Ep 70 | Bill Housey | Has the Quality of Junk Improved? | ROI Podcast

Investors have been on edge this year, as mounting concerns related to geopolitical risk, interest rate risk, and credit risk have contributed to rising volatility.  Bill Housey provides his prospective on where investors are and are not being adequately compensated for taking risk.

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Transcript

Ryan 0:09

Well, as we enter the second quarter of 2026, there are a number of issues on the minds of investors. Investors are worried about what's going to happen with the conflict in the Middle East. They're worried about interest rates. Is the Fed going to ultimately cut rates? Will we have a new Fed chair soon? What's going to happen with all of the disruption in AI and the impact on the bond market? Joining me today to discuss these and other topics is Bill Housey, managing director of fixed income at First Trust. Bill and I are going to explore the risks as well as the opportunities with all that's going on in the world today. Thanks for joining us. So Bill, this is your uh this is your sixth appearance on the First Trust ROI podcast. You were, I believe, the second eight guest that we ever had on the podcast. Bob Carey was the first, and you were the second. Um so I mean congratulations. Thank you. Um it's great to be back, Ryan. It's great to be glad you're joining us again. So I want to talk um about what's going on in fixed income in general. I want to get your take on um some of the issues surrounding credit. Um, but before we jump into that, I want to start kind of at a macro level because there has been a lot that's changed this year. Obviously, there's been the outbreak of war, there's been volatility, there's been oil prices moving higher, concerns about inflation because of oil prices moving higher. Um I think at the start of this year, there was the market was pricing in between two and three 25 basis point cuts from the Fed. Today, I think we're pricing in um you know, maybe uh 40% chance of one cut or something, something like that. Um, there's a new Fed chair that's uh being being grilled right now to see if Kevin Walsh is going to be the next Fed chair. Um, with all of those things swirling around, um, as a portfolio manager, you know, how do you think through the implications? So all these different moving pieces. Um I'll let you riff on that for a second.

Bill 2:15

That's a it's a great way to start indeed. When you go back to where we came into the year and you think about the narratives building coming into the year about a growth reacceleration in the economy, certainly um I think very few, if any, had um bombing of Iran, U.S. and Israel um bombing of Iran, going after nuclear capabilities on their bingo card. And so, you know, I was sitting at the end of the first quarter and putting together my fixed income commentary um on income insights, and I thought, you know, Mario Andretti, famous race car driver, had this quote that basically said, if things seem like they're under control, you're not going fast enough. And you just think about that. And for many markets where you know conditions are perfect, speed is critical, and you're just riding the race and and staying, just very laser focused on the finish line. But sometimes conditions change. There's an accident on the in the race, there's weather conditions, and so it's just as important to be considering kind of where things go next as it is to control speed in a race. And I think in this situation, right, we get this deviation, and and certainly, you know, when it comes to the the geopolitical aspect of this and how it will play out, there's certainly another a number of combinations and permutations in in terms of how to think about that. But sometimes it's good to just take a step back and think about things from 30,000 feet. And so, you know, you go through the setup. The setup was oil surge is 60 percent, and so inflation expectations rise, and therefore interest rates begin to rise. But what we saw notably was that most of the impact with respect to interest rates happened on the front end of the curve, meaning that when you looked at inflation expectations and how they changed, it was really in that two-year inflation expectation for the bond market that the market said, hey, we have line of sight here, higher oil is going to lead to higher uh fertilizer costs, higher gas costs, right, higher food costs. And so with line of sight, the bond market said immediately there's going to be higher inflation in the near term. And that was priced in largely in that first couple of years. And so we immediately saw those rate cuts that were priced into the curve get removed from the curve. And so a lot of the pressure we saw was actually on the front end of the curve. And so if you looked across the curve, what you saw was that, you know, uh the two-year surge call it from three and a half to four percent, while the rest of the curve was up, you know, 10, 15 basis points. So not as meaningful. As you went out to five years, it was a little bit um, you know, less it was less than the two year, went out to the 10-year, it was less than the five-year. And so as you went further out, the bond market was basically saying, hey, we don't think this is a systemic inflation issue, right? And I agree with that. And so what I think is important as you s lay this framework on a forward basis is that we don't know exactly when it ends, right? Some days it seems like you know, war is on, war is off, right? It's just flipping back and forth, toggling. So it really comes down to probability of outcomes. And so, statistically speaking, I think if you look at the probability of a resolution still remains our base case. And if that happens, the oil price will fall, inflation expectations will fall, and interest rates should follow, because we don't have a supply problem for oil. We just have to get the war over and get the Strait of Hormuz open and and resupply. It'll take time for things to work out, but as we've seen on some positive headlines, these are the kinds of behaviors you see. And alternatively, if you don't have a resolution, well, what do you think happens then? You have higher inflation, higher oil, right? That leads to higher inflation, higher interest rates as a result, and those things tend to crimp growth. And so I think that the next derivative of that is that interest rates would tend to fall under that scenario as well. So because you'd be more worried about the growth implications of those variables. So you know, to tie a bow around that or think about it a little bit differently, um, you know, you have two pretty significant probabilities. One is that we get a resolution, uh, and the other is that you don't. So if you're in that camp, you still end up with it's going to have an impact on growth, and therefore the bond market would react to lower rates in that scenario. So I think in both of those, you know, you kind of end up in the same place.

