The transcript from this week’s, MiB: Sonal Desai, Franklin Templeton Fixed Income CIO, is below.
You can stream and download our full conversation, including any podcast extras, on Apple Podcasts, Spotify, YouTube, and Bloomberg. All of our earlier podcasts on your favorite pod hosts can be found here.
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00:00:02 [Speaker Changed] Bloomberg Audio Studios, podcasts, radio News. This is Masters in business with Barry Riol on Bloomberg Radio.
00:00:16 [Speaker Changed] This week on the podcast, I have another extra special guest. Alai, what can I say? She runs the Fixed Income Group as Chief Investment Officer for Frankie Templeton. She directly manages $215 billion in assets. Sonal has been named to just about every most influential woman in finance list baron’s, five years in a row, Forbes Pension Investments. If you are at all interested in fixed income, what the thought process is like in trying to figure out how to structure a portfolio of fixed income, what you think about what affects the returns, you’re gonna see. This is gonna be a great podcast for you. I thought this was interesting, really fascinating, and I think you will also, with no further ado, Franklin Templeton’s. Sonal Desai. Welcome to Bloomberg.
00:01:12 [Speaker Changed] Thank you, Barry. That’s, it’s so kind of you to have me here.
00:01:15 [Speaker Changed] Well, it’s, it’s a pleasure. I’m, I’m excited to talk to you. Let’s start out with the background that you come from, bachelor’s in Economics from Delhi University, PhD from Northwestern, also in economics. What was the original career plan?
00:01:32 [Speaker Changed] This is a really interesting one because, you know, I grew up in India. My, you know, there’s a, there are two careers at that time, there were two careers. Any good parent wanted from, for his son, or in my case, daughter. You could be an engineer or you could be a doctor. And if you really didn’t want to do either of those, you could work for the government. I didn’t want to do any of the three, and economics seemed at that time to be the one which left the most options open for me. So I did economics. At the end of my undergraduate degree, though, I didn’t feel like I’d really learned enough about economics, and so I decided, you know, not having understood the concept of sunk cost, I decided to do even more. And I did a PhD.
00:02:16 [Speaker Changed] That’s what happened. And was that two years, three years?
00:02:18 [Speaker Changed] The PhD? Yeah. No, that was a full five. That was
00:02:21 [Speaker Changed] Four and a half, five years, years. So that’s more than sunk cost. That’s, yeah, double. More than double, exactly. So, so you come out of Northwestern with a PhD in economics. What was your first job in finance? Or what was your first job outta school?
00:02:35 [Speaker Changed] I was a assistant professor of economics at the University of Pittsburgh. And here’s the deal, when I got that job, the, I, I had also interviewed with the IMF and I had really liked the IMF, but you have to understand, I don’t know if it’s that way today, but at that time, there was no way I was going to my thesis advisor and telling him, yeah, I do have a tenure track offer from a decent university, but you know, I’m gonna go to the dark side and work for the IMF. So I, I couldn’t bring myself to do it. I went and I did the academia thing for a couple of years, and I was young enough that the IMF told me at that time that, look, if you change your mind within the next two years, let us know.
00:03:19 [Speaker Changed] Huh? I mean, academia isn’t for everybody, and it might take a year or two to figure that out. I mean, if that lifestyle works for you, it certainly, you know, could be rewarding intellectually.
00:03:32 [Speaker Changed] Very much so. Look, academia, I admire it. I think it is the pinnacle of what this country does. Brilliantly. Having, having academia, having those research universities, all of that is absolutely superb. For me, the problem was I’d spent five years of my life essentially doing research, and now I wanted to get out there right. And do something with it. To me, getting into the IMF, it was mind Bogglingly, Iowa. It was fantastic. Remember, this is in the mid nineties, so let’s, let me date myself. Yeah. So this is in the mid nineties. Eastern Europe is just coming in from the cold. Right. And that was where I focused most of my time.
