Karen Watkin
Welcome to AB's Alpha Females, the Multi-Asset Investment Podcast from AllianceBernstein. I'm Karen Watkin and I'm a fund manager in the Multi Asset Solutions team here at AB. The Alpha females are those women who have developed unique areas of expertise and made their mark in the investment industry. For many clients, generating income from their investments is a priority. But market conditions are very different now from those that we've had over the past decade’s decade. So, taking a flexible approach to income and getting original and informed perspectives to investing is more important than ever. In this series, my guests, the Alpha Females share their expert insights on the key questions for investors, such as how does the shifting economic picture affect the markets? Why can emerging markets provide rich pickings when looking for income? And how should we invest over the long term to have a fruitful retirement? They'll also be telling me about their career journeys, the challenges they've faced and the lessons they've learned along the way. Only when the tide goes out do you discover who's been swimming naked, warned the legendary investor Warren Buffett. In other words, chasing the highest returns blindly can leave you dangerously exposed when the economic tide goes out. So, is it possible to earn high levels of investment income without sinking under risk? This is where the idea of efficient income comes in. It's income that offers the greatest yield when set against the level of risk. To achieve this, investors must broaden their horizons globally and across asset types when navigating a course in pursuit of higher levels of income. There's a whole ocean of income opportunities out corporate bonds, emerging market debt, mortgage securities and more. And spreading our income investments out increases the chances of putting wins in the sales of our portfolios. To further carry the nautical analogy, it's also important to make sure the boat is balanced and is carrying stable assets like government bonds as ballast alongside higher yielding but unpredictable investments like corporate credit. This balance helps if or when choppy economic waters hit. To help explain what efficient income really means in practice and why it's crucial for investors today I'm joined by Sonam Leki Dorji. Sonam is a Senior Vice President and Portfolio Manager at AllianceBernstein, overseeing high income fixed income strategies. She's an engineer-turned investor with 20 years of experience and she specializes in finding that sweet spot where income is high, but risk is kept in check. Over her career, Sonam has built interest rate models, navigated global bond markets and now manages multi-sector income portfolios. So, she truly knows how to hunt for yield in safe waters. Sonam, welcome to the podcast.
Sonam Leki Dorji
Hi Karen, very happy to be here.
Karen Watkin
Thank you. So, I hope I didn't overdo the nautical analogy in the introduction, but I think it serves to illustrate just the amount of complexity that we need to navigate when we're looking for income and investments. And I think while we all understand there's this basic kind of balance between risk and reward; I'm really interested to hear from you how that translates to high yielding investments in particular and what this idea of efficient income really means. Can you tell me a bit more about that?
Sonam Leki Dorji
Sure. First of all, I think the analogy was perfect. It brings to light how we actually think about investing in the high-income space, specifically in fixed income. And I especially liked the way you talked about interest rates sort of being a ballast. We do think very carefully about how we balance our portfolio risk and interest rate exposure tends to be the way that we do it. You know, going, going to your first question in talking about high yield specifically and what we, what we mean by efficient income there. If you think about the high yield space at the very top level, at the index level, you think that they are pretty high yields. However, if you delve a little bit deeper and look at the credit ratings across within the high yield space, you have the double Bs, the single Bs and the triple Cs. The highest yielding part of that market is a triple C part of the market. However, if you look at the default rates, historically close to 80% of all the defaults that happen in the high yield market happens within the triple C space. So, when you're talking about high yield investments, you do much better if you focus your investments on the higher quality side and avoid the Triple Cs because you want to harvest the efficient income, if you will, while avoiding the tail risk. And the downside, as you alluded to when you were talking about introducing the subject, you talked about when markets get choppy and you want to avoid the deep tails. So, to answer your question, what do we mean by efficient income when we think about structuring our portfolios? It's that it's getting the better risk adjusted returns and avoiding the tail.
Karen Watkin
Tell me how you think about those tail risks and what they look like in practice.
Sonam Leki Dorji
So, when you think about the volatility of asset classes, what that means is you're looking at average changes in the returns over a long period of time. When we're talking about tail risk, we're talking about the events that don't happen very often but have very, very outsized impacts to your returns. If you are not cognizant of that tail risk, the deep tail, you're going to set up your portfolios for a very large drawdown, say for example, when Covid hit or the 2008 global financial crisis. And that is very hard to recover from. The other way to think about it is if you think about volatility, it doesn't differentiate between positive returns or negative returns. You don't care as much about the positive returns, but you do care a lot about when you have deep negative returns. So as we're structuring our portfolio, we think about not just the volatility, which helps you to look at better risk adjusted returns across a lot of asset classes, but at the same time you also want to look at in the detail how does that asset class perform, how does it relate to other assets that, that you have in your portfolio as well?
