Nancy Davis (02:45):
I think the FED has a lot of upside at this Jackson Hole, cause it probably couldn’t go worse than their predictions at the last Jackson Hole. They said the labor market slack was going to be easing. They said inflation was transitory so we’ll see what they say, but I would expect they would really be addressing the inflation that everyone is feeling in their day to day life. It’s been very hard for a lot of people around the world. It’s a global thing right now, cost of food is expensive. It’s really hurting small businesses. The labor market is still incredibly tight and so I think I’m curious to hear if the FED is going to address more using their balance sheet as a monetary policy tool because I feel like right now they keep hitting only one nail over and over and over again, which is hiking rates and hiking policy rates can help on easing demand, but it doesn’t help on other aspects of the supply side issues or the labor market.

Nancy Davis (03:45):
So I’m really eager to hear if they talk more about using their balance sheet as a way of reducing inflation expectations, because I’m relieved that we had CPI. The last print was eight and a half, which was down from 9.1 but eight and a half is still nothing to get excited about and I think the big problem with that CPI number is it’s just one index, right? It’s a consumer price index, just like you wouldn’t look at the Dow Jones Index and say, aha, this is equities or the US stock market. You can’t do that with inflation either because so many people it’s so personal, what impacts everybody’s day to day inflation expectations, but I’m sure they’re going to be very tough talking about inflation because the last time they said it was transitory and they were so wrong.

Trey Lockerbie (04:34):
Your former employer, some economists over there, Goldman Sachs have come out thinking that instead of these 75 point basis hikes they’ve been doing, it probably would be more like 50 just given that inflation is, I mean, to your point, how do you measure it? But it’s been relatively flat month over month or at least from June to July. Do you have any expectation of your own as to what a further rate hike might look like?

Nancy Davis (04:58):
The rates market has already priced in additional hikes and there’s more than 75 that’s priced in just before the end of 2022. So the FED needs to hike 110 basis points just to meet what’s priced into the market. So I don’t think it really matters whether it’s 75 and then a 25 or whether it’s a 50 and two 25’s. The reality is what’s priced in, is already there and you can see that with the level of the two year interest rate. It’s so much higher than where the FED funds policy rate is, which is a band is 2.25 to 2.50, but you can buy even a T bill, short term treasury bill and get paid over 3%. So the rates market has already priced in that expectations of hikes and so it’s really up to the FED to either meet those expectations or say we’re going to be doing something else other than hiking policy rates to combat inflation.

Trey Lockerbie (05:59):
I like that you focus on that. I’ve heard you say that it’s not what the FED does, it’s what is priced in. So let’s talk a little bit about inflation because I’m curious if you think it’s actually peaked, the CPI was unchanged seasonally adjusted it rose eight and a half percent over the last 12 months and the index. I love this fact about the index with less, the food and energy is only a 0.3% seasonally adjusted, which who doesn’t use food and energy. But anyways, in your opinion, are we seeing the rate hikes actually ease inflation or is it too early to tell?

Nancy Davis (06:34):
I think it’s probably too early to tell because I think the one thing I feel like everybody right now is speculating on whether inflation is going to be falling or going up or going down. I feel like everyone right now appears to be a macro tourist and everyone has their own view about what’s going to happen in the future.

Nancy Davis (06:54):
I think people are really not thinking about it the right way. In my opinion, if you just think about your personal balance sheet, you have whatever you do professionally for your job, you have your savings and if you don’t have inflation inside your portfolio, you’re actually shorted in your real life because we do live in a real world and we do have to consume things, not everybody consumes the CPI. They’re different, whether it’s college tuition or avocados or diesel fuel, whatever it is, we do live in a real world.

Nancy Davis (07:34):
So I think everybody has exposure to inflation in their real life. And I think it’s foolish to try to bet whether inflation’s going to be going higher or lower. It’s not a trade it’s your life and it’s your savings and I think it was Ronald Reagan who called inflation the thief in the night and I think that’s really important, especially for people who are retired, it’s even more critical for those people because they’re not going to benefit if you go think about a personal balance sheet, they’re not going to benefit from wage inflation, right, because they’re out of the labor market.

Nancy Davis (08:09):
So they’re just going to have a higher cost of living and that pool of savings with whatever investments are inside of it are going to have to, you don’t want to outlive your wealth and inflation is one way, especially if you have fixed income and interest rates are moving higher, you can look at some government bond funds have lost way more in price terms than US equities. And that’s especially hard for retirees because they think they’re being more safe by having less equity exposure but they’ve actually lost more than if they did have more risky portfolios.