00:04:15 [Speaker Changed] So how long did you stay in, in, at Pittsburgh before you joined the IMF? Two
00:04:20 [Speaker Changed] Years? It was two years.
00:04:21 [Speaker Changed] So, so what, what was the experience like in Europe in the nineties working for the International Monetary Fund? No,
00:04:27 [Speaker Changed] No, no. So I worked out Washington dc I worked on Eastern Europe. Ah, so, so I’m talking about countries like Bulgaria, Macedonia, Romania, Croatia, prior, it, literally, the wall had fallen in the late eighties, 89 was it, you know, and so these countries, some of these countries didn’t even have the concept of GDP as we know it. They had gross social product. They didn’t have CPI indices. So it was, in some ways, the initial piece was like an extension of being at university because we were bringing these concepts to them. It was, it was an amazing experience.
00:05:05 [Speaker Changed] So any lessons that you learn at IMF that ultimately influenced your investment philosophy?
00:05:13 [Speaker Changed] My enormous respect and belief in macroeconomics actually comes from my time at the IMF. We were, you know, the IMF got a lot of dings for program countries, you know, for programs which were put into place around the world. Some were better than others. I get all of that. But here’s the thing, we would go to these countries and the idea was really, frankly, orthodox fiscal and monetary policy. And sometimes when you are starting from a certain point, be it hyperinflation, be it out of control, fis, fiscal balance, be it lack of any kind of international reserves, you need to go back to orthodoxy, it kind of works. And that, carrying that forward, I think it’s influenced a lot of how I’ve thought about emerging markets through the, through the years, for
00:06:02 [Speaker Changed] Sure. How, how long did you stay at the IMF for?
00:06:06 [Speaker Changed] It was, it was six years. It was six years in DC and then half a year, basically, my husband and I at that time, we, we, we chose to move to the private sector. Right? He was moving to the private sector in London, and I was following him, and I had accumulated six months of vacation. They let you do that? They wouldn’t cash me out for six months, but they said, take the holiday. You know what I did? I had the IMF pay for me to do a professional patisserie course in London, because I had to take the holiday. I couldn’t go out and work right. But I was being paid and I couldn’t not be paid. So I took a one year course, pushed into six months
00:06:43 [Speaker Changed] Full on pastry and
00:06:45 [Speaker Changed] T on blue. Wow. Basic, intermediate, and superior.
00:06:48 [Speaker Changed] Wow. Do you still do a lot of cooking?
00:06:50 [Speaker Changed] So I do a lot of cooking, but I don’t do much, much baking, baking, much baking anymore. My husband always complains. He says, I baked more before the patisserie course because after that I would come into our rental apartment and say, I can’t work in these conditions.
00:07:04 [Speaker Changed] So you became a chef Prima Donna, is that what you were
00:07:08 [Speaker Changed] Suggesting? Pretty much. I, I, I have to, looking back at myself, I have to believe I became a prima donna.
00:07:12 [Speaker Changed] So you relocate with your husband to London. I’m gonna assume that’s how you end up at Tames River Capital, is that right?
00:07:18 [Speaker Changed] No, first, actually, I was on the sell side. So I’ve done it all. I’ve done academia, then I did the public sector, the IMF, then I did the sell side, DRES, Melein, ward, Wasserstein Investment Banking, and I was in the research team there. And that was in London. And then after six years with them, I moved to Thames River Capital, which was a macro hedge fund in London.
00:07:39 [Speaker Changed] How, what was that experience like that you were there right? Through the great financial crisis? So,
00:07:44 [Speaker Changed] Yeah, actually, so I started with them in 2006. And in 2009, I moved back to the long only buy side. I think it was absolutely eyeopening, right? And I think one of the great things about working with them, small team, boutique firm, hedge fund, but a macro hedge fund. So at every stage, it felt like, and I’d been on the sell side, and now it’s on the buy side. It gets you a little bit closer to the end point. I think it was a fascinating point of time, because essentially over the course of the two thousands, the private sector really came into its own. So in a sense, when we were at the IMF, a lot of these emerging markets, they came to the IMF because there wasn’t a true alternative. Private markets, especially for em, had not deepened enough. And now as, as we got into oh 8, 0 9, you started seeing the strength and power of the private sector.
