On this episode of Your Life Simplified, Daniel Sharkey, senior wealth advisor, is joined by Sandy Pourcillie, head of fixed income. They unpack common misconceptions about fixed income and bonds, strategies and how you may want to consider them as part of your portfolio. 

Dan Sharkey: Fixed income is often misunderstood. Today, we are unpacking some common misconceptions and how you should be thinking about it in your portfolio.

Welcome to Your Life Simplified. My name is Dan Sharkey, CERTIFIED FINANCIAL PLANNER™ and senior wealth advisor here at Mariner. On today’s episode, I have an extra-special guest. Sandy Pourcillie is the head of fixed income at Mariner. Sandy, welcome to Your Life Simplified.

Sandy Pourcillie: Thank you. Thanks for having me.

Dan: Where does this podcast find you today?

Sandy: I am outside of lovely St. Louis.

Dan: Excellent. So let’s just dive right in. So for all our listeners out there, let’s just first talk about what you and your wonderful team do here at Mariner and when did your love affair with bonds really begin?

Sandy: My love affair? Well, first, the team at Mariner, our fixed income team, we manage high-quality separately managed accounts for clients, about 5.3 billion under management right now. We offer three broad, more intermediate-maturity strategies, and we allow customization in those strategies because no two clients are quite alike. We also offer some laddered, strategies and those are really geared to clients that maybe don’t yet have a large fixed income allocation.

I would say my love of bonds really are reasons people don’t probably like them. Bonds are actually quite complex. They’re based on legal contracts. They don’t trade on a formal exchange. So, it makes trading much more labor intensive but also fun because it allows you to pick up values, and it can be fun shopping around for bonds. And I know that’s not the common thought when they think of bonds.

Dan: So let’s unpack that a little bit. You said a bunch of really interesting things there. I mean you’ve been doing this for a long time, Wells Fargo, Ascend Investment Partners before, we were lucky enough here at Mariner to have you join and lead our group. Of all the different things that you’ve mentioned, let’s get down to the core. If you’re an investor, why would you want to include bonds or fixed income, interchangeable words in our side of the world? Why would you want to include those in your portfolio?

Sandy: Well, there’s a variety of reasons people look to add bonds, and what we do are really what I like to think of as foundational. They’re high-quality, more intermediate-maturity types of portfolios. And so the goal with that is to lower overall investment risk for clients. Obviously, bonds have a risk spectrum. You can go from very, very safe short-term Treasuries to high-yield bonds. But overall, we focus on the high-quality part of the market. And fixed income, rather than being ownership share like equity, is actually a contractual obligation.

So clients, if you are buying a bond that is from a very strong company or municipality, you have a contract to get your principal back, which is very, very different. And people, they actually use bonds also for volatility tampering, but income, very obviously income and just diversification. It’s a buffer, generally, when equity markets are falling. It’s got that lower volatility. So the price stability factor, the income factor. And did I mention that you can buy tax-exempt bonds as well, that you’re going to get the income and not pay federal income taxes on? So, there’s a lot to love there.

Dan: That’s a really interesting point, and let me just throw something at you and allow you to react to it. So when I talk about bonds and client portfolios, I often encourage them to think beyond simply the historical definitions of the asset class and more so the role that it plays in a portfolio. How do you think about that concept? Is that something that you and your team think through, and how can clients begin to think beyond just that bond should be included, but what they’re really doing such as the volatility tampering that you mentioned a second ago?

Sandy: No, we definitely think about that. When we think about different strategies potentially to roll out, we’re really thinking about the clientele and the role we want to serve because there are all types of different fixed income options out there. We look at this as every client, as an advisor, I’m telling you something you already know, they have their own goals, their own risk tolerance, their own tax implications, their own time horizon. How much bonds you put in a portfolio really depends on those factors. And so I think of it more as the more conservative a client is, the closer they are to their maybe retirement date, bonds serve a purpose of being that sort of dampener to volatility as you approach retirement.

Don’t forget the income, there’s income and fixed income, but in a nutshell you get some diversification from equities and more volatile asset classes, you get that income, and overall it just is … I like to think of it as our job is to mitigate risk and let people sleep at night. We don’t want to be the part of the portfolio people are very stressed about in a down market.

Dan: It’s really interesting about thinking about the part of the portfolio that people stress in a down market. So one of the aspects of what you and your great team do is you use individual bonds to build these portfolios. What is the advantage of using an individual bond versus, let’s say, a bond fund? And then can you also talk a little bit about how the use of individual bonds change in terms of how they price and what the return spectrum looks like versus equity, which I know is very different.

Sandy: Yeah, I mean individual bonds are unique for clients because obviously the market moves every day, and it’s no different for interest rates than equities. And so you may buy a bond, an individual bond and hold it and at any given time rates could be up and down. You could see green or red on the screen. But the thing about owning an individual bond is you have a maturity date, you have a contractual maturity date.