Ryan 6:34

Okay, so are then from a positioning standpoint, are you more focused when it comes to maybe key rates on the sh in the sort of short to intermediate term uh part of the curve then if you're positioning for either of those outcomes?

Bill 6:47

Yeah. So what we saw with that backup in interest rates, that move higher in interest rates, we thought that that was a good opportunity to take advantage of the buying. And we were definitely taking advantage of what I would call the wings, if you will. Um, we already liked the intermediate part of the curve. And if you looked at the tenure over the last two years, it's been in a four to four and a half percent range. It really hasn't done anything, it's been in sideways movement. But with that big move higher in twos towards four percent, we wanted to buy that, of course, because we think that this plays through. And even on the further out on the curve, as we saw the move in the 30s towards 5%, we thought that was very opportunistic as well. And we wanted to take advantage of that. And so that's the move we were we were you know capitalizing on into that. And so that to us seems like a good um, you know, forward return outcome. And what I'm talking about here is that as rates move higher, the asymmetry in the bond market really begins to tilt more in investor favor. And so, you know, if you go back to 2021 and your your setup is rates are zero and you're going to run into substantial inflation, and the Fed's going to raise 21 times on you, the equivalent of 21, 25 base point hikes, and you have no protection in the bond market because rates are zero, there's of course going to be a negative outcome. Right? You're gonna have a a statistically and painful outcome because your protection of the bond market is income. And so the setup today is very different. When you look at where yields are and certainly after that move higher in response to what was happening with oil, in response to what's happening with the war, it seemed as though to us mathematically, when you when you run scenarios and you say, what happens if rates go up another 100 basis points from here, for example? But what happens if they fall 100 basis points? The the math skews much more in favor of investors, right? There's a much better risk-reward profile in the bond market from those yield levels. And so for that reason, we were taking advantage of those moves and we continue to. Um, I want to pivot a little bit and talk about credit.

Ryan 8:48

Um, and by the way, uh, you mentioned your your Mario Andretti uh example and the the housies income insights publication. Thought it was a great um a great analogy to think about um from a portfolio management standpoint and try to positioning portfolios for you know the end of the race, not necessarily who's winning on this lap. Um, but but I was surprised at how much information you're able to squeeze into that little pub publication. I mean, you you've got commentary on just about every sector in the fixed income market. You've got some broad category, uh, some some broad commentary. So um let me let me give you a plug. If anyone hasn't checked out the housing income insights, um it's it's a it's an easy read and it's something that people should take a look at. So uh that being said, Bill, um I want to talk about one thing that one topic that's really um generated a lot of questions lately with all the all that we've been talking about, and that is um the credit markets, both public and private. And um maybe maybe you can set this up for us. Um, you know, what's what's the biggest structural change you've seen in the credit markets over the last five-ish years um that is maybe underappreciated by investors?