00:08:42 And then we had the global financial crisis. Holy cow. That was, you know, that was when I would walk around and I’d, I used to walk home from, from my work, and I was just thinking, everyone keeps talking about, oh, you know, living in unprecedented times, living through history, I’d rather read about it. You know, I didn’t, living through it was, was, was amazing. I remember waking up at three or four in the morning to find out what had happened overnight, right? What, what were markets doing. It was a whole different level. It was just amazing. It, and now I look back and it’s like, great, we did that. We did that. But I will tell you, one of the best things about that time was remembering to look out of the window. We, we worked out of Barclay Square, lovely offices, looking out the window and watching people having normal lives and realizing, you know, the world doesn’t begin or end with finance for
00:09:39 [Speaker Changed] Sure. It certainly has an impact, but yeah, it’s kind of funny. Some of the younger folks who are late thirties, early forties, I know this is, it’s hard to imagine this is before their time. It is, it is. Like they were in co So I was in grad school during the 87 crash, and it was off on the side. You really didn’t pay attention to it. I imagine anybody who was in undergraduate or graduate or even just starting to work into oh 8, 0 9, you really don’t understand how unusual and the force of that debacle across the entire economy.
00:10:19 [Speaker Changed] Barry, take it one step further and recognize that somebody, some kid who got into JP Morgan as a trader and was fortunate enough not to lose their job in oh 8, 0 9, this is somebody who probably through COVID, ended up being a senior trader and has never lived through truly non-zero interest rates. I mean, yeah, the Fed started raising them, but through what I would consider normal, normal, normal right. Normal business cycles, it is remarkable. It, that’s when you really realize, wow, you’ve lived through interesting times, right?
00:10:55 [Speaker Changed] To say the very least. Yeah. So you, you mentioned you joined Franklin in oh nine, the long only. Yes. Pretty good timing to join a long only shop mid, mid oh nine. Tell us what that transition was like, going from a long short hedge fund to a long only asset manager. So
00:11:13 [Speaker Changed] Actually, you know, the reality is the team I joined at that time was a GLO was the global macro team within Franklin Templeton. And in many respects, that team works with deep value investing, in a sense, looking for emerging markets, which are totally outta favor thinking in terms of long business cycles and really investing abroad. So it was a bit of a natural transition. The part which was more complicated to get my head around was being part of an enormous organization after having basically been a part of a very small team, a small boutique team where if you wanted to do something, you could be very entrepreneurial and go out and do it. At Franklin, you had to get to get your arms around a much bigger organization, but it was very good.
00:12:02 [Speaker Changed] 2018, you become Chief Investment Officer for the fixed
income group at Franklin Templeton. Is that the timing? Right?
00:12:09 [Speaker Changed] Yeah, roughly. Yeah. That’s, that’s the timing.
00:12:11 [Speaker Changed] That’s gotta be a pretty big change in, in role from head
of research to
00:12:17 [Speaker Changed] Yeah.
00:12:17 [Speaker Changed] Running fixed income.
00:12:19 [Speaker Changed] So it was a big change. And now we get to the point where my predecessor was retiring and Jenny asked if I thought I could do this, and
00:12:32 [Speaker Changed] Jenny
00:12:32 [Speaker Changed] Johnson, Jenny Johnson, CEO of Franklin, Templeton Franklin, and she asked me if I, if I thought I could take this role on. And I have to say, my first reaction was that there’s too many pieces that I can’t do. And I tell you something, this is a difference between men and women. My husband, when he looks at, you know, a job description, there’s something like 20 things on that job, and he said, I can apply for this. I said, but, but, but, but you know, you haven’t done, you haven’t ticked every one of these boxes. He says, I ticked that one, and he’ll apply for it and he’ll likely get the job.