So, in a down market when you’re seeing red on the screen, you know that whatever yield you locked in when you bought that bond you are going to get that and not realize a loss if you hold to maturity. Whereas if you are buying an ETF or a bond mutual fund, you get greater diversification and more liquidity, but you give up that ability to control not just tax consequences, the visibility, but also the idea of you have a maturity date, you are not affected by other clients’ decisions to buy or sell that fund. So, individual bonds are a great way to create a foundation for our portfolio. You’ll have to remind me, what was the second part of that question? You had a whole lot there.

Dan: No, this is really helpful. What I think often gets people confused is when they own individual bonds is that they price different than equities. And that is that there are two components, one being the price of the bond and the yield. Explain a little bit how that factors into how the return is computed for those that hold individual bonds.

Sandy: No, that’s a very important thing for each investor in individual bonds to understand. There are so many yield terms and other terms thrown out there. I find a lot of clients just tune it out because it makes no sense. Most generally, when you get a yield to maturity or just the yield, you buy a bond that you lock in. That is simply the return you can expect holding the bond to maturity. But obviously, again, through the lifetime of that bond, interest rates are changing, the price of that bond is moving along with that.

So, a lot of times or most of the time if you own bonds, you’re going to see a total return, basically just like looking at your equity returns. And what that measures, it’s really two pieces. One is the income you’re receiving from that bond. The other piece is during that finite time period, we’re measuring the movement in the price of the bond as if you were to sell it at current market prices. And so, the total return is, like equities, the movement in the price, but that is also buffered by income. I hope that helps.

Dan: That’s really interesting. Let’s talk a little bit about the differences between … Bonds is an all-encompassing term.

Sandy: Yes.

Dan: But there’s obviously very different implications for where you move on the yield and risk curve, everything from U.S. Treasuries, which I think most people are fairly familiar with. And here at Mariner, we really focus on what we would call investment-grade bonds, bonds that are highly rated by the various rating agencies, Moody’s, S&P, etc. Can you explain a little bit what the difference between investment grade and what is commonly referred to as high yield or junk bonds and how those two instruments differ even though that they’re both quote-unquote bonds?

Sandy: Sure, yeah. There are so many flavors of fixed income. There are even bonds that don’t pay a fixed income. So it’s a huge market, that’s a big all-encompassing term. So yeah, we think of bonds in the spectrum of risk, and the primary risk you first consider is credit risk, or the risk that you’re not going to get your money back on that contractual maturity date. And all we mean by investment-grade bonds are generally thought of on a scale of rating of credit strength. Investment-grade bonds are considered rated between AAA is the strongest quality and BBB as the less strong, but still considered safe investment.

Anytime you get below BBB, you are talking about high-yield junk. And that term is kind of interesting because I don’t want to date myself, but when I was studying in college, I had a friend in graduate school with me that worked at Drexel back in the day, and junk bonds were usually thought of as fallen angels or what used to be high-quality companies that sort of fell down, had poor financial resort. And high yield now today is really outright issued as an asset class. These are lower-quality companies that are borrowing just like a high-quality company would for operating purposes.

And so the thing with high yield is while it can pay a fixed income and it is a bond, it behaves very differently than investment grade because companies that are considered high yield have a much higher chance of default. They’re much more in tune with the economy and the movement in the general market because they are kind of lower down on that edge in terms of the strength of their credit. So, they move more like equities, they respond more like equities than what I would consider investment grade bonds, which interestingly, if we’re looking at corporate debt, the debt of a company versus the equity of the company, the holders are kind of at odds a little bit. The fixed income part, we want strong balance sheet, we want the cash on hand to pay debts, and the equity want that investment and growth. So, think of high yield as more on that side of the table.

Dan: It’s a really important point and for all those listening, the implication of holding high yield is that it maintains that equity-like risk, meaning that in falling markets, those companies that are of lower credit quality have the potential to default at a greater level than those on the more lower end of the risk spectrum. So it’s an important point to consider, and again, it ties back to this idea of role in the portfolio, meaning why are you holding this? So it’s a good thing to consider when you’re thinking about what’s in your bond collection on your balance sheet.

Let me just throw a curveball at you and push back a little bit from a common investor sentiment that I get. And that is bonds don’t provide the level of diversification anymore, so I’m not going to keep them in my portfolio. What are your thoughts on that idea?

Sandy: Yeah, that has been a hot topic since the Fed started raising rates because what we saw was a positive correlation. Both equities and bonds were down significantly in 2022 when the Fed started raising rates that March. And I would say although bonds can be positively correlated with risk assets, that does not mean that they don’t provide somewhat of a buffer. And I would say this rate cycle is very unique in the sense that we had interest rates set at zero by the Fed for 2008 to 2015 and again 2020 to ’22. And so you’re starting at a very, very low level. So bonds reacted much more to the Fed raising rates rapidly, 5.2% or 525 basis points. And that wasn’t normally the case that you would see that movement. But my point being, even if in a more inflationary type of scenario where we do see more positive correlation between bonds and stocks, they provide a buffer.