Bill 10:09

Yeah, well, thank you for the plug-on income insights. I worked very hard to try to consent, condense a view of the bond market down to one page for investors. But um, as you as you look at the structural changes, honestly, I would probably go back even further than five years, back to the global financial crisis. And you know, when I think about the big structural changes and the way that credit markets have evolved since then, to me, the most notable change was that after the financial crisis, banks were much more restricted in the types of lending they could do. Um, as we know, looking back through time and having lived through the financial crisis, of course, it was a very challenging market for banks. And it was very clear at that point the regulators said, we're never we're not going to allow this to occur again. And so banks had much greater restrictions in terms of what types of lending that they could perform. And therefore, what we saw was much greater growth in other credit products around banks. And that's where, for example, you know, private credit grew pretty substantially. I think the last number I saw was something like $2 trillion. I don't know how they track this or how well it's tracked, but the the private credit market has grown to $2 trillion. But I would say that what's the biggest change is that what that means is that the risk venue has changed. So it used to be lending by banks, and that's what, as we know, led to the financial crisis, some really aggressive lending standards, for example, by banks. But that that risk venue has gone from banks now to private credit. And I would argue that it's actually even gone, despite the growth in public credit markets, it's gone in many ways from public credit to private credit. But what I think we've seen is that in many ways the risk venue has changed from both banks and in some ways public credits, uh the public credit markets and moved into private credit.

Ryan 12:07

So what is the uh what is the implication of that for the the public market? What does it mean for investors?

Bill 12:14

Well, I'll give you an example. So if you look back at, say, the high yield market in 2007, it was about 37 percent double B rated. Okay. So think about investment grade ends at triple B. So you're talking about one notch below investment grade was about 37 percent. And today, so you move forward from 2007 to today, that number is almost 60 percent. So the quality, so as as high yield has grown in size, as I mentioned, it was 700 billion, now it's a trillion and a half, the percentage that's one notch below investment grade has gone from 37 percent to almost 60 percent. So when I talk about quality improvement, it's demonstrated in in rating quality up tiering, right? That's what we see. And that has investor implications in the sense that those ratings tell you something. Okay, so I I wouldn't use them as a as a blind investment tool to say, oh, it's rated X, therefore it's investable, right? We have to do our homework, we have to understand the business, we have to understand the volatility. But mathematically, these ratings through time have been empirically studied by those who produce them. And what we can infer from these ratings is something very important. We can infer a cumulative probability of default over the next five years, because statistically this has been well documented, well studied. So, for example, if I bought a single B rated credit, a mid-single B, it has a 27% cumulative probability of default over the next five years. So over one in four of those companies is likely to default over the next five years. But if you move up to double B, that number might be 12 or 13 percent. So much closer to a 1 in 10 probability of default. And of course, if you go up to triple B in investment grade, it's about a 3 to 5 percent chance that it could default over the next five years. So much lower statistical probability. So what it really means is lower risk. And that's what I mean by the risk venue has changed. Because as private credit has exploded, right, what we've seen is that that insatiable demand for private credit has led to the private credit market having to look elsewhere to fund the with that, those proceeds and those assets that they've raised to find investments to meet that demand, right? We that's a high-class problem in the investment world. Raise a lot of money, have to put it to work. But what they did is they said, boy, the deals in private credit are pretty small. A lot of times, I mean, 30 years ago, 20 years ago, private credit was a small deal, you know, a small company, maybe one lender, maybe a small clubbed-up group of lenders making a loan. That becomes a lot harder to put to work when you're raising billions and billions of dollars. So where do you go? You go up market, you go to the public markets. And in terms of the doorway into the public markets, are those private credit dollars going to find the highest quality companies or the lowest quality companies? Because they have a much higher return hurdle to meet in private credit. So naturally, they gravitated to what we would argue are the weaker deals. And for that reason, credit qualities continue to improve in public markets.

Ryan 15:30

Okay, so the implications from I'm trying to um you know think through what you're what you're telling me. And it seems like so that the credit quality or the probability of default has improved for the public credit market because uh some of what normally be in the public credit market is now has gone in the private market. And therefore, my question for you is so everyone's observed the the spreads for these high yield indices and you know the sort of the the aggregate um high yield public credit have been very narrow, relatively tight. Is that just a reflection of a higher quality set of uh of loans that are or you know uh bonds in the portfolio? And is that structural? Is that something that's gonna be around for a while?