00:13:05 [Speaker Changed] When, when I had Jenny here for an interview Yeah, we talked about that exact thing. Oh, did you? And she, she mentioned, she goes, women will look at this and say, oh, I can’t do that. Yeah. Like, I don’t have one, seven and 12. Yeah. And guys are like, yeah, we’ll figure it out as we go. And it’s a very genetic difference. It’s
00:13:23 [Speaker Changed] A, it’s a real genetic difference because my instinct is, well, I haven’t done that before, so I can’t do it. And between, between my husband and Jenny, they basically kicked me in the pants and said, no, you can do it. Learn, learn on the job. And I guess I did. It was, it was fantastic. It’s been really fantastic.
00:13:45 [Speaker Changed] Really interesting. So let’s talk a little bit about Franklin. So you’ve been chief investment officer for seven, almost eight years now. What’s been the most surprising thing about this role?
00:13:58 [Speaker Changed] Number one, when you challenge yourself, you really can step up. Number two, there are parts of fixed income that I thought would be, i’ll, I’ll just say it, boring, right? They’re not, they’re not as as exciting as going out and finding that emerging market. And what you find is actually, everything is fascinating if you spend enough time looking at it. So that’s been great. And I’d say the other part of it, which has been somewhat surprising to me, I’d say, is it goes actually into the broad, into broader markets. Not just my role within, within this, within this group. It is the extent to which markets look at what is happening currently. And it’s a very short step for analysts to look at what’s happening, extended it into the future, and give you a reason for why it happened, how difficult it is to break out of the mold and try to actually genuinely look forward. Does this make sense? Yes.
00:15:04 [Speaker Changed] We, we, you know, flick on the tv, radio. Yeah. And people are constantly explaining, yes, what just happened when they had no idea what was gonna happen. It’s a lot of hindsight bias.
00:15:15 [Speaker Changed] Yes. And there’s also what just happened, and therefore why it should continue happening. And I think that’s something which I never realized how deeply ingrained it is and how difficult it is to break people out of that way of thinking,
00:15:30 [Speaker Changed] Just extrapolating to infinity. Infinity. Yeah. Yeah. That happens all the time. You recently were on with my colleague Ali, and you said to her, investors need to price risk more seriously. Explain what you mean by that. What
00:15:45 [Speaker Changed] I mean by that is, I said more than it’s, I’m looking now since the global financial crisis, and Barry, we just talked about the fact that there are entire, entire generations of people who have never lived in a world where liquidity was anything other than hyper abundant. And by the way, we are still in that world. You look at the Fed’s balance sheet, sure. It’s still enormous. I think it’s very hard for people to even realize that the Fed sat on a minuscule balance sheet prior to this. They were, we were not in a situation where essentially there was always a get out of jail for free card out there.
00:16:25 [Speaker Changed] The classic Fed put
00:16:26 [Speaker Changed] The Fed, the Fed put, eventually it was a Fed put, then people thought there was a Trump put. And quite frankly, over the, over the last four or five years, we’ve had a fiscal policy put, we have puts all over the place. And I think that what happens in that environment, you know, when I said that we need to price risk, start remembering again how to price risk appropriately. It is the fact that when financial markets started moving out along the yield curve, out along the risk spectrum, I’ve even seen the IMF talk about, oh, well markets need to price risk correctly. Well, hello. They were forcing us into those positions explicitly when the first set of QE one, two threes happened, it was explicitly there to get financial markets to take risk. Again, QE one, definitely QE one and two, maybe, you know, markets had frozen up. We needed to liquefy frozen markets. And to me, if I look at that, that made sense. Problem is we hung onto it for too long. If I look at high yield credit, let’s talk about fixed income markets. High yield credit, typically in a recession, spreads of high yield credit over treasuries, equivalent treasuries should be at around 600, 6 50, even higher. We’ve never gotten there. We never,
00:17:46 [Speaker Changed] Still very tight. Even
00:17:47 [Speaker Changed] Today, no, today we are close to record types, right? We’re only looking at a few hundred basis points with sub 300. This to me means that while people like to talk the talk of recession, what they’re really saying is cut rates. We want more liquidity because we’re not getting rid of all of all of our assets over here. The risky assets, which should sell off if people truly expected a recession.