Nancy Davis (08:44):
So just, I think people are overthinking about whether it’s going to continue or not. I don’t think it really matters. And I do think it’s a really important thing to stress that future inflation expectations are really not very high right now. Even though realize inflation is at 40 or highs, whether you say it’s nine or eight and a half or eight, even seven, it’s still high, but future inflation expectations are priced very low and that’s because the market thinks the FED hiking policy rates is going to ease inflation in the future.

Nancy Davis (09:17):
So just like when you’re evaluating buying stocks, it’s not about what did the company do last time? It’s what is the multiple, what is the earnings estimate? Do they beat earnings? Do they miss earnings right now? Future inflation expectations are very cheap. They’re very much around the 2% symmetric target of the FED, even though realize inflation is so high.

Trey Lockerbie (09:42):
On that point. What if inflation has actually peaked? And what do you think about this, I would say disconnect between what the markets are saying in the actual economy because there’s some alarming data points in the headlines like Redfin reporting mortgage rates nearly doubling from last year USA Today reported more than 20 million US households are behind on their utility bills, retailer inventory [inaudible 00:10:07] from Walmart and others. I mean, there’s this ominous sentiment out there with the actual economy. Do you think there’s further to fall or is consensus just playing into its typical fearful bias?

Nancy Davis (10:18):
I think there are a lot of risk out there. I mean, inflation is raging. We have a lot of whether it’s droughts or geopolitical tensions or consumer sentiment being at all time low. I think the problem is also the labor market is that it’s really hard to hire people, even though people have added more employees, their productivity is down.

Nancy Davis (10:41):
So it’s a really tough time for small businesses in particular and I think people really should be adding in things that are more defensive to their portfolio in my opinion, because we just don’t know what the future holds. We don’t know if the FED hiking policy rates is going to do anything to stop inflation and right now the rates markets are priced that future inflation is going to slow dramatically.

Trey Lockerbie (11:08):
You mentioned earlier the FED’s balance sheet and I’ve actually heard you refer to it as the elephant in the room. Given the market has been absorbing these rate hikes, do you think the FED will get more aggressive with offloading its balance sheet, and if they were to do that, what exactly would be the steps you think they would take?

Nancy Davis (11:24):
Well, the FED has been very delicate so far. They put in place these caps that’s probably because the last time they tried to do balance sheet unwind, they totally blew up the market so they’re being very delicate with their steps this time. The FED’s caps are going to increase in September, so I think it’ll be really interesting tomorrow with Jackson Hole and the press conference to see if the FED talks more about maybe not holding mortgages on their balance sheet. They’ve alluded to that in the past.

Nancy Davis (11:55):
It’s really important that investors look inside their fixed income portfolio, especially things that are core fixed income because so much of the market has moved into indexing and there’s nothing wrong with indexing but when you have a lot of these core fixed income managers, it tends to be that a third of their exposure is mortgages, and mortgages very simply, if you think about it, homeowners are on the option to prepay. So owners of financial mortgages are short options to homeowners and whenever your short options, your short volatility.

Nancy Davis (12:33):
So most people, I don’t think really realize it, but within their fixed income portfolio, they tend to be short, fixed income volatility. So it’s super important to see if you have things called a core fixed income. They tend to be benchmarked to the AGG Index and the AGG Index is just, it’s old, it used to be the Lehman AGG and then it was the Barclays AGG and now it’s called the Bloomberg AGG, but it was created before the US Treasury invented the inflation protected market so it has no inflation protected bonds in the AGG, which is not very core to me if you have no inflation protection and it tends to only have short volatility because about a third of the AGG is mortgages.

Nancy Davis (13:17):
So I think it’s just super important to be mindful of what you own and don’t go by the strategy’s name, really see what’s inside your portfolio and where your risks are.

Trey Lockerbie (13:28):
Jim Kramer came out today saying he thinks the market’s going to be flat after this weekend. In my opinion, that’s kind of shorting the volatility, if you will, which you were just kind of saying. Anything he says, it gives me a little bit of pause, but I’m curious when you talk about owning options or shorting options being shorting volatility, can you talk a little bit more about that and what you mean by it?

Nancy Davis (13:47):
Yeah. So anytime you sell an option, you’re actually selling volatility. Whenever you buy an option, you’re buying volatility. So volatility and options go hand in hand because volatility goes into pricing option. Derivatives, they’re two main types of derivatives or linear derivatives, which go up a dollar, down a dollar, which is futures or forwards or swaps. And those are typically, I think of them as credit card exposure, where you get more exposure than what you pay for. And they go up a dollar, down a dollar.