Bill 16:19

It's a really good question. So I I think that there's a couple of ways to frame that. So, first, I would say that the correlation between spread volatility and the equity markets will exist forever. So that's not going to change. There's going to be when risk sentiment changes, we'll see spread winding in these markets. So there's still risk in all of these markets that have some sort of non-risk-free aspect to them. And in this case, we get paid a spread to take the additional risk. What I would observe about spreads, though, is that when if you're looking at it through a rearview mirror approach and you say, boy, you know, spreads in 08 and 09 could do something like 900, 1,000 over treasuries, but the credit quality was much worse at that time. I go back and I think about investing through that period, and I would say that, well, there was a definite difference between double B spreads and single B spreads and triple C spreads. They weren't all the same, right? And so in that lower quality basket. So as the quality or as the percentage of the market has gone up of double B's, naturally I would infer from that that the statistical cumulative probability default is now lower, which would mean that, yeah, by default, you know, no pun intended, you would expect to have lower volatility around those spreads through time. Not no volatility, not no correlation with risk. Um, but you should absolutely mathematically have a lower volatility around those spreads than you had historically. So that would warrant uh a different perspective going forward. But again, I think it's really important to keep context. You will still be correlated with risk on and off, but perhaps the the bands around that relative to history will be different simply because there's been a pretty substantial increase in credit quality there.

Ryan 18:09

Got it. I love it when you can weave in a bond kind of pun uh you know, get into the conversation. I do that for you, Rod. I appreciate Bill. Um, okay, so um let's talk about the investment grade um credit market. Um, right now we've got these huge hyperscalers, we've got Amazon, Google, Meta, Microsoft, Oracle. I think together they're closing in on maybe $665 to $700 billion in CapEx just this year. Um, there was a time when a lot of those companies were relatively um asset light, and they you know they tended to be able to finance their capex with cash flows, um, but they're probably gonna borrow a lot of that capex or to borrow a lot of that uh to fund their capex. Um and so thinking that through, if if AI, everyone's very um maybe optimistic, enthusiastic. There's a lot, I mean, us included. We think that there's a lot that AI is doing that uh is gonna make productivity and efficiency in a lot of different businesses um really improve over the next several years. But um, but what about if the revenue disappoints? Um how think about that tail risk. How do you think about that as a fixed income investor?

Bill 19:30

Well, it's a really good setup, primarily because as a fixed income investor, we don't often think about the pie in the sky and the growth um and the future uh potential upside. We tend to think about things through the lens of what could go wrong, right? And how does that set us up and where will we be positioned? And so to your point, like for example, in the investment grade world, we saw you know something to the effect of $80 billion of debt issued in the first quarter by these hyperscalers. And it doesn't stop there. It goes down into the high yield market, going back to you know what the conversation we were just having. We haven't seen this in the bank loan market, we've largely seen it in the high yield market, but you know, there's some 30 billion now of debt that's been issued for data center build-out. But the point I would make on this is that the companies that are doing this are some of and in fact the biggest in the world. And that is a very different setup. When I go back to having looked at and invested through the dot-com bubble burst, 99, 2000, 2001, 2002, and the financial crisis, and you think about where the problems arose, and there's a lot of similarities. When you go back to you, there was a big telecom build-out in 99, 2000, 2001, for example, and it was uh uh massively debt funded. And they were there was a tremendous amount of build it and they will come with respect to dark fiber, and you know, a lot of defaults occurred as a result of that. And I think about the sit the setup today, these again are some of the biggest, strongest companies in the world that are doing this, and they're not necessarily willing to break their balance sheet to do it, but they're big enough to be able to do it. And I would say that you know, in the investment grade side, you know, we want to look at these companies and say, you know, how durable are they through a cycle? Of course, these are the best companies in the world, but even in the high yield side, what we're seeing is the data center build out, that 30 billion of hyperscaler debt we've seen, while there's a uh a small component of that, or a component of that that's build it and they will come, meaning we're gonna build this data center, and we think there'll be demand to fill it. A lot of that that we've seen in that space, that data center build out, has been driven by these hyperscalers that are the off take for that. So it is the good. Google's on the other side, the Amazon's on the other side building it because they want to use it and they see line of sight to needing it. And your lease counterparty in those data centers are some of the biggest and greatest companies in the world. And for that reason, many of these are very highly rated because they're just being rated based on the offtake, if you will, the strength of the counterparty that's leasing the data center. So, you know, these companies are incredibly strong. I think that it's very challenging for me as an investor who's seen many cycles to look at this and say there's no chance of an overbuild. There's always an overbuild. I'm having a hard time coming up with a scenario where there wasn't an overbuild, where it wasn't overbuilt, because the build it and they will come investors and company builders, they inevitably they see insatiable demand until it goes. And so will we see that again? I think there's a chance we see that again because we've always seen that. I don't know when that happens. Nobody does, but I think it's wise to keep that in mind. But I do think the mitigant in this case is that number one, like if you looked at it through the lens of the high-yield companies, these structures are pretty unique. They're amortizing. Many of these have hard amortization taking place while they're under construction. They they construct it, they build, then they amortize. It's a nice structure with stru solid, you know, very high quality investment grade offtakes. These, you know, the Amazons and Googles and Metas of the World, for example. And so, you know, these types of structures I think are are very, very durable, um, even in a sensitized scenario. And I think that it's going to be important to have a uh a good through-the-cycle view of this. But today, obviously insatiable demand. There's nothing but demand today. Um, but do I think that there's a chance of an overbuild? There's always an overbuild. In every one of these cycles, there's been an overbuild.

