SAM Webinar: BondPlus: A Different Approach to Fixed Income

Thanks everyone for being here today and taking the time to be with us out of their busy schedules. Um I'm Mario Valente and I'm currently the deputy chief investment officer here at Stanbury Asset Management. Um, and since we have some some folks here that are SAM clients and that aren't SAM clients, I I thought I would also um spend some time and just and provide a few minutes and talk on a very high level about the backstory um of our firm. So we were founded over nine years ago uh in 2016 wi with the idea that an asset management entity could su successfully provide the same type of of independent um active portfolio strategies that Stanberry Research subscribers have likely implemented on their own behalf for their own accounts. We actively manage 10 different public market portfolio strategies with varying degrees of risk and reward and we launched the first alternatives investment vehicle focused on private in 2023. And while we were initially based in New York, we recently established new headquarters in Dallas, Texas with offices also in California and Washington. And a couple of years ago, we started offering holistic planning solutions for all of our clients to help them accomplish financial goals like building generational wealth. And finally, I'm proud to announce that we currently manage just over $1.2 billion of assets for individuals and institutions. So, so the path to 1.2 2 billion has been a consistent climb year-over-year over the last nine years despite some macro pitfalls like like co 19 in liberation day of 2025. But the year I I I really want to highlight is the year that at first glance doesn't really look like much at all. In 2022, the Federal Reserve had just embarked on its hawkish monetary policy journey, aggressively hiking rates from near zero. And these actions sent shock waves through the markets as equity indices like the S&P 500 and NASDAQ were down 20% and 30% respectively. Even the universal Bloomberg Barclay's aggregate bond index was down 15% during the year. Nothing was safe. But as we entered 2022, the SAM investment team correctly recognized that our central bank's policy actions would likely wreak havoc on the markets and hence significantly dialed down risk across our strategies. And in in fact, arguably one of the most important tactical decisions we made at the time was a 0% allocation to fixed income across the firm. And so as a result, we generated relative outperformance across our strategies that demonstrated to our clients that when the markets experience material turbulence, our firmwide commitment to capital preservation really shines. And and so so we earned a lot of trust from clients during that time period, which resulted in our clients allocating more of their portfolio assets to SAM for active management. And furthermore, a lot of our clients were so impressed with our results, they felt comfortable referring us to their friends and family. And and for us, that was the ultimate praise. But but enough about us. So, let's get into what what we all came here to learn about and discuss. And that's Sam's differentiated approach to fixed income. So, so the first thing I'd like to emphasize is that the US fixed income market offered some of the best income opportunities in decades. After the global financial crisis in in 2008, unique circumstances helped keep Treasury yields at depressed levels for almost a decade. Below mandate inflation combined with a sluggish economic recovery led the Fed to maintain a prolonged period of near zero policy rates and quantitative easing. But since the the 2020 pandemic, however, higher quality fixed income yields have returned to historically attractive levels, creating a very compelling opportunity to enhance portfolio income. and and the recent move higher reflects a return to more normal expectations for long-term growth supported by by solid US fundamentals. And absent a significant shock, we expect yields to remain in this higher range for the foreseeable future. So, so why does one even need bonds in a portfolio anyways, right? We believe there are three main reasons why investors should be allocating to fixed income. Number one, it really starts with diver with diversification and this idea of modern portfolio theory which is based on the efficient frontier. It determines the set of ideal investment portfolios that balance risk in return. Portfolios that offer the lowest risk for a given expected return or the highest expected return for a given level of risk are considered. Right? Portfolios achieve this desired efficiency through diversification of asset classes which reduces overall risk by combining assets with low coariance like stocks with bonds. This diversified framework can really enable investors to align portfolio construction with their risk tolerance while maximizing potential returns. Um, number two, bonds also provide a form of protection in a portfolio given their lower volatility, right? That's because bond holders are generally entitled to receive the full principal value of their bonds at maturity regardless of any short-term changes in market value that might have been caused by fluctuations in interest rates. Therefore, fixed income can function like a safe port in the storm when other asset classes suffer. And and finally, number three, the