Active fixed income investing – the future?

Sean Dranfield, CEO and principal at PT Asset Management discusses active fixed income investing with Beverly Chandler.

This episode is brought to you in partnership with HANetf.

Transcript

Beverly Chandler

Hello, my name is Beverly Chandler and I welcome you to this recording of the ETF Express podcast, video and podcast this time, in partnership with HANetf. I'm here with Sean Dranfield who is CEO and Principal of PT Asset Management, and we're here to discuss the firm's active approach to fixed income investing. Welcome, Sean. It's very nice to have you here. 

Sean Dranfield

Beverly, thanks so much.

Beverly Chandler

And I, I've heard, look, it's a great pleasure. I just heard London's your favourite city so we, we we love you for that. I want you to tell me a little bit about yourself and your role with PT Asset Management.

Sean Dranfield

Yeah, absolutely. So I'm originally from Canada actually, so I hail from Montreal originally and one of the reasons why London is my favourite city is because I, I we actually lived there for 11 years and I've been in Chicago for some time. And so I've been, you know, in this seat sort of CEO, head of janitorial services at at PTAM for, you know, a decade and it's been, it's been really fun. And I think you know, we're very much sort of bond educators and we have a very different way of thinking about the world of bonds. And so it's it's really been a privilege to sort of share that with clients and and offer something that we think is quite different, unique and helpful. And now sort of, we get the pleasure of doing that in in Europe as well. So it's an exciting time for us.

Beverly Chandler

So let's start with taking a look at your approach to fixed income investing. Can you talk me through it?

Sean Dranfield

Absolutely. So if I just take a step back and I think about sort of equities versus bonds, I think, you know, we have a tendency to think you know, any security sort of has a total return of a profile; and if you think about a stock, the stock’s total return is typically a function of a dividend and a price. And similarly with a bond, you have a a coupon and price to equate to total return, but they're fundamentally different instruments. And what I mean by that is with an equity there's no knowability, so I may read research that attempts to predict the dividend or the price of say Google, but I don't know. Whereas with the bond there is this knowability to bonds because they're math based instruments. So the coupon is a contractual obligation, so it's a known, as is the principal payment at the end of the bond's life. And the beauty of bonds is if if you can, if you don't, if you know what interest rates are, you price has knowability, you can calculate price to the 10th decimal place in any interest rate environment - which is unpredictable, but you can calculate price. So there's this knowability to bonds because they're math based. That's fundamentally different. So I would start there. And so what we do is we basically say, let's embrace this idea that bonds are math and and we also believe that the the way traditionally we've been taught to think about bonds has some inherent flaws. So the math has flaws. So for example, I sort of alluded to this, but one of the things we don't believe in is interest rate predicting. We think there's overwhelming evidence that no one can consistently predict interest rates. And there's lots of evidence of that. The Fed over the last 20 years has been right within 100 basis points, which is a massive margin of error, roughly 12% of the time. The central banks are typically not good at predicting interest rates. And the other thing about interest rate predicting is we tend to use sort of central banks as a proxy for interest rates where where that's simply not true because interest there is a yield curve. So when I say yield curve, I mean that there are different interest rates for different levels of maturity. So like a 10 year gilt has a different rate than maybe the Bank of England's rate, and similarly in the US. So even if you could predict what the Fed or the Bank of England or the ECB was going to do, it really means nothing about your ability to predict rates at another part of the yield curve. So we embrace the idea that you can't predict rates. And then at a bottom up level, oftentimes bond investors defer to these two sort of shorthand metrics for for return and risk, namely yield as a proxy for total return and duration as a proxy for interest rate risk. And they have inherent flaws and which I can go into if you'd like. But, but basically we developed this way of overcoming these math based flaws through this methodology called shape management that we developed over 30 years ago and it's a mathematical based way of looking at bonds, but it fundamentally overcomes some of these flaws.

Beverly Chandler

So yeah, tell me more about the shape management technology.

Sean Dranfield

Yeah. So so it starts with this idea, ‘let's free ourselves from interest rate predicting’ and then when we think about yield and duration so so yield is not actually what you get on a bond, it's not the the return that you get. So it presupposes you hold the bond to maturity typically, which you may or may not do. The formula presupposes that your coupon is reinvested at the same yield at which you bought the bond which is not true because interest rates go up and down. And duration is meant to be this predictor of price movement for interest rates and it fundamentally doesn't work because it's sort of this linear equation that doesn't capture the other things that mathematically drive bonds prices. So what shape management does, is it it it basically goes into the detail of the other mathematical drivers of price that influence price differently in different interest rate environments. So an example of that, we talked about a yield curve earlier. So typically yield curves are upward sloping which makes sense. So if you lend money to the government for a longer period of time, you would expect a higher return than if you lent money overnight. So if you have an upward sloping yield curve, over time a bond will roll down the yield curve. So if you bought a ten year bond today, in three years that bond would be a seven year bond and that bond would roll down the curve. So when yields go down, the price of a bond goes up. So that's an illustration of something that could mathematically impact price that neither yield nor duration measures, but you can do the math on. So that's what we do. We basically free ourselves from interest rate predicting and we look at the other fundamental drivers of price mathematically that influence total return. And and a shape is basically the total return of a bond in different interest rate environments because we don't know what will happen to interest rates and then what we try to do is we try to combine shapes to generate at a portfolio level a more rate agnostic total return because we don't know which way rates are going to go. So the way I think about it is offence combined with defence. So offence would be a bond that might help you if rates go down and defence would be a bond that might help you if rates go up. And if you combine them, you can create a smoother total return, embracing this idea that that no one knows which way rates will go.

Beverly Chandler

And this is what makes you an active bond manager.