Ryan 23:54

Okay, so we were talking about private credit earlier and the impact of private credit on some of the public markets and the composition of benchmarks and that overall aggregate set of high-yield companies. And um it seems to me that there's been a lot more marketing of private credit towards retail investors than than in the past. Um maybe you can comment on whether or not that's true, but that is at least the perception that I have. But as you think about uh retail investors in the context of private credit, um, you know, is that something to be concerned about? Um, you know, does anything keep you up at night on regarding that?

Bill 24:33

Sure. So I I think you're absolutely right. I mean, retail has been a certainly a strong component of what we've seen in terms of growth in private credit. Um, I think that what we're seeing today, we're not even in a recession. What we're seeing today, and we know it because it's in it's in the news every day, with the redemptions in these private credit funds now exceeding the gates, you know, typical 5% gate on a quarterly basis. We know that investors are starting to realize or recognize that there's more to the story than a high sharp ratio, which is largely, I think, in many ways, the way the asset class has been presented to retail. Hey, look at this asset class. It has a really strong risk-adjusted return profile. You should look at this. Um, you know, I was probably five years too early on bemoaning the issue with this because the the point is that you know, if you have an asset class that, again, it's existed as far back as certainly the 30 years I've been in this industry, um, and it's but it was largely institutional, and it's migrated now into retail. And I think that you know what you see is you tend to see investors becoming too concentrated in less liquid investments, right? There are certain behaviors that in every cycle they tend to rhyme. And one of those is that you know investors tend to get more concentrated in the investments they make. Um, and we could see that very clearly with you know in the SP 500 with 40 cents of every dollar going into the you know the the Mag 7, for example. Uh if you look beyond that, you could see investors tend to get uh they give up liquidity in every one of these cycles. And they you can see that very clearly. They say, oh boy, well, you know, I don't really need that liquidity. It's gonna be fine. Market just goes up anyway, right? I don't ever need liquidity. Well, we all know that doesn't tend to end well. And of course, investors tend to get more levered later in the cycle, and a lot of these structures are levered. So I think it's a very normal behavior from a cycle perspective to have seen an asset class like this grow, explode in growth. Um, but I would just say you know, you want to be eyes wide open. So there's some some things that I think are really concerning. Number one, some of these, they're not all the same. Some of them are very concentrated, concentrated by a number of sectors, concentrated by types of companies they own. Um so if you have a single sector comprising 100 percent of your credit fund or 30 percent of your credit fund, well, that would be very concerning to me as a somebody who's been through many cycles, who's made investments through many cycles. One of the key ways to defend principle, which is really what you're trying to do through a cycle, is to be well diversified, right? You don't want concentration. If you want to take concentration risk, by all means do it in the equity market where you're really well paid to take it. But when it comes to lending, uh you're not as well paid to take that risk. So I think that concentration risk is important. I think that you want to be mindful of how the markets might change through time and what your exposure is to private credit. So, for example, if I have a low liquid investment, but my public investments can fall by 25 or 30 percent, how does that private exposure change? Am I you know I am I doubling the amount of private in my portfolio in that scenario when I might need that liquidity? And I just want to be mindful of those things. But ultimately, I think it comes down to this. The risk in private credit is not as transparent as it is in the public credit markets because the assets aren't marked every day, right? And so, you know, I've I've uh certainly seen terms like the laundering of volatility, for example, right? It's not really marked to market. So when you start to run things like risk-adjusted returns, how are you measuring that? It's not really marked to market on a daily basis, for example, the way the public credit markets are. You could have public credit markets trading down meaningfully, like we saw in February with respect to SaaS apocalypse with the software sector coming under pressure. And I don't think private credit marked those assets down at all relative to what we saw in the public credit markets. And a lot of that is, you know, you'll you'll have different views on this, but you'll hear private credit investors say things like, well, fundamentals are still still improving in these companies, still generating strong cash flow. All true. By the way, same type of things could be said about the public credit markets, but the public market's gonna trade where the next buyer cares. That doesn't flow through as well at all, really candidly, into that private credit market. So these are things investors should be mindful of when investing. It doesn't mean it's a bad asset class, doesn't mean investors shouldn't consider it. I'm not here to tell investors that, you know, if they love it, that the baby's ugly. It's just you might want to check on the baby.