predictability of steady and frequent interest payments makes bonds very attractive to a wide range of income-seeking investors. Unfortunately, it it can it can be very difficult for investors to buy and sell individual bonds, particularly relative to equities. There are inherent complexities in bond markets that make it really difficult and expensive to invest in as an asset class. Uh number one, it's a large complex investment universe, right? Unlike stocks which each have a single single ticker symbol, bond issuers typically have multiple issues in the market. So while the S&P 500 has roughly 500 constituents, the BFA US high yield constraint index consists of 2,000 issuers or 2,000 issues from about 1,000 different issuers. And so as a result, investment decisions not only boil down to which companies to own, but also which specific issues to own as well. There are also trading costs and complexities, right? High yield fixed income trading continues to be largely conducted over-the-counter rather than than on an exchange like equities. And so as a result, trading costs are relatively high, making it very expensive to build and manage a diversified portfol portfolio of bonds containing numerous issues. And so and so once an individual learns about these hurdles, they will often times resort to investing in a passive um fixed income vehicle. But the problem is that passive approaches may expose investors to several forms of unintended risk both both minor and major. Right? Um number number a great example of this is high turnover. Uh bond benchmark indices have experienced significantly higher turnover than most equity indices. Like new issuance, bond maturities, corporate actions such as tender offers and credit ratings, upgrades and downgrades are all contributing factors that have caused the composition of the BFA US high yield index to continually change resulting in higher index turnover relative to equities. There's also there's also minimum size requirements. Um, most large passive ETFs impose minimum size requirements such as a minimum uh USD uh 1 billion outstanding base amount at the issuer level or 500 million outstanding base amount at the issue level. and and these types of restrictions can can really reduce the investable universe and can result in passive ETF vehicles being concentrated on the largest most liquid bonds within the index which oftentimes are employed by serial issuers where creditworthiness may be suspect. But I believe there's one significant reason why passive investment vehicles and fixed income are more than suboptimal. And this reason is that credit downgrades and upgrades can cause passive strategies to trail active ones. For example, in the Bloomberg investment grade corporate index, securities downgraded by at least at least two of the three main credit rating agencies like standard and pores or Moody's or Fitch must exit the index by the end of the month in which they're downgraded. But the problem is that deteriorating credits often sell off before they're downgraded as investors anticipate the downgrade. And so you have a situation where the indices are often forced to eliminate such bonds after they've fallen in price and then passive investment vehicles are then the last ones to be selling. Um, conversely, it also works the other way as active managers can also take advantage of positive credit quality dispersion. Right? So, for example, passive strategies with a specific mandate to follow may not only may not only own a security that is rated doubleB until its rating is potentially increased to tripleB and considered investment grade. But as an active manager, uh, active managers can purchase that bond at its doubleB rating before it's upgraded and take advantage of that market dislocation. So, so ultimately, fundamental research can significantly help active managers identify deterioration or improvement in a credit before the ratings agencies do. and and more importantly even before that credit shift is priced in by the markets. So, so what is Sam's active management philosophy? We believe uh security selection is based on fundamental research, right? We believe the corporate credit market is inherently inefficient and we rely heavily on our own internal analysis to identify and take advantage of various market inefficiencies whether security is mispriced or misrated and and this can provide us with opportunities to anticipate credit ratings upgrades or downgrades which can materially impact performance. Also, we take a concentrated approach to to portfolio construction, giving clients a greater opportunity to benefit from our team's best ideas. Um, we also rely on prudent risk management given the asymmetric risks associated with defaults in the high yield market. Uh, in other words, your upside is capped at par while your downside due to default is significant. Right? It's important to note that an active approach permits more thorough risk management. And through an active approach, we can assess the full corporate balance sheet, including current and future sources of cash flow to determine which companies may be best positioned to meet both their current and future debt obligations. We also assess companies with respect to their willingness and ability to potentially engage in behaviors that could prove detrimental to bond holders such as issuing new debt to