Nancy Davis (14:23):
The options markets are non-linear derivatives so they don’t have that same linear payout. They have asymmetrically payouts. They can have asymmetrically positive payouts or asymmetrically negative payouts. When you sell options, you’re selling volatility and that’s the thing that I’m trying to stress to investors who have things like the AGG Index is you are embedded short volatility, specifically fixed income ball with that exposure because homeowners are on the option to prepay and owners of the financial mortgages are short options to homeowners. And whenever you’re short options, you’re short ball.

Trey Lockerbie (15:03):
Interesting. I find it a little ironic that we’re entering this phase of tightening, but our current administration has just put policies in place to spend more to combat inflation and to forgive some student debt, which is essentially in my opinion, a form of UBI or say a STMI check, if you will. I recently read someone even implied that this was even a form of moving the private debt of the FED to the public and because they know they’re starting to realize that repaying the debt they have would basically resort to hyper inflation, what is your non-political but general take on the effect of these current policies that are starting to play out.

Nancy Davis (15:43):
It’s tough to say. I mean, obviously a lot of people are hurting right now because of inflation. The cost of living is much higher. It’s really hurting consumer confidence. It’s hurting small businesses. I think all of these policies are well meaning, but it creates more of a wealth gap because think about the people who maybe didn’t go to college because they couldn’t afford it.

Nancy Davis (16:08):
Now, those taxpayers who might be working at X, Y, Z, whatever industry they are, their taxes are going to relieve the debts of other people. So it’s I think well-meaning policy, but it can have ramifications that aren’t necessarily fair. Now nobody said life is fair, but I think that’s one thing I always think about is when you give debt forgiveness, you’re basically encouraging and rewarding those people who took on the debt to begin with.

Trey Lockerbie (16:38):
And I wonder if colleges will just hike their prices $10,000. We’ll see what happens. What are some of your main concerns on the supply side? You mentioned the labor market is tight and supply chains still seem to be pretty chaotic is a supply side recession on the horizon and what would happen in your opinion, if we did start to see unemployment start ticking up?

Nancy Davis (17:00):
That could be the stagflationary outcome. Stagflation is a made up word from the ’70s when you had lower growth and higher prices, a combination of both at the same time and you really can’t roll that out, especially so far in 2022, we’ve had stocks and bonds sell off together. We’ve had two negative GEP prints, whether that’s recession or not, I’m not going to go there, but we’ve had lower growth and higher prices. And so I think that’s one of the things that investors just have to be careful of is not trying to make a bet about what outcome or what regime we’re going to have in the future, but just being really diversifying to be prepared for a lot of different outcomes because nobody really knows if inflation is not a US only thing it’s very much the entire world is feeling inflation.

Nancy Davis (17:53):
I feel very fortunate every day to be a citizen of this country and to have clean water and food. And we can feed ourselves as a country. They’re horrible things happening around the world with inflation and drought and starvation and famine, and it’s a really tough environment. So I think it’s just really important to whatever your view is about the outcome just make sure you have diversification in your portfolio. So you’re not betting for one specific whether the FED hikes 50 or 75 basis points. It doesn’t matter. We’re not day trading the number of FED hikes here. We’re thinking about how to plan for our retirement, how to have enough, not outlive our savings, how to have good productive lives. That’s what it’s all about.

Trey Lockerbie (18:44):
You mentioned bonds and stocks selling off at the same time. Is that in your opinion, just a symptom of the stagflationary type of environment or is the correlation between stocks and bonds a thing of the past.

Nancy Davis (18:57):
It’s unclear. I think that the problem with correlations is they can change, right? Correlations are just looking at what happened in the past and there’s no guarantee that things are going to continue. A lot of these model portfolios, like a 60/40 portfolio, which has typically 60% equities and 40% bonds, that assumption is that stocks and bonds are not going to become correlated.

Nancy Davis (19:20):
If they do become correlated the whole portfolio construction doesn’t really work and so I think that’s where you should be looking at other things that can potentially help diversify that traditional 60/40 portfolio, because we just don’t know what kind of outcome we’re going to have.

Trey Lockerbie (19:37):
I’m kind of curious what indicators you pay most attention to. Let’s talk about the yield curve and start there, whether it’s the 10 year, two year, or 10 year, three month, but just in general, when you’re looking at the environment, especially around treasuries, what indicators are you paying most attention to?