Ryan 29:14

Check on the baby. So I want to uh kind of just briefly double-click into something that you said because you know it's easy. Sometimes we turn on we we talk about terms, jargon, you know, sharp ratios. And I I think it's I just want to remind people who haven't thought about what's in a sharp ratio. It's basically your excess return above the risk-free rate divided by your standard deviation. And you don't have much standard deviation if you're not marking the price every single day. You don't have the volatility and the risk reflected, and that's why those risk-adjusted returns maybe are apples to apples. Um, so you know, you I think that's something that investors need to be aware of when making those comparisons, maybe between private versus public markets, um, just because, and it's not because of anything that anyone's trying to hide necessarily, it's just that they're private assets that aren't publicly traded, so they're not marked every day like your loan book is for your senior loan fund or something. Right.

Bill 30:17

And it's it's you you do, absolutely. It's it, you know, return per unit of risk is the best way to think about it. And you want to make sure that if you're measuring something like return per unit of risk, that the return is accurate and the risk is accurate. And that's what we're getting to. And I think you know, go back to something you said earlier when we were talking about valuations. So in a tight spread environment, it doesn't just stop in the public markets. The tightening of spreads goes all the way down into private credit. So when you start thinking about, boy, in the world of stock market at record highs, spreads near tighter levels, where do you want to be taking risk? Do you want to be moving down in quality? Because no matter how you define it, it's really difficult to argue that smaller, less liquid companies are more durable than big and liquid companies. And so there's an argument from the private credit side that, hey, you can pick up 200 base points by moving down into private credit. Well, that's true. That's you know, factually accurate. But where is that enough when spreads are really tight like they are? Wouldn't you be better off, and I would make the case you are, in a tight spread environment, moving up into more durable and defensive credit like public credit?

Ryan 31:32

It's all about compensation for the level of risk that you're taking. End of the day, right? So that being said, you know, um, if you're a sophisticated investor uh in fixed income and you're thinking through uh you know private credit and and you see a manager who's a great manager who can identify opportunities and manage risk, and it's um you know the right structure, um, is is there a scenario where that's still a wise investment in your in your view?

Bill 32:02

Well, I I absolutely I think that when you look at the menu of investments, right, these are just considerations one would want to make. How much liquidity am I willing to give up at this point in the cycle? What valuation, what type of excess return or spread should I require for making that investment, right? Same way we think about every individual investment we make, whether a single asset, single bond, single stock, whatever that situation is, we want to make those same considerations for an asset class and to be considerate of how things may change through time. It's very easy to look at a point in time, and this is where the market gets things wrong a lot, and to uh extrapolate what's right in front of us as though it'll be out into perpetuity. There's no doubt, like for institutional investors with a long investment horizon, that an asset class like private credit through time makes a tremendous amount of sense. Where things get a lot more challenging is when you open the door for retail, for example, and investors are used to a certain level of liquidity, and we're seeing we're not even in recession and gates are being thrown up. I I think that that's something that investors just need to be really mindful of. Because if you're not in a recession and that's what you're facing, what do you think that looks like in a recession, for example? So if that has all been considered for a client and those types of scenarios are well understood, well, of course, there's going to be a reason to consider it. But again, you want to come back to things like, am I well diversified? I think you want to be very careful with narrow private credit, for example. You want to be very careful with high concentrations in private credit because that just doesn't work in credit, period. You want to be wide, right? You want a lot of diversification, and then you want to be thoughtful about the type of risk you take. So it's not a uh always or never such situation. It's just have I considered all the variables?