00:18:12 [Speaker Changed] So I’m gonna assume you are not in the recession camp here.
00:18:16 [Speaker Changed] I haven’t been, I haven’t been. I’d say that I can proudly say that it’s been, you know, I’m on record. So I think it was in probably early 2021 when inflation started picking up Yeah. That I was saying, yeah, this, this, this isn’t looking so good. You know? Right. This transitory stuff isn’t looking so good. And most importantly, it wasn’t at all clear to me why we were expanding fiscal while we also had this massively easy monetary policy and how that could possibly result in a recession. And we’ve been having recessions, which are two quarters out now, I think a rolling two quarters out for the better part of something like three and a half years. And I will say we’ve not bought into that. I think it’s a very strong economy.
00:19:00 [Speaker Changed] So it, it certainly has been, we continue to see consumer spending despite weak sentiment. Consumers continue to spend. Yep. The labor market is tight. Yeah. There’s some warts on the housing markets and you know, there’s always some sector you, you could, you could poke at, but by and large, this seems to be a fairly robust, fairly resilient economy. Fair, fair statement.
00:19:24 [Speaker Changed] I think that is a fair statement. Because here’s the thing, you know, the, in the first few months of this year, we saw sentiment tank and everyone said, well, hard data will follow. I wasn’t so sure because sentiment was moving on something which was unusual. It wasn’t moving on the back of weakness in labor markets or people feeling uncertain about their jobs. It was weakening on the back of pronouncements, you know, on top of policy pronouncements. I’d say the execution of that stuff was really bad and continues to not be particularly good in terms of tariffs that impacted sentiment. However, people continue to spend, they didn’t stop spending, as you said, and, and not suggesting that this economy is recession proof. I’m just saying so far we haven’t got whatever we need to push us Right. Into recession into it. Right.
00:20:13 [Speaker Changed] Yeah. A any thoughts on the idea that perhaps sentiment measures are broken? That when you see Michigan sentiment Yeah. Worse than the pandemic, worse than the financial crisis, worse than the 87 crash. And yet,
00:20:27 [Speaker Changed] Yeah.
00:20:28 [Speaker Changed] You know, you look at the data, you’re just not seeing anything remotely
00:20:31 [Speaker Changed] Like that. I have to say that I’m looking a little bit less at some of these indicators. I think they need to be nt we need to now do more digging. Our country has become very polarized and that feeds into people’s sentiment. It doesn’t feed into their shopping habits. Right. That’s the, that’s the reality, right?
00:20:49 [Speaker Changed] So I’m wondering how much of this is driven not just by media, but by social media and algorithms. It seems to send people to more extreme perspectives.
00:20:58 [Speaker Changed] Absolutely. Huge. And I think that the, the speed of the, of the news cycle, the need for clickbait style, right? Tweets, headlines, whatever it is, I think that exacerbates every sentiment. However, people still seem to be relatively sensible in terms of how they actually behave. Because we are not hearing about people massively canceling their European vacations, which according to Delta, we are taking in record numbers. Right?
00:21:30 [Speaker Changed] It’s so funny you say that because last quarter they dropped their guidance. Hey, everybody’s frozen. Yeah. JetBlue did something similar. We don’t know what’s happening. They just came out in the most recent few days talking about not only reinstating guidance, but being pretty aggressive as to what they see going forward. That’s fairly constructive, kind of fights against the, oh, this tariff war is gonna cause a obsession and, and crash everybody.