buy back stock. And we also engage in dynamic positioning. Right? As an active manager, we can construct and position our portfolio to better align with our market outlook by overweing or underweing specific credit rating categories or industries based on economic trends. This flexibility can be particularly important in periods characterized by rapidly changing market conditions or when certain sectors of the market are heavily in or out of favor. And furthermore, we can be more opportunistic about the price at which we buy or sell a security and will only do so if we determine that a compelling total return opportunity for our portfolio exists. So, so after much consideration, we opted to launch Sam's first portfolio strategy focused on fixed income called bond plus. This strategy is actively managed designed to produce steady returns in most market conditions. As you can see in this graphic that depicts the risk the riskreward profiles of our portfolio strategies. Bond plus is nearly our most conservative strategy designed to to hold a variety of fixed income asset classes like investment grade and high yield debt, mortgage related and preferred securities. and and the plus component refers to the strategy's unique features, mainly the ability to not only purchase cheap unrated debt, but to also invest amongst neglected securities like busted convertible bonds. So this is a page that kind of uh provides kind of the key metrics of Bond plus as of June 30, right? You can see here kind of our top 10 largest positions within bond plus very much diversified. uh you can uh that the the yield metrics and credit quality metrics are here on the page as well. I would also like to point out that since June 30, we've managed to improve the portfolio such that current yield is is now just over 6%. Uh yield to worst is closer to actually 6 a.5%. And by the way, we haven't sacrificed any credit quality at all as evidenced by our weighted average credit ranking of triple B+ across the strategy. So, so I want to circle back and double click on one of the key distinguishing features that I mentioned earlier about bond plus which is this idea of investing in unrated debt. So, in order to do this, I think a simple primer on bond ratings would be helpful. So, as a reminder, ratings agencies like S&P Global and Moody's assign their proprietary credit ratings to the fixed income securities of corporations. And and so the simple reality is that because most bonds have ratings, the ones that don't are often considered riskier by investors. And as a result, they often trade for higher yields relative to rated bonds with similar levels of credit risk. These ratings convey the differing levels of creditworthiness of each bond and investors use these ratings as a tool to understand the credit risk and price the securities accordingly. And so credit ratings can really make things easy for investors. But but aiding unrated bonds however cannot potentially help fulfill such mandates easily. Right? They require deep fundamental work to understand each distinct bonds risk profile rather than pulling up a credit rating in seconds. And so as a result, unrated bonds are kind of an orphaned corner of the credit market and potentially carry somewhat of a stigma. And so for much of the fixed income markets, it's much easier to stick to rated bonds that are believed to have the rating agency's well understood um stamp of approval. Um, now the com the most common reason why a bond may not have a rating is because a company chooses not to pay for it. Right? Mo most investors incorrectly assume that a company chooses not to pay for a rating because it doesn't want a third party research firm bringing investor attention to its challenges, which would be a major red flag. But but but there are there are many other reasons that companies choose not to pay for a credit rating, right? none of which would be put in the red flag category. So, some some common examples are that the issuer already has established relationships with lenders who understand their business well and so there's no need for a rating or or the issuer operates in a small niche industry that that the ratings agencies don't cover well and as a result have misrated the company's securities in the past. And so ultimately, while we understand credit ratings serve a purpose for some in the marketplace, they don't really have an emphasized role in our research process. And so, as a result, our approach to finding attractive unrated bonds is exactly the same as finding attractive rated bonds. We do the bottoms up fundamental work to understand the true credit risk of the issuer. And so at the end of the day, it helps us that many investors continue to ignore unrated bonds, preferring to stick to the much larger, more competitive universe of rated bonds. And as long as that remains the case, we expect that our unrated allocation will continue to be a major feature of our bond plus strategy. And so among the many compelling opportunities within the unrated fixed income universe, we think busted convertible bonds offer some of the most attractive riskreward characteristics. As a reminder, convertible instruments combine characteristics of stocks in traditional fixed income securities, providing investors with unique opportunities for managing risk and enhancing returns. Like stocks, convertibles