Ryan 33:48

It sounds to me, and I I don't want to put words in your mouth, but it seems to me that you um that the in your view, the balance of risk that's being rewarded, you're being compensated for that risk, has maybe shifted more towards the public markets at this point in time. Is that is that a fair statement?

Bill 34:04

I do think it. So if you look at, for example, like I mentioned, with the quality and the high yield market having improved, and you're talking about you know, six and three quarter to seven percent type yields as we went through that recent correction and a market that's almost 60% double B, I think that creates a pretty durable outcome for investors without a lot of excess risk, for example. And even in the bank loan market, what we saw was that, in my opinion, as these private credit funds began to face substantial redemptions, many of them had to sell what was liquid. And the asset class that they looked to to meet those redemptions was the public bank loan market. So the floating rate bank loan market. So what we saw was that there in the bank loan market, spreads had gotten really tight, and even in our fixed income allocations, we were shying away from that floating rate market. The Fed's cutting, and we thought valuations were really tight. We were trying to get away from that exposure. Enter the month of February, and what we saw was that these public, I'm sorry, these private credit funds were certainly leaning on and selling what they could. You know, there's you know you sell everything that's not nailed down when you're facing with those redemptions. So you have to ask yourself, you know, as an investor, what's left in these structures after those redemptions? What am I, you know, what are you selling? The easiest thing to sell is always quality, right? Because quality dictates liquidity. And so, you know, I think that's an important consideration. And and what we saw was that in, for example, the floating rate bank loan market, the average price in the market came down by a couple of points, um, which means it cheapened up on dollar price percentage of par, um, call it you know, 94.5, 95 cents on the dollar, while the yields went up to seven and a half to eight percent. And so in that setup, because of a technical overhang from what we saw in my in my opinion from private credit, it created an opportunity to inflect and to capture some potential upside in a market that we've largely been shying away from. And so, you know, I think that's an area of the market that was particularly uh compelling in into that.

Ryan 36:08

So, well, thinking about the SaaS Pocalypse, which um, by the way, kind of reminds me of like the old remember the Shark NATO movie? Like I love when you jam these things together. So the SAS pocalyp, uh, software as a service companies, um, really they were disrupted by artificial intelligence and concerns that vibe coding was going to replace some of the software. Maybe, maybe AI was going to be so good that uh there were gonna be layoffs, and and anyone who had seat-based licenses were gonna have declining revenue. There's concerns about margins uh for some of these companies, and many of those concerns are still lingering today. Um so for somebody who's thinking about given all of the sell-off, valuations have come down, spreads have widened for some of the debt. Um, as you think about investing in that space, is it better to be an equity investor or a fixed income investor? If you're on the debt side, should it be public or private? Um, do you have any opinions on that?

