about the municipal bond market in terms of the relative safety of AA rated bonds or better? And the maximum one should be investing in municipal bonds as a percent of their fixed income portfolio. For example, should I hold no more than 25% of municipals in my bond portfolio? Should I place limits on individual bonds from a certain issuer? Should I place limits on bonds from specific regions?

[00:25:37] Hozef: So big picture, think about two things. Two dimensions here. The first dimension obviously is the default rates. The municipal default rates are a lot lower for the same rating. It's generally a hard quality market compared to investment grade corporates. You've seen about a 0.1% default rates over time in municipals compared to 1% in high-grade corporates. Both obviously fairly low, but municipals have that advantage there.

[00:26:04] Secondly, municipal bonds obviously, they can be tax-free for some investors. Ultimately, how much allocation to give to the portfolio depends on your personal tax situation, which obviously I cannot comment on. But they should be part of a diversified portfolio.

[00:26:19] And as to different states and so on, I think it's good to have, in general, a very diversified portfolio. The municipal index is a bit more top heavy in terms of a few states dominate the overall market. So, again, very critical to have the right diversification. 

[00:26:36] Diversifying into different sectors, different types of bonds, and again, keeping it to account the yield curve is very important for municipals also. Just like it is for Treasuries and corporate markets.

[00:26:48] Jon: From the Bogleheads® forums from username ‘DaufuskieNate’: 

[00:26:54] “Bonds can be evaluated from the perspectives of credit risk and term risk. On the credit risk side, does Avantis use their own independent evaluation of credit risk?”

[00:27:02] Hozef: The question raised was how do you think about ratings? Ratings typically lag the actual credit outcomes. You've seen it time and again. You saw it back in the 2008 crisis, the ratings actually were lagged for quite some time. Because the market always tries to price in future correct outcomes much faster than ratings do. And one way you can do that in a process is to look at different yield curves for different ratings. So, you could have for a given sector, let's take consumer cyclicals, for example, corporate bonds. You could have a different yield curve for the sector for different ratings. A, AA or BBB, all those different sectors within the consumer cyclical space could have their own yield curve. And what you can do is, compare the bond in question against all those yield curves and think about does that bond I'm trying to incorporate in a portfolio, does that behave more like its own rating or does it behave more like something of a lower rated bond on the curve?

[00:28:09] So if an ‘A’ bond, the spread is trading more like a BBB bond, then that is the market implied credit quality for the issuer. And it's like we do in our process. You can build different yield curves by rating and then evaluate every single bond against the yield curves by rating of its sector and decide, "okay, you know what? The market is pricing something else for this particular period. I should at least respect that." Try and think about the crucial outcomes for the period as the market implies them to be. 

[00:28:42] I would say an active portfolio should do that as a process, looking at all the bonds and trying to evaluate them and make sure, does the bond really behave like what its rating supposed to be? Or is it more of a quasi-high-yield or quasi-junk bond, because indices don't change unless ratings change. 

[00:28:59] Many times, what ends up happening is many of these credits which are quasi-high-yield, they don't end up leaving the index until it's too late. Anything which basically takes into account a process which derives upon more the market implied ratings, can have a more severe outcome compared to just following the ratings of the bond itself. 

[00:29:19] Jon: From the Bogleheads® forums:

[00:29:20] On the term risk side, does their evaluation of call and put provisions on bonds also include looking at information embedded in equity and equity option prices?

[00:29:28] To comment a little bit, we were talking about call provisions. The bond issuer can pay your bond back in one lump sum if interest rates decrease. Mortgage holders do this all the time. Rates decrease. They refinance. They get a lower rate on their mortgage. They pay less money in interest. 

[00:29:48] A lot of corporate bonds and a lot of municipal bonds will have a call provision allowing those issuers of that debt to do the same. That is a risk for the investor investing in those corporate bonds and those municipal bonds that they'll be paid back all their money, immediately losing out on those interest payments, and that's a real risk if interest rates drop.