typically offer upside appreciation in rising equity markets and are less sensitive to rising interest rates. And like bonds, convertibles provide income and less exposure to equity downside in declining markets. And so therefore, one of the more attractive attributes of convertibles is that many have historically participated in a greater portion of their underlying stocks upside performance than their downside. And this dynamic creates a riskreward profile that is compelling to an investor who desires equity participation and is willing to exchange maximum upside to mitigate a great deal of equity downside. Curiously though, the US convertible bond market has long been overlooked by asset allocators and investment managers, primarily due to its relative complexity. Convertibles are more complicated than their non-convertible brethren, and many investors simply lack the expertise required to analyze them. for managers with the requisite expertise. However, we believe convertibles are an excellent source of alpha and as the drivers of return are materially different than the non-convertible universe. And so identifying attractive convertible opportunities requires one to understand the fundamentals of the issuer and the performance characteristics of each security. Even veteran fixed income investors can have a difficult time understanding the performance characteristics of convertibles if they lack direct experience in the market. And and this complex this complexity is exactly what creates the opportunity for us as we have the experience and knowledge necessary to identify attractive issues as a unique feature in our SAM bond plus strategy. So, so approximately two years ago, we initiated a corporate bond sleeve within our flagship strategy because we started to see some very compelling opportunities in this space that simply were not there in years prior because the Fed's low interest rate policies during CO 19 made the yield environment very unfavorable. And specifically, we identified unrated busted convertible securities with very favorable riskreward profiles. And we accumulated a 15% sleeve within our all-w weather strategy. And and frankly, the results have been outstanding. This corporate bond sleeve has generated over 14% annualized returns for our clients portfolios. In other words, we were able to produce equity-like returns for our clients using fixed income securities. These positive results gave us confidence that we could successfully implement the same process for a dedicated fixed income portfolio strategy. So, this next chart depicts the performance profiles of several different scenarios. The thick blue line shows cumulative performance over time of the bond plus strategy without factoring in any upside downside dynamics of the plus sleeve. And so at the end of 12 months, for example, an investor would expect to earn approximately 6 12%. But the asymmetric return profile of the plus sleeve creates the potential for greater risk adjusted returns. Let's take a look at the dotted orange line which illustrates a return profile if the plus sleeve underperforms. So after 12 months, an investor could expect to earn approximately 6%. But now let's take a look at the green dotted line which depicts the return profile if the plus sleeve outperforms. In this case, an investor could expect to earn approximately 9%. In other words, the plus sleeve introduces an incremental return profile of 250 basis points of upside versus 50 basis points of downside. By opportunistically maintaining a plus allocation sleeve of anywhere from 10 to 40%, we believe we can generate meaningful incremental performance from these asymmetric investments. And there's one final compelling feature about owning busted convertible bonds that that's definitely worth highlighting. So in the bond indenture, which is the legal contract between the bond issuer and bond holder that governs the note, convertible bonds contain language such that an allcash takeover of the issuer will trigger a bond put by bond holders at par. And so what does that mean exactly? Well, let's say the equity of the issuer is trading at $10 a share and an allcash acquisition is announced for $13 a share. Stockholders realize appreciation of 30%. Which is which is a great outcome. But what about convertible bond holders? Let's say that the same issuers converts were trading at 80 cents on the dollar. The put provision in the indenture means that the bond holders can put the bonds back to the company at par, thus realizing a 25% return. So in this scenario, bond holders can realize an upside outcome that is nearly the same as equity holders. However, right, the riskreward is completely different than simply owning the stock because convertible bonds because they're fixed income instruments possess much better downside protection than their underlying equities. Okay. So, so lastly, thanks so much for turning into our webinar today. Um, if you're new to Stanbury Asset Management, I encourage you to take advantage of our complimentary review with a SAM professional. Uh, feel free to take a a photo of the QR code on the screen and fill out the subsequent form or simply reach out to us at our contact information below, by phone, email, or simply go to our website and click on the get started button. We really look forward to seeing you on our next webinar. And thank you.