00:21:59 [Speaker Changed] Yeah. You know, I really never bought the vibe session idea on tariffs. I mean, let’s, can we talk about tariffs? Sure. I mean, it’s been talked to death, but why not? Let’s, let’s talk about tariffs briefly. Here’s the thing. I look at our country, and I’m gonna use big round numbers here, where about a 30 trillion economy, okay? 29, call it 30 trillion economy, 70% of our economy is consumption. Okay? So you get to around 21, 20, 20 1 trillion, 70% of consumption is services. Guess what? Services aren’t really impacted by tariffs right now I go to, okay, I’ve got around six, six and aqua six and a quarter trillion of consumption of goods. How much of this is actually imported around 3.4 trillion of goods are imported. So half, so I’m looking at 3.4 trillion against all of this, this huge economy size. And I say, okay, they’re talking about putting tariffs.
00:22:56 You know, let’s assume tariff revenue ends up being 300 billion a year. It’s not, yeah, that’s, it could be much lower. 300 billion if I were to spread this out over all goods and services like the Europeans do using a VAT, that’s a 2% tax, right? Would we all be jumping up and down saying vibe session, if magic happened and the federal government did something very intelligent and put just a small consumption tax on the economy to lower the budget deficit, we wouldn’t. So I guess what I’m trying to say is I don’t love tariffs. Please. Tariffs are a highly inefficient form of raising revenue. They, they, they’re distortionary because they randomly hit some products relative to other products. I don’t love tariffs. I just don’t think that they are as catastrophic for the US as they are for the rest of the world. The rest of the world. Yeah. That is a big problem. The US doesn’t depend. It’s a huge economy, which is essentially a large closed economy,
00:23:56 [Speaker Changed] Closed economy. Yeah, it is. That’s very interesting. How, no, how do
00:23:59 [Speaker Changed] I come to that?
00:24:00 [Speaker Changed] It seems like, look, our, our phones are made in China. I’m wearing a watch wear in Switzerland. Cars are from Japan and Germany and Korea and elsewhere. It feels like we see so many imported goods, clothing, just all this stuff. But what you’re really pointing out is the things we import are relatively small percentage.
00:24:20 [Speaker Changed] No, exactly. I think you are totally right. You know, and here’s the thing. Should we be manufacturing more in the us? This is actually a political decision and people vote for this and don’t, and you know, anybody who says that’s a crazy idea, well, Germany does it. Japan does it. Right? You know, it’s a choice. It’s a choice. It’s a political choice. And I think that it is up to the people of our country to decide which direction do they wish to go in. There’s no right answer. It’s a democracy. People need to choose. However, it is an incredibly wealthy country. And therefore, when we talk about imports and exports, I look at exports, which is how our GDP gets impacted via, via tariffs or trade or anything. Imports are 10, 12% of, of our overall GDP because we import around four and a half trillion of goods and services, three and a half of just goods, four and a half trillion out of, you know, 30 trillion economy, call it 12, 13%. That is where we are looking in terms of our imports. And you compare this to a Germany, Germany including its exports to the rest of the Euro area, it’s around 44% of GDP.
00:25:32 [Speaker Changed] Isn’t that true throughout Europe? They’re just, it’s, they’re
00:25:35 [Speaker Changed] Much more like
00:25:36 [Speaker Changed] I I look at Germany, France, yeah. Italy, Spain, sort of like New York, California, Texas, Florida. ’cause there’s substantial economies and they’re right there, there’s no ocean in between them
00:25:49 [Speaker Changed] And they, no. And they also export outside. Right? So they’re very, very dependent on what the whims of the rest of the world are because they need, here’s the, here’s the reality of it. You know, every time the administration talks about VAT as a trade barrier, any economist will tell you that’s just plain wrong. Yeah. It’s not because it’s a trade. It’s paid
00:26:10 [Speaker Changed] In on an basis,
00:26:11 [Speaker Changed] It’s a trade basis. No, and it is basically, it’s not a barrier because it’s a border, what we call a border adjusted tax. So you know, we export a car to Germany, absolutely you have to pay VAT there, but you’d have to pay the VAT on the BMW made Germany, it
00:26:24 [Speaker Changed] Doesn’t matter, right? Doesn’t matter. Whatever you’re gonna consume, you’re paying
00:26:26 [Speaker Changed] Tax. So that’s just wrong. However, if you wanna take again that 20,000 foot up in the air view to this, there is an economic model which I think the Europeans have chosen to follow, which is to penalize consumption in Europe with the VAT. Right. 22% tax on average on consuming, which means the Europeans aren’t consuming not European stuff and not American stuff. That’s right. And we have some of the lowest taxes in the world and everyone, we consume everybody’s production. So we are supporting global GDP via our desire for consumption.