Nancy Davis (19:55):
So I really like looking at the interest rate markets, as you mentioned, Trey, I think it’s a very simple way to look at what the market expects in the future. The FED just like any central bank in any country sets a policy rate. That’s the overnight lending rate. That’s a FED fund futures rate in our country.

Nancy Davis (20:15):
So currently it’s 2.25 to 2.50 is the band. But where interest rates are at different points of time is the term premium interest rates and that’s where lenders lend money. I think it goes down to the value of money and what it costs to borrow money. Right now, the yield curve is fully inverted, meaning you can actually get paid more yield to own a short dated bond than you can, a long dated bond. And that’s really weird if you take a step back and you’re like, if you’re lending me money Trey, and I say, can I borrow $1,000 and I’ll give you say 3%, right? Let’s say 3%. And I say actually, instead of borrowing money for a week, can I borrow money for 10 years? And you would say, okay, I’ll charge you less to give you that loan.

Nancy Davis (21:04):
That doesn’t make a lot of sense. So it’s a very unusual environment right now where we have this inverted yield curve. It’s not something that it’s really, I think a reflection of the rates market saying that the FED is going to hike policy rates and that’s a policy mistake and that’s going to slow growth. I’m not saying that’s right, but that’s what’s priced it.

Trey Lockerbie (21:28):
Let’s talk a little bit about that because to your point, the yield curve, these bonds are experiencing negative convexity. It would seem, and you are an expert on convexity. So I’d love if you could just explain to the audience myself, like we’re five, maybe about what exactly convexity is and the implications of when a bond is experiencing negative complexity.

Nancy Davis (21:50):
So all that means is how sensitive. So with a mortgage, a mortgage is often considered negatively comebacks because homeowners are on the option. So you can think of convexity as a way of thinking about how your payoff is. So it’s very important for looking at, in fixed income exposures to have things that are not only short optionality and something that’s positively convex.

Nancy Davis (22:16):
Most investors only have negative convexity in their bond portfolio. It’s a complicated concept, but it has to go down to the payoff. If your payoff is positive, meaning you can make more than you can lose that’s positively convex, or if you could lose more than you can make, that’s negatively convex in a simple way.

Trey Lockerbie (22:36):
So in a time like this, when you are seeing inflation near 40 year highs and interest rates are around 3%, how do you play the potential normalization that may occur?

Nancy Davis (22:47):
Yeah, so we created a fund, Access That Market. It’s something that was previously something that most people couldn’t access on their own because it’s the interest rate market. It’s more of a traditionally institutional market. Most, whether it’s a corporate or sovereign around the world, whenever an issue or a bond issue, or somebody sells bonds in US dollars, they go and hedge their interest rate risk. They don’t sit there and say, oh geez, we hope the FED doesn’t hike rates, they immediately go hedge their exposure in the interest rate market.

Nancy Davis (23:21):
So I think it’s surprising to a lot of people, but the interest rate markets are huge. They’re approximately five times larger than the US stock market. It’s a huge big market because think of every sovereign in the world, whether it’s the ECB, Japan, the Kingdom of Saudi Arabia, whether it’s global corporate AstraZeneca, Sony, everybody sells bonds in the world and so it’s a huge market is interest rate.

Trey Lockerbie (23:49):
That’s really interesting. I mean, my only real experience with volatility or trading around it is around the VIX. And that seems to just have a negative trend forever because the stock market goes up 75% of the time, roughly. So there’s going to be those pockets where it performs really well, but trying to time that seems very hard to do. And I did see this chart the other day, it’s a little ominous where the VIX is kind of tracking almost perfectly to these 2008 levels and within maybe a few more months, there’s this huge spike from the 2008 chart and it kind of looks like we’re heading that way. So is something like volatility, something you advise people to take a position on around this time, just given the current environment and the risks that are in play.

Nancy Davis (24:33):
I’m not trying to give financial advice about speculating on the level of volatility. The thing I want to educate people on is most it’s not equity volatility that you should be worried about. It’s actually fixed income ball because most people are short, fixed income ball inside their bond portfolio. And that’s the negative convexity and positive convexity is something that I think is very good to have as part of a diversified bond exposure.

Nancy Davis (24:58):
What that means with positive convexity is when you make money and that instrument moves in your favor, you make even more so it grows exponentially positive. Most people are only short fixed income volatility because of their mortgage risk and I think it’s especially dangerous time to have that exposure moving into even more quantitative tightening and September with the caps increasing, that can be vol increasing. We’ve seen interest rate volatility move higher, whereas equity volatility has not moved higher this year and I think it’s really a trend that who knows whether it’s going to continue, but with quantitative easing, it was very fixed income volatility reducing.