Sean Dranfield

Absolutely, absolutely. So we we tend to look at, we've learned over 30 years that three year horizons through back testing are the right way to look at bonds and but and the math changes, sometimes it doesn't, but sometimes it does. And so our perspective so so shapes are all about ‘go forward’ total returns so if the math isn't accretive to the portfolio on a go forward basis, and by that I mean does it enhance the total return or does it make the total return more rate insensitive. If the bond doesn't do that on a go forward basis, we may sell the bond or we may choose to buy bonds where math has fundamentally changed because sometimes that does happen. So we're always looking at go forward math and and sometimes we may not do much because the math doesn't change in a given sector, but sometimes we may actually buy or sell depending upon the go forward math.

Beverly Chandler

And fixed income in ETFs have become has become much more popular over 2025. Can you tell me for you how has that worked? Has it worked in your favour or I mean has it been a very tricky year or a good year?

Sean Dranfield

Yeah. Yeah. So, so it's interesting. So I think there's two sort of themes at play. So the first theme that's at play is, I think there's there's been a move slowly over time to sort of active ETFs. And I think it started with equities. And I would say in the last couple of years, there's been an inflection point and active bond ETFs have emerged. And then the second is this fairly dramatic change we've seen in interest rates, right? So if you think about, you know, 2021 probably was the, or 2020 was actually the low in rates, but 2020-2021 interest rates were fairly low. So from a bond from an attractiveness perspective bonds weren't, you know, particularly attractive. And of course now interest rates are much higher. So I'd say that's been the other thematic driver behind the demand for for active bond ETFs.

Beverly Chandler

And also you manage money in the US and in Europe. So perhaps you could just tell me how yields in the US have compared with Europe over this year?

Sean Dranfield

Yeah, absolutely. So so I'd say generally speaking, yields are a little higher in the US than they than they are in Europe. There are some exceptions, for example, like the 10 year gilt is fairly attractive, but generally speaking the rates rates are typically slightly higher in, in the US. I think in light of our methodology, there's there's something else that the US offers as a bond investor that that is not as available in in Europe, and that is that's defence. So when I look at the the European bond index and I compare that to the US bond index, there's one similarity and there's one stark difference. So the similarity is bonds that are in the index are typically rate sensitive bonds, right? So if I think about the US AGG, it’s treasuries, investment grade government, investment grade corporate securities, mortgage-backed securities; and the European index is largely sovereigns, governments and and investment grade corporates. Those bonds, all of those bonds are interest rate sensitive. So you're basically you're making a rate call if rates go down the bonds do well, if rates go up they don't. The big difference in the US is structured credit, so or collateralized debt. So. So in the European market that, that, that segment of the index is around 5%. In the US it's over 25%, it's close to 33% of the index and the other big difference between bond indices and stock market indices is the bond market indexes are very poor representations of the bond market. So the AGG in the US only represents roughly 50% of the market, whereas like the S&P 500, I think is 81% of the US equity market. So there's all these sectors that you can buy in the US that aren't on offer in Europe and they're typically in the structured credit space. And the beauty of that space is you can buy lots of these defensive bonds that will help you if rates go up. And and so I think what we offer to European investors is access to sort of more rate insensitive total returns and they could then combine those with their more traditional bonds and together they create a more rate insensitive return profile for their end clients. And I think that's that's what we fundamentally can offer to to European investors.

Beverly Chandler

And so your commitment is clearly to being an active manager of fixed income within the ETF space. And I mean, I didn't get any feedback or well you must know from your own data how much added alpha performance you can achieve through this approach.

Sean Dranfield

Yeah. So the interesting thing. So this is another, I think distinction between bonds and equities. I think there's pretty strong evidence that active management works in, in the bond, in bond world, generally speaking. I think in most developed equity markets that's that's a harder sell, right? So why pay for an active manager if you can, you know, match the index with the passive index fund for a significantly lower price. I think in bond investing, you know, there there's definitely data that supports the idea that active management works so it justifies the price. We've managed through this methodology to deliver very consistently strong returns over a long period of time. And and we've we've managed to to beat the index pretty sizably, net of fees. You know where we may underperform the index is if interest rates decline rapidly, because we're always gonna have this balance of defence and offence, so our defence, the prices won't go up you know when when rates plummet but but in that environment we'll offer offer and and that will also offer a pretty good total return. So I think there's pretty solid evidence that that active investing does work and particularly for our approach it does and and the the cool thing about our methodology is it it, it also tells you what not to buy because you can identify, go forward math that might lose in both a ‘rates up’ and a ‘rates down’ environment. And so if I think about the index for example right now in the US, residential mortgages are a good chunk of the index, and frankly they're not very attractive bonds. They become a little bit more attractive, but relative to other forms of offence or defence you can win in other sectors, so I think it's, you know, so so if you exclude those bonds, you probably beat the index in the US. So you know it's it's, it's interesting the you know the whole active versus passive sort of debate as it relates to the differences between the two asset classes.

Beverly Chandler

Yeah, absolutely. And I think you've covered that answer really well, thank you. I'm gonna say thank you to my guest today. So this is Sean Dranfield from PT Asset Management, and thank you to you for watching and listening.

Sean Dranfield

Thanks very much Beverly.

Beverly Chandler

It's a great pleasure to have you here. Remember to subscribe and leave a review and feel free to contact us at podcast@chandlerpublishing.com. This has been an Off the Record recording from ETF Express in partnership with HANetf. 

Outro

Off the record is brought to you by Chandler Publishing. Production by Imogen Rostron, music by Otto Balfour and hosted by me, Beverly Chandler. Thank you to our guests on this episode of Off the Record and to you for listening. We look forward to you joining us next time.