Karen Watkin
And you mentioned Covid there as a good example of where we saw big tail risks across the market. And I think particularly in some of those higher yielding assets, we saw them experience some really deep tails through that period. Can you explain to me why perhaps it's the higher yielding parts of the market that can often come with those more negative drawdowns when we kind of hit crisis periods? And how do you think about navigating that as a, as an income investor?
Sonam Leki Dorji
Sure. So, if you think about the various ratings, the double B, the single B, the triple C, the triple C, part of the market tends to be focused on companies that are usually more riskier, have higher leverages, have higher interest rates that they have to pay back. And so, when you have these detail events, they are the first ones to get impacted. They are the first ones that maybe go out of business and won't be able to give you your money back. If you think about the securitized world there as well, the lower rating or the lower quality part of the market, they tend to be the ones to take the first losses. And as a result, what ends up happening is the low-quality part of the market tends to be the first ones that actually take huge losses.
Karen Watkin
So, you're getting a little bit more upside but taking on a lot more downside risk.
Sonam Leki Dorji
Exactly.
Karen Watkin
So how do you think about building a robust kind of long-term strategic mix across those high-income assets to start with?
Sonam Leki Dorji
I think on a strategic allocation across these asset classes, the key tenets of investing across in a multi sector framework for us is one, diversification. And you can think of diversification as diversification across different sectors. But even within those sectors, diversification across each issuers. The other part is when you think about the high-level sector, multi sector gives you a very broad set of investment choices you can take. And that gives us the luxury of then allocating to the best risk-adjusted parts of the market, including being cognizant of the tail risk across these asset classes. And then the third piece of it is you have to be nimble. It's not a set it and forget it. At the end of the day what you do need to do is as market moves, there are opportunities that presents itself even within the high yield space. We say we avoid Triple Cs for example, but at some point, the valuations will get interesting with depth of fundamental analysis. There are opportunities there as well which we can take at the high-level overall risk. The best example I think was when we had most recently Liberation Day and you had markets react very, very dramatically.
Sonam Leki Dorji
And for us to have a set of scenarios set up and for us to have a fundamental view, we are able to take advantages of these types of dislocations in the market.
Karen Watkin
So, you mentioned there being diversified and that you take this multi sector approach and the fact that you can take this really broad perspective. Can you give me a brief overview about the breadth of what you look at when you're trying to find attractive high-income assets?
Sonam Leki Dorji
Sure. So, to sort of broadly outline the universe that we see in terms of our asset classes. On the credit side there is high yield, both US and global, there is investment grade credit, both US and global. There is emerging market bonds on the corporate side, but also on the government side. And then on top of that you have the securitized asset class, which is broad, very broad. Right. That's on the credit side. Now if you think about the duration side then there's high level duration, there is US duration, there's generally global duration, whether you think about Germany, the UK, et cetera. So being in this seat, we do have exposure and the ability to invest across a lot of different asset classes. The third piece, which we don't do as often is effects as well.
Karen Watkin
So, when you're looking across such a broad investment universe, how do you filter through all the information that you must need to consider?
Sonam Leki Dorji
So therein lies, I guess, both the interesting aspects of this role and the challenging parts of this role. First and foremost, it's again having a lens into the past and into the future. Into the past you're looking at best risk adjusted returns across all of these asset classes, making sure that you understand the tail risks at each of these contribute to your portfolio and then structuring a portfolio where you are happy with what your risk adjusted return looks like, your income looks like, and stress testing your portfolio to avoid significant drawdowns based off of history. Right. And then we rely on our overall fundamental view. What is the macro backdrop and how do we position for risk based off of that in that scenario as well? And then depth of both quantitative and fundamental analysis that helps us to leverage the tools, whether from a stress testing point of view, from a fundamental standpoint, sort of looking at the scenarios across how the analysts are looking forward based off of what they know today. And all of that helps us build resilient portfolios for the most part.