Nancy Davis (25:41):
So it’s logical to say with quantitative tightening that it will probably increase the level. Just think about it if you don’t have that everyday big buyer in the market, it would seem like volatility would increase especially if the FED does start to maybe sell some of their balance sheet, like they’ve talked about selling mortgages or not owning mortgages long term on the balance sheet.

Nancy Davis (26:03):
So a long option is positive convexity, so just to go back to that concept again, that means if the underlier moves say 1%, you won’t make 1% like a linear derivative you might make 0.5, which would be at the money option, but if it moves another 1%, you make more than that 0.5. It has that positive payout.

Nancy Davis (26:27):
As the asset class moves, you can make more than you can potentially lose, whereas negative convexity is the opposite. So when you start to make money, the next step is you make less.

Trey Lockerbie (26:40):
TIPS seem to be so irrelevant for so long that I think some people have kind of forgotten they exist. Are TIPS something retail investors should seriously consider at a time like this.

Nancy Davis (26:51):
I’m not sure about retail investors. Some retail investors might prefer there is an inflation, a different type of inflation protected bond, but it’s limited to $10,000. So I think it depends on how much money, if you have less than $10,000, it might be better to use that other inflation protected bond.

Nancy Davis (27:09):
TIPS are Treasury Inflation-Protected Securities, that’s Treasury Inflation-Protected Securities. That’s the acronym for TIPS. So they are treasury bonds, but they reset with the level of CPI, which is a consumer price index. So it’s a relatively new market. A lot of people look at commodities to add inflation protection to their portfolio because they existed in the 1970s.

Nancy Davis (27:34):
I think the thing to keep in mind about TIPS is they were only invented by the US Treasury in 1997, so they’re relatively new instruments and a lot of investors just don’t have them because they’re not part of those passive benchmarks, whether it’s a active fund or a passive fund, most fixed income funds are benchmark to the AGG Index. And the AGG Index was created before TIPS and they’re no inflation protected bonds in the AGG and it’s only that negative convexity from mortgages.

Nancy Davis (28:07):
So it’s just important to know what you own inside the portfolio and don’t go by just because it says core fixed income. It might not be as diversified as you actually think.

Trey Lockerbie (28:18):
What you’re referring to right there, I would say is something like the AGG Index and so a lot of folks, whether it’s the AGG or something else are very bullish on passive ETFs, what are some of your observations around passive ETFs and you mentioned the mortgage risk. What are some other risks about around just holding passive ETFs?

Nancy Davis (28:35):
I think the problem is just, there’s nothing wrong with passive strategies. In the case of the AGG, there’s no inflation protection in it at all. It’s only short volatility because about a third is US mortgages and so I think it’s just, you can have your core holdings be passive indexes, but you want to also understand what they are so you can augment it based on your own personal risks.

Nancy Davis (29:02):
Many investors, I don’t think realize that the AGG is shortfall. And I don’t think a lot of people realize that the AGG has no inflation protection inside of it.

Trey Lockerbie (29:13):
So I noticed that your ETF IVOL is fairly uncorrelated to equities and even the AGG Index, what explains the lack of correlation here?

Nancy Davis (29:23):
It’s something different, nothing in IVOL is in the AGG. So it’s logical, again correlations are historical. So there’s no guarantee that it will continue to be non-correlated, but at least what it has inside of it, which is about 80% of the fund is in TIPS, which is a type of treasury bond and then it has exposure to the interest rate markets. And that’s not in the AGG so it’s logical that it wouldn’t be correlated to the AGG because it’s something different.

Trey Lockerbie (29:55):
So here’s a fun question in your world, your expertise, what are the things that people should understand about volatility markets themselves?

Nancy Davis (30:03):
So anytime somebody talks about a volatility market, they’re talking about a options market, it’s sort of like, do you use a Kleenex to wipe your nose or do you use a tissue? It’s really the same thing. So in order to have a volatility market, you have to have a options market because volatility goes into pricing options.

Nancy Davis (30:21):
So I think it sounds like a very complicated thing, but it just means non-linear derivatives, which are options. Most people have linear derivatives inside of their bond funds, whether it’s a future or a swap or forward, all of those go up a dollar, down a dollar and their linear derivatives. Options are non-linear derivatives that use volatility to go to pricey options therefore their ball markets.