Bill 37:08

Yeah, well, it's a it's a great setup, Ryan, and and I candidly think we could spend an entire podcast just talking about this. So there's no doubt there's a lot to cover in that. But I guess, you know, as I think about it, the key for us is it's really important that you have a process in how you approach it. I have no doubt that certain companies' business models will be challenged in the new world of AI. Um, and we've been really trying to look forward on that for a long time now, and the reason for that is because we've all seen, as users and consumers of AI, the evolution, really revolution, the log rhythmic growth that this space has, you know, has experienced with respect to how much better it has gotten. A couple of years ago, you were playing around with these tools and thinking they're interesting, kind of fun, but today you start to find real value. And that real value is it's going to change a lot of different industries, not just software. Um and you start to think about what that means, you know, if you have developers, for example, you know, what you've done here is you've you've removed a barrier to entry, which means that you should have more development, more software, more technology, more innovation, not less, more. And so what it means is there'll be more companies. And you know, I think that if you take a um sort of myopic approach to that to say that all these new companies win and all the old companies lose, you're probably gonna miss something in that. You're probably gonna miss that a lot of these companies have really important attributes that they bring to major corporations in in the world. And you know, at the end of the day, a board of directors and management teams have to sign off on what they're doing. And a lot of these companies that are well embedded and integrated in the systems of these companies are going to continue to exist. Now, will they go out then and acquire companies that are innovative and changing the landscape? Yeah, they will. They'll they're gonna look for ways to continue to innovate, look for ways to continue to improve what they're bringing. But I do think you want to really be certain on some key points, and and some of those reside around you know, what is it that these software companies bring? Because they're not all the same. So do they have uh a proprietary data source? Uh do they have data that isn't publicly available that industry professionals rely on? I think that's a great moat. And I think that you may have charged as a company with a SaaS-based license, but you may charge differently in the future. You may charge based on the amount of data that's consumed. What we've seen in real-world examples of this is companies' margins in the software space have actually increased, not decreased in that world. So we're starting to see that evolution take place. In the near term, what's happened? Uncertainty has led to a reset lower in valuations broadly. That's very normal. The valuations were so high to begin with. Naturally, they reset lower. When the I think when the smoke clears and the dust settles, the focus will ship back to fundamentals and valuation, and then investors will begin to do to better bifurcate who can win in this environment and who the losers will be, because there will be winners and there will be losers, and there'll be new growth and new innovation. And I think that those are all really important considerations. So um, you know, being scale, having proprietary data, and and so these are key things that you might want to consider whether it's an equity or whether it's a bond, for example. And so I don't think it's uh specific to one or the other, but it's really and important that that you have uh you know a good discipline about how you approach it.

Ryan 40:48

Yeah. So it's not either or necessarily, it's kind of both and depending on um, you know, maybe the specific credit or the specific company, their upside, uh, their risk, um, all those things. And you know, you as an active manager, as you're managing fixed income funds, um have the ability to allocate based on where you're seeing the compensation for risk. Um is that are there any of the funds that you manage uh where you see um any sort of tie-ins that particularly with AI and and maybe to build on that, is there another industry that you think are there any other other uh sort of warning bells and industries that could be disintermediated or disrupted going forward?

Bill 41:33

Yeah, there's no doubt about it. I mean, some of the you know great example of this would be um you know a recent story where KPMG, you know, one of the big four came out and told their auditor that they weren't going to pay him as much. They said, we know that you you know, even though we're in the same business, we know you can do it for less. We know you're using technology, we know you're using AI, we know that that you know, we're hearing it from our customers, so we know that you have the same challenge. So I think you know, when you look at various industries, right, you're going to have it's going to change. We're going to have change in a number of industries, but you're going to have industries like this where you know it isn't simply um there's a lot of narratives you can build and and and you want to be careful with that. You want to look at some of these and they're they're individual situations. Like what value is being brought? Today, if I want to start a business, right, and this could be for anybody, and I I would ordinarily need some kind of consulting to do it, I can now go to AI as my consultant. How do I build a supply chain? Where is this product typically sourced from? Who are the biggest players in this market? Right? You start to think about like you know, where AI is incredibly valuable today as a consultant, as a coder. You know, these types of things are why we're going to see probably more businesses created, right? More innovation, more companies, because it's going to be easier for people to innovate. But the companies that were providing that consulting service, for example, are probably going to face some headwinds in terms of what customers of theirs, consumers of theirs are willing to pay for those services as a result, right? So what is the real value add? If you show up and you have to do a really custom, bespoke analysis on a company to implement their benefits and systems and things like that, well, that's going to be worth more, for example, than sort of run-of-the-mill type analysis and all those things. So these are things we're thinking about across all the sectors we're investing. We want to understand on a forward basis where we're most at risk. And we are, you know, and have been very, very careful and critical of where that risk could exist.

Ryan 43:44

All right. So, Bill, uh, once again, thanks for joining us on this episode of the First Trust Rogue Podcast. Always appreciate your insights, and I look forward to uh having you join us again. Um, and thanks to all of you as well for joining us on this episode of the First Trust ROI.