Karen Watkin
So, you mentioned there this idea of understanding what that macro backdrop looks like and the fundamental views that you need to build around that when you're thinking about your portfolio. We've obviously been through a period of pretty elevated volatility and some big changes in terms of what we're seeing in that macro backdrop, whether it's potential inflation or interest rates. Obviously, the impact of tariffs has been a big question for investors. How has that current environment shaped what you've been thinking about in terms of your investments over the last few months?
Sonam Leki Dorji
I think the biggest key is volatility here. There's a lot of uncertainty that has allowed us to take risk and duration back and forth based off of where valuations are. Having a fundamental view on the forward-looking market lets us be able to do that. Coming into Liberation Day, there was a lot of anxiety toward what the tariffs would do to the economy in the US and the impact more globally. And for us as portfolio managers coming into that, we were, I would say, at the tail end of our risk allocation. And the rationale for doing that was the valuations were not as attractive at that point. If you think about the high yield space specifically, and you were not being paid to take that kind of risk. However, we've had since then a complete revaluation, I guess twice. Right. You had huge sell-off and then we were able to add risk in that and then the rally back and we were able to take back risk. The reason why we were able to do that is as we were looking forward in say, early April, one of the things that we wanted to position the portfolios to be able to do was to have enough liquidity to be able to take advantage of the volatility. In terms of the fundamental changes, as you said in the macro backdrop, whether we think about where interest rates are today and inflation, starting with interest rates first of all, today, where they stand at the end of June, the all in yields in high yield space, for example, is over 8%. And usually that is very representative of what forward looking returns look like. From our perspective. That is actually a very significant and attractive return. On the inflation front. Inflation has been moderating for the most part. It is elevated and the expectation is that it probably settles higher than it has in the past. But if you think about looking forward, the inflation expectations are very, very well anchored. They haven't moved as significantly as you would have thought. And as a result, I think in terms of where we stand today, the efficient income universe, still, you know, the high yield space looks very attractive in all in yields. Even duration, which is your ballast, as you say, is no longer just a ballast. It is pretty significant in terms of what yield it provides and the room it has to rally if we were to hit a road bump down the road.
Karen Watkin
So, you're having to navigate all of that on the duration side of the portfolio as well. And as you said, it's certainly not kind of set. And forget you need to have this element of being nimble. Why do you think it's so important to have that flexibility and how do you look to kind of build that in ahead of time almost so that you can take advantage actually of volatility rather than it necessarily being a negative.
Sonam Leki Dorji
So, if you're reacting as the markets are moving, it is much harder to have a very clear idea of why you're doing things versus either fear or, or exuberance because of momentum. So, the way that we think about on the duration front is, as I alluded to earlier, you have some sense of where valuations make sense. You have your basis of why you think that is the case. And then as valuations move in your favour, you can either add, or if the valuations get less interesting, then you can reduce your positioning. That is much easier. Easier if you set up a framework and say, okay, these are the scenarios, and this is how I'm going to react and have a game plan. And then as that happens, you reevaluate why you thought that was the case. If all your reasons and your rationale still holds, then it is best to be disciplined and go ahead with what you set as your game plan. If that is no longer the case as new data comes in, then it's a higher hurdle. But you do question the foundation.
Karen Watkin
And so, I wonder if part of the way you think about that has been influenced at all by your background. I mentioned in the introduction that you started out as an engineer. And I just wonder if you see any echoes of engineering when you're thinking about your investment frameworks and building those.
Sonam Leki Dorji
Out 100%, I would say I still think like an engineer. And the reason I say that is for me, engineering is problem solving. It is trying to look at all the information and make some inference and some deduction and to create a solution that works. And that is what investing is as well. You're assimilating as much information as you can, being true to the data, but having some kind of forward-looking view as well. So that when you're creating a solution, you're really trying to solve for how do you build a resilient portfolio and how do you react and take advantage of in terms of creating a solution that adds more alpha. I mentioned data a little bit. I think having that engineering background, it makes you a lot more open to what the data is telling you.
Karen Watkin
As you think about data. Obviously, the amount of data and the speed of which we can get data today is vastly different to when you and I both started out in our careers. So how do you think that engineering background helps you deal with that?
Sonam Leki Dorji
The wealth of data is very, it's both empowering and overwhelming, as you said, right. To me, I think it's still a big advantage in being able to look at the data and to compute things and look at analysis so much more quickly than we could before. Having all of that at our fingertips actually really empowers us to look at what the data is telling us and then to have our own views versus spending all that time collecting the data, going through it. So, your focus is a lot more on what I think is the added value. And both data and technology help you to be able to do that better today than it did 15 or 20 years ago. But at the same time, it can be overwhelming. This analysis paralysis as we talk about and it is quite easy to get pulled into creating your own story. And that's where I think the discipline in staying honest and you know, like having intellectual honesty is very, very important. And as an engineer, you will understand when you are torturing the data to tell you what you wanted to say.