Trey Lockerbie (30:48):
I think a lot of people think about volatility maybe on the downside, maybe not so much on the upside, but with your strategies, are you making money on whichever way the market’s going in that way? The volatility market?

Nancy Davis (31:00):
Yeah. So you’re right. People use volatility to talk about the historical standard deviation of returns. So there’s volatility, what I’m talking about is its own asset class. It’s like what is in the options market. And so for our strategies, they’re all long volatility, meaning we own options and when you’re long volatility, you can actually profit from higher volatility.

Nancy Davis (31:23):
So it’s like owning, there’s realized volatility, which is what’s happening previously and then there’s implied volatility, which is what’s happening in the future. So we own options therefore we are long fixed income volatility. It’s not the VIX. The VIX is equity volatility. In fact, it’s one specific index for equity volatility. There are lots of different types of volatility, any place that there is an options market, there’s a ball market.

Nancy Davis (31:50):
And I think that’s what I keep going back to the core fixed income or the AGG. Most people are only short fixed income volatility in their bond portfolio, which I think is part of our thing, standing on our sum box, trying to educate investors is that you have to understand your bond portfolio is probably short volatility and you might want to do something to help at least neutralize that without taking a bet that fixed income ball is going to fall, right? Because when you’re short volatility, you’re betting that fixed income volatility is going to go down. It might not be going down anymore, especially with GT starting in a bigger way.

Trey Lockerbie (32:30):
I think I’m getting a sense of maybe why you started the IVOL ETF, just to that point, educating people, getting this trade in place, if you will, that people seem to be missing, which is again, a little hard to wrap your head around, but I’m interested in how you’ve pivoted your career into this ETF business and what kind of drove you to get it up and running.

Nancy Davis (32:51):
So I started my career at Goldman in the late ’90s and it was right when the US Treasury invented this TIPS market, the Treasury Inflation-Protected Securities, and I remember being a young trader and just thinking that makes no sense, TIPS are bonds so they are treasury bonds and they will lose money when interest rates go higher based on their duration risk.

Nancy Davis (33:15):
So I was like, that’s not necessarily the best way to be thinking about hedging inflation with a product that will lose money when based on their duration exposure. So I wanted to solve, instead of many investors use short duration when they’re worried about interest rates going higher, they buy short duration, but I feel like that strategy, it’s almost like a fake name, because it’s not short anything. It really should be called less long because anytime you have a bond it’s long duration.

Nancy Davis (33:45):
It’s just a question of how long duration it is. So I wanted to create a product that could actually benefit from long dated yields going higher, which is when the TIPS will lose money based on their duration but I also wanted to give investors exposure to have a positive convexity fixed income fund instead of just being short convexity with mortgages and inflation is really a risk on asset class. So that’s why we like using fully funded options because A, we’re long fixed income volatility and B, inflation is not buying a stock. It doesn’t have zero. It could go below zero. It’s a very risk on asset class. You can lose quite a bit of money in inflation, whether it’s commodities, oil went negative during the pandemic, inflation tends to fall when equities sell off and so I like using the long fixed income volatility is a way of potentially reducing the volatility of TIPS by themselves.

Trey Lockerbie (34:43):
We’ve seen the yield curve invert a few times this year, you mentioned it’s fully inverted right now. You were quoted a year ago talking about the stagflation environment, very early. I’m kind of curious what were the signs even before the yield curve that you were maybe looking at to make such a call like that?

Nancy Davis (35:01):
I think it’s the old thinking about 60/40 portfolios that concerned me because it was like, look, if we have stagflation that is going to make stocks and bonds sell off together and I think a lot of people count on that traditional 60/40 portfolio to be diversifying.

Nancy Davis (35:19):
The whole point of asset allocation is to not lose money on everything all at once. And that’s exactly what’s happened in 2022. So something again, I always think correlations are just that’s history. It’s happened in the past and there’s no guarantee that correlations will continue to behave the way they have historically and I think the stagflationary environment is especially dangerous for the 60/40 portfolio and I just wanted to alert investors to that risk and obviously nobody wants stagflation, but it’s unfortunately really played out for a lot of investors this year with stocks and bonds selling off together.

Trey Lockerbie (35:59):
With the inflation where it is, I think traditional thinking leads you to think part assets, right? Real estate, you mentioned some risk around that because you’re short the volatility, but I’m kind of curious what your opinion is on hard assets in general, during a time like this as a, either hedge of to inflation or a safe haven, however you want to call it. But just generally speaking, is there anything in the hard asset realm that you would potentially consider for a portfolio?