[00:30:07] Hence, that is a good reason why you may want to stick to just Treasuries, which generally don't have that call risk. If folks want to nerd out on that, they can check out David Swenson's, “Unconventional Success”. I'll link to that in the show notes for our podcast listeners. 

[00:30:23] Hozef: Many bonds in the fixed income market have this call option, but the issuer can retire the bonds before maturity. And some issuers choose to call their bonds at the call price before. So, you have this embedded call optionin the bond, and you need to account for that when you think about what's my spread over government bonds for given corporate security? You have to account for this optionality - what you call the option value the bond - being callable by the issuers. That's very important. And, we do that.

[00:30:56] Ellen (audience): A question about bond investing for simple passive investors doing asset allocation. The Vanguard portfolio would have a person own the Vanguard Total Bond Market Index Fund with more short-term TIPS as they approach retirement.

[00:31:14] Other advice has been that one should just hold Vanguard's short-term bond index or Vanguard intermediate-term Treasury as the basic holding. But to keep the bond portfolio with simple and low-cost funds. What advice would you have for people trying to use that approach to investing in bonds?

[00:31:35] Hozef: As long as your portfolio relies on transparent, diversified and low-fee vehicles, I think that's a good ultimate goal to have. The one thing where indexing is different than a more active approach is indices typically allocate the highest weights - or the percentage allocation - to companies with the largest amount of debt outstanding.

[00:31:59] When they do that, they also buy and hold new issues until maturity. So, that's how typically fixed income benchmark runs. What then ends up happening is, with this particular construct the issuers - when they issue - usually they want to minimize their cost of capital. If you're a CFO of a company, you want to issue debt when it's obviously cheapest to you. Because the benchmark is following its rules, it will add all those bonds without as much focus on the expected returns of that particular bond. 

[00:32:33] The whole corporate new issuance process or even a Treasury issuance really is designed to work more for the issuers. We've seen this happen in terms of the index composition. The fixed income indices right now are very government bond heavy, and that's been the case in the last few decades because you've seen government issuance far surpass everything else in the market. You end up owning whoever is the biggest issuer over time.

[00:32:58] You could perhaps think about, obviously, you want to have transparency, you want to have a low fee, but perhaps a more active touch can also be useful in terms of portfolio construction. Thinking about the various yield curves, thinking about the construction of the portfolio in terms of risk management, and importantly using information which is current because as you've seen, the market can change rapidly in fixed income. Yield curves can move quite rapidly. You've seen this happen in the last six months. The yield curves were steep in Treasuries until last year. Right now, they're inverted. So having that information which is current in the market and using that to incorporate in your portfolio construction, I think can be also useful. 

[00:33:42] Jon: Hozef, any final thoughts before I let you go today?

[00:33:47] Hozef: Oh, thank you. I think it was a great discussion. The questions really highlighted the various challenges and opportunities right now in the fixed income market, which has become quite interesting. Yields obviously have moved a lot higher. So definitely different, interesting environment to be investing in. And, we'll see how the year shapes up. Thank you. 

[00:34:08] Jon: That's all the time we have for today. Thank you to Hozef Arif for joining us today. And thank you for everyone who joined us for today's Bogleheads® Live.

[00:34:13] Next week we'll have Annie Duke answering your questions about decision making. Until then, you can access a wealth of information for do-it-yourself investors at the John C. Bogle Center for Financial Literacy at boglecenter.net.

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[00:34:32] Thank you to everyone who's helped make this series and successive podcast possible. Barry Barnitz, Chris, Tristen Rogers, Jeremy Zuke, Andrew Beauchamp, Richard Feldman, Tedd Shimp, and Zach Foster.

[00:34:42] Finally, I'd love your feedback. If you have a comment or guest suggestion, tag your host @JonLuskin on Twitter. Thank you again, everyone. Look forward to seeing you all again next week. Until then, have a great week.