Karen Watkin
Yeah, I totally agree, and I think it's fascinating the way you bring that kind of engineering mindset to how you think about finance. I'm interested in what prompted you to make that move and what's kept you in investment for the last 20 years.
Sonam Leki Dorji
So, the way I happened into finance, it's a bit of an accident, you know, I was studying engineering. And at the time I assumed that was the role I was going to take. And you know, I started interviewing and had an offer to work for a large company. And as I sat and thought about how my day would ensue, I would be doing something, a very small piece of a large project without understanding, like, you know, how it impacts the broader product or even bigger. Right. And to me that was a little bit less interesting. And at the time, quants were in high demand on the hedge fund side and people were looking for people with engineering backgrounds that would help them build, you know, all of these trading strategies. And so, to me that was very interesting because I'd never actually done it. And I thought, well, you know, this is a great way to just explore and see if, you know, I do enjoy it. And that's how I first took my financial engineering job in finance out of engineering. And what I liked about it in general is there's no end to learning. And every day is sort of you come in with the challenge of you don't really know what's going to happen and you just have to figure it out. Right. And its problem solving continuously over a very long period of time and it doesn't get old. And so, from that perspective, I think that's the reason I've stayed. The other reason I think I stayed is because you have a lot more exposure too. It's not just about your portfolio, it's understanding the macro picture, it's understanding broadly what's happening globally. You have both the bird's eye view of understanding what is happening at the high level, and you have the detailed, like looking through all the details of what securities you're putting in your portfolio and understanding that at a different level.
Karen Watkin
So, before we wrap up Sonam, I want to just finish with what you think are the three key things that investors need to remember when they're looking for high levels of income.
Sonam Leki Dorji
The three key lessons to me it's one is diversification. Number one is diversification and diversification through sectors, diversification through securities and avoiding high concentrated, idiosyncratic risk. Number two is structuring your portfolio in a way that takes advantage of the best risk adjusted returns while avoiding the tails. And that's your example of whether it is a double B high yield or triple C high yield. And the third piece is being nimble. So, when you structure your portfolio, being nimble is, and how you achieve it is in several ways, right? One is having the liquidity and planning for that and to be able to take advantage of the liquidity and having game plans so that you are prepared and can have a well thought out plan and the ability to adapt. If things were to change and your foundation is different, the foundations of your belief have changed and therefore that sets you up to really take advantage of volatility and uncertainties in the market.
Karen Watkin
They're great lessons to take away with us. Sonam, thank you so much for sharing those and thank you so much for joining me on the podcast today. It's been a real pleasure.
Sonam Leki Dorji
Thank you so much, Karen. It was a real pleasure talking to you as well.
Karen Watkin
So, I learned a lot from Sonam in that conversation about what it means to be a high-income investor. And I think she mentioned a number of really important things. First and foremost was this idea of efficient income, which is really about not just trying to find those investments that can give you the highest yield, but really understanding the amount of risk that might come along with it. And so, making sure that you're balancing how much income you're seeking to generate with the amount of risk and in particular kind of tail risk, you know, how might these things perform in a crisis is really important. The other thing I thought was really interesting was this idea of being nimble, but in particular having a game plan. So, thinking ahead of time, what are you going to do when you hit these periods of volatility? And so, by doing that she explained that they have a really disciplined investment approach, and it means they don't get swayed by sudden market movements and volatility that can lead to behavioral biases or more emotional reactions. And I thought that was really important for investors to remember. And then the third thing I thought was interesting was how she thinks about building that. She talked about having a lens both to the past but also to the future and having this balance between what we learn from history and the data in the past but also building that perspective and view on what's likely to happen as we move forward. So, lots of really interesting lessons I think, from Sonam on how we navigate income investing. And with that, this brings to a close this episode of AB's Alpha Females, the investment podcast from Alliance Bernstein with me, Karen Watkin. If you've enjoyed this episode, don't forget to tell your colleagues and friends about it. It only remains for me to thank Sonam Leki Dorji. This episode was produced by Richard Myron from Earshot Strategies.