Nancy Davis (36:25):
I mean, I think most people have exposure to real estate, whether they own homes or whether they’re renters, they have a step in the hard asset, we all need a place to live. So I think most people have that in their exposure. I think commodities are used a lot for inflation because they existed in the ’70s, whereas the inflation protected bond markets, the inflation markets didn’t even exist back then. So I think a lot of people are not looking at inflation or interest rates for that explosion exposure because it’s newer, it’s a newer market. The interest rate derivative markets didn’t really even start until the 2000s.

Nancy Davis (37:08):
So I think it’s just important to be focused on diversification and commodities are fine and real estate is fine, but you might want to think about other things as well because we just don’t know what’s around the corner and I think it’s especially important for people who are retired because they’re not going to be benefiting from wage inflation because they’re not in the labor market anymore and they probably have more of an allocation to fixed income so they’re even more at risk that inflation turns out to be not something that’s falling, which is what’s priced in right now. The inflation markets are pretty complacent right now that the FED hiking policy rates and being as hawkish as they have been, will slow inflation and it’s priced in.

Trey Lockerbie (37:57):
Now I’ve heard you talk about oil is similar to gold as sort of a technology and they’re easier and easier to come by because technology, it gets better over time and it’s easier to access these resources, but there’s a lot of narrative out there that would say otherwise.

Trey Lockerbie (38:12):
For example, OPEC seems to be hitting capacity. There hasn’t been much investment in new oil drills or rigs over the last five years and Warren buffet has even come out really strong on this bet being bullish, oil it would seem with his consistent investments in now Chevron, but also Occidental and it just increased his potential position to 50%.

Trey Lockerbie (38:34):
I’m kind of curious when you see that stuff playing out in the headlines, does it make you rethink where inflation might be able to go from here, just given oil, being such a big driver of it?

Nancy Davis (38:45):
Yeah. I mean oil is a huge driver because the infrastructure is not there around the world. Also the geopolitical situation in Europe is creating the real problems in the energy space. So I’m not saying those are bad investments. It’s just commodities are not the only way to think about inflation. That’s my point. I’m not saying don’t have commodities in your portfolio. Don’t have energy stocks in your portfolio. Those are fine but just like anything else you don’t want to plan on that alone working. It’s just what everybody has been running to because that’s what worked in the ’70s and that’s the only period of high inflation that we have to look at and I think going forward, when people look back and they look at TIPS, which are the Treasury Inflation-Protected Securities markets, they’re going to be disappointed in my opinion, because I don’t think TIPS will really provide that inflation protection because of their duration exposure.

Nancy Davis (39:43):
And that’s where IVOL tries to help to say, look, we’re going to give you another measure of inflation, which is interest rate where lenders lend money, which is currently inverted, that inverted market plus access to fixed income long volatility instead of just being short volatility.

Nancy Davis (40:02):
So it’s just something different. I’m not saying you don’t want to have everything being the same way and you don’t want to have everything as one bet. So I think oil 20 years from now, let’s just put that if you’re say you’re 70, right? Reasonable to expect you only have 20 years left in your life so maybe oil is fine for people like Warren Buffet, but say you’re 22 and you want to have inflation in your portfolio, oil might not be the best long-term holding because eventually there will be infrastructure built out and eventually there will be a way more supply will come online.

Nancy Davis (40:42):
Maybe OPEC will break, it is a oligopoly, right? It’s a pricing cartel. So you just don’t know what’s around the corner so I’m not saying energy is a bad thing to have in your portfolio. It just might not be only thing that you should have to express inflation.

Trey Lockerbie (41:00):
Thank you for the clarification and it’s an interesting point because commodities are, and they’ve been a great trade over the last couple of years, but they’re getting to near all time highs is what seems so depending on the commodity itself, I’m kind of getting a better idea of where IVOL fits into a portfolio because I’m trying to get a feel for that here, because it seems like it’s this hedge almost in a lot of ways, which I would think would be somewhat of a small position in a portfolio. So in the 60/40 kind of going away commodities, maybe not being a focus, equities seem to have a lot of risk. So I’m just trying to get a feel for where retail investors should really, I guess wait, and it’s not financial advice, but just which assets given the current environment are going in your opinion to perform the best, I guess say over the next 10 years?

Nancy Davis (41:46):
I mean, I would say a lot of people, the way that they’re using IVOL is to complete their core fixed income. So if they have, let’s just say $100 allocated to the AGG Index, the AGG has no inflation protected bonds. It’s only short volatility, they might say, all right, we’ll take a third of that exposure and add IVOL to make it a more complete, a more diversified portfolio by adding inflation expectations in the future, adding long volatility to neutralize a short ball in mortgages to help diversify the portfolio.