And while this isn’t a great scenario, let’s look at this for the year 2022, if you had held only Standard & Poor’s ETF, you would’ve earned about negative 18% or so. If instead you had owned the index, the Bloomberg Barclay Intermediate Government Credit Index, which is probably the closest thing to what we offer in terms of a benchmark, you would’ve been down a hundred percent in that index, 8.25%. But look at it this way, a 60/40 portfolio, if you had owned those two in proportion, you would’ve been down about 4% less. It’s not the best performance by bonds in terms of diversification, but it can still be a buffer, and it can still pay interest during that period.

Dan: And it is a really important point to ensure that you’re thinking about things beyond a single time stamp and time frame. If you go back to when the Reagan administration first came in, there’s basically been almost a 40-year, 45-year bull market in fixed income or in bonds, so I would really encourage everyone who has that idea that bonds quote-unquote no longer provide diversification to really expand your scope and look back over time.

Even as we saw in 2023 and 2024 as rates normalized, there really was that return to providing that safe haven assets, particularly those that are of higher credit quality. So that’s really interesting. Staying on the Fed, a big topic of conversation is this 50-point, basis-point cut. It was higher than a lot of people on the Street expected. And how in your mind does that change client approaches and why is that important? Why should clients really be thinking about how this impacts them as we go forward in 2024 and then into 2025?

Sandy: Sure, and I definitely have an opinion on this. The Fed held rates at a very artificially low level since the financial crisis. And every time we saw a hiccup, Silicon Valley Bank, the most recent, the Fed has introduced certain lending programs and even gone as far as buying corporate bonds, high-yield corporate bonds, to keep the market elevated. And in that environment since 2008, you have a generation of traders that know only that very cheap money, basically. So there’s always this thought when things settle down, we’re going back to that environment.

And so, I think that there is this sense that the Fed is going to continue to support, I think back in the Greenspan days, we called that the Fed put. And so throughout the cycle, once the Fed started looking closer and closer to easing, the market really got ahead of itself. And we’ve seen several instances, if you follow federal funds futures market, which are basically large futures bets on where the Fed target rate is going to be at each meeting, what you’ll see is the market has consistently priced in more cuts than they’ve actually seen or that the Fed themselves has forecast and had to reprice. We’ve just seen this again. We had traders pricing in large cuts through the end of 2024 and now we had a strong employment report on Friday and all of a sudden, we’re back to what the Fed said they think they’re going to do.

And the bottom line for clients is we get questions like this, “Okay, the Fed’s cuts rates, does that mean something with my bonds and I shouldn’t buy them?” Well, first of all, any gains from a Fed easing campaign, a lot of those are already priced in, thanks to that hopeful wishing that we’re going back to this very low rate environment. So what we’ve seen bonds, how we’ve seen them appreciate as the Fed started easing, we’re pretty far ahead and priced in a lot. So that means investors that already hold individual bonds, they’ve seen that appreciation happen. For investors coming into the market, we’re not at the high-end rates we were last fall based on this anticipation of the Fed cutting rates. But if we look at the last almost two decades, even today, when you’re getting into the market, investors are getting comparatively a handsome yield to continue to loan their money. And our feeling is buying individual bonds is not a tactical trading move.

This is a foundational asset allocation, is really all it should be, piece of your portfolio. And during these interest rate cycles, you’re going to see bonds go up, bonds go down. But the important thing is to stay true to your allocation and stay in the market, and what it means with the Fed cutting rates, we saw interest rates drop. Are they going to drop further? Possibly, if the economy weakens further and we have a lot of geopolitical risk. Don’t want to look at the headlines on Bloomberg every morning. It’s a little worrying, right?

But these are cycles. And the goal of our group when managing portfolios is not to be reactive. It’s to have a more long-term approach and realize that you want to hang in there and look at your performance over a whole interest rate cycle instead of jumping in and out saying, “Is this the high of rates?” Or “Is it so low I should sell my bonds now?” We really preach stick to your knitting, stick to your asset allocation. That is the biggest influence on your investment returns, and trying to become tactical with your allocation probably not the best idea for investors.

Dan: Absolutely. And it also speaks to those that have been holding cash in a money market. You’re going to begin to see those rates coming down. So, for anyone thinking about how they should allocate the more conservative side of their portfolio, taking this longer-term approach that you’re advocating for is really helpful.

Thank you, Sandy, for being so generous with your time. We’ve been speaking with Sandy Pourcillie, head of fixed income here at Mariner. And if you’ve enjoyed this conversation, please be sure to check out any of the ones that we have done before. And also make sure to please hit that ‘Subscribe’ button on Apple podcast, Spotify, YouTube, wherever you get your podcasts. And just a quick scheduling note. We won’t be releasing an episode on Thanksgiving, but we’ll be back on December 12th with an all-new Your Life Simplified. From the Mariner family to yours, we hope you guys have a wonderful holiday, and we’ll see you in December.

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