Nancy Davis (42:24):
So I think most people are using it, not as a bet, so to speak, but more as a diversifying completion portfolio.

Trey Lockerbie (42:33):
Another interesting point about IVOL I’m seeing is that it’s got this distribution that I find to be somewhat uncommon. What’s driving your ability to give those coupon payments out to investors.

Nancy Davis (42:45):
So IVOL has paid a minimum monthly distribution of 30 basis points since July, 2019. So we’ve paid 30 basis points minimum every month for the past three plus years, that is a different type of most investors to augment government bonds. They take credit spread risk. So to whether it’s high yield, investment grade, levered loans, splitting rate notes, all those things are taking corporate credit spread risk.

Nancy Davis (43:15):
We don’t take corporate credit spread risk. We take interest rate spread risk. So it’s just something different. Also TIPS CTFs often don’t pay monthly distributions because TIPS are variable yield product. They reset with the consumer price index. So you can look at the monthly distribution on TIPS in 2020, there was no distribution paid out for most TIPS CTFs until September or October so you had the bulk of the year with no monthly distribution. IVOLs had more of a steady monthly distribution that is potentially enhanced above TIPS alone.

Trey Lockerbie (43:56):
One last clarification around the duration of bonds. Can you just walk the audience through how the durations change or how people position themselves differently based on the interest rate volatility?

Nancy Davis (44:07):
Yeah, so duration, very simply all bonds are long duration, even a shorter dated bond is still long duration. So short duration really should, in my opinion, be called less long duration and duration is the bonds sensitivity to a one basis might change in interest rates. So if interest rates move higher, bonds lose money in price terms.

Nancy Davis (44:31):
So for instance, you can look at any of the treasury or investment grade or high yield or muni, or pretty much all bonds are down this year in 2022 and most of the losses have been from higher interest rate. Credit spreads have widened a little bit, but not very much. It’s mostly from rates. And so I think it’s just really important for investors to understand that all bonds are long duration and when interest rates move higher, traditional bonds will lose money.

Nancy Davis (45:03):
IVOL has a way to profit from either lower front dated yields or higher, long dated yields. So the treasuries that we own are just bonds. So they want real yields lower because they’re bonds, which means prices higher, but the options inside of it don’t really care about the level of interest rates so if interest rates were say 4% or 10% or 1%, it doesn’t really matter to the options. The options just want the spread between short and long date rates to widen. So it’s just a different type of spread risk instead of only using corporate credit spread risk inside of bond portfolios.

Trey Lockerbie (45:45):
Okay, Nancy. So before I let you go, and first of all, thank you so much for this education. Something that I’ve been trying to learn a lot more about, before I let you go, though, I’d like to give you the opportunity to hand off to our audience where they can follow along with what you’re up to, your ETF IVOL, and any other resources you want to share.

Nancy Davis (46:02):
Sure. So we have a fund website, which is ivoletf.com where investors can see our prospectus and our SAI, our materials are there as well under the materials tab, like our fact sheet and that’s a good use. I’m recently new to Twitter. I just joined Twitter about three months ago. So I have, I guess it’s like a bot hashtag because I did a double underscore, but you can follow me @Nancy__Davis at Twitter. I also use LinkedIn and our website also has a contact us page so if you want to be added to our distribution list to receive our quarterly letters or any materials that we send out, you can sign up on the ivoletf.com website.

Trey Lockerbie (46:51):
Well, Nancy you’ve opened my eyes to how the markets are pricing in these FED actions and I’m really eager to see what happens next so I would love to have you come back on after the dust settles maybe in the next few months and we have more insight as to what the FED is currently thinking.

Trey Lockerbie (47:06):
So Nancy, once again, thank you for coming on the show. We appreciate it.

Nancy Davis (47:10):
Thank you, Trey. Thanks so much for having me on it was great to have this discussion today. I hope it was helpful to your audience.

Trey Lockerbie (47:17):
All right, everybody. That’s all we had for you this week. If you’re loving the show, don’t forget to follow us on your favorite podcast app and if you’d be so kind, please leave us a review. It really helps the show. If you want to reach out directly, you can find me on Twitter @TreyLockerbie and don’t forget to check out all of the amazing resources we’ve built for you theinvestorspodcast.com. You can also simply Google TIP finance, and it should pop right up and with that, we’ll see you again next time.

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Outro (47:56):
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