00:27:05 [Speaker Changed] We, we also have, have privatized things that the VAT tax subsidizes in Europe. Yes. Yeah. Yeah. So we pay our own healthcare and retirement and college. Yeah. For many European countries, they’re paying much higher taxes. But that’s part of the sort of the social safety net, not part of the private sector.
00:27:24 [Speaker Changed] Totally agree. And again, I’d come back to the idea that these are choices made by democracies and there are no right and wrong answers. So it’s wrong for us to say, get rid of your VAT. They made the choice to have that
00:27:37 [Speaker Changed] VATI. I will tell you that I have a vivid recollection of being in London and Brussels during the.com crash, like two thousands for business. And you leave New York where everybody’s kind of freaked out and stressed and you go to London and people are a little more relaxed and you go to Brussels and they’re even more relaxed. And I guess there’s no fear of losing your healthcare or co owing college loans or saving for retirement kind of makes people a little more sanguine when it came, comes to the economic cycle.
00:28:10 [Speaker Changed] It is, you know, there are trade-offs on everything, right? So we could have an entire philosophical discussion in terms of the choices people make and everyone doesn’t make the same choices. The other side, I would argue of the coin that you, you are pointing out correctly, which is the lack of stress associated with all these fundamental needs of life. The other side can and is a lack of innovation. Sure. Which you see across the board because there is no, is no apple, Microsoft Invidia in
00:28:46 [Speaker Changed] Europe. SP,
00:28:47 [Speaker Changed] There isn’t a desire of a risk taking. Right? And that’s what permeates the entire American dream, so to speak. You know, you work really hard, you, you can be entrepreneurial, you go out there, you do great things and you can make it. And I’m an immigrant, I’m a naturalized American. And I have to tell you, that’s what I bought into and I really believe in it. I love that about this country.
00:29:11 [Speaker Changed] Huh. Really, really interesting. You mentioned earlier all the liquidity that the Fed has flooded the system with. What’s the implication of that for fixed income today?
00:29:24 [Speaker Changed] So I’d say the implication is when you are looking for, let’s call them risky assets within the fixed income space to invest in, it’s quite difficult, like I said, typically risk assets. You look at the premium you get for taking the risk over the risk free asset, which is of course the treasury. And the reality is there’s clearly enough to the point of complacency, I would say comfort around what is going on within the economy and what the expectations are from the Fed. That those spreads, if I, again, I point to something like high yield, they’re nowhere close to what, what I think would be reasonable. Nonetheless, you are getting close to 7%, 7.5% depending on the day you’re looking at it, right? Without, not in spread terms, but all in terms for, for a high yield or a risky bond in the for, for a high yield corporate.
00:30:21 Now this I think remains reasonable if you are active. I wouldn’t buy passively into this because when you have way too much liquidity, clearly some excesses are bound to creep up. And I think that probably they have, we are active managers, so we are literally doing bottom up picking company by company. And I think you need to do that. So what do you do? I look at tenure treasuries and I look at fed funds and I try to decide at 4 40, 4 50 we’re range trading right now, is this a screaming by? Should you be jumping in because you think that treasuries are gonna rally massively? And the answer is actually no. I would call myself aggressively neutral. I’m stealing that term from a colleague of mine, aggressively neutral at this range. I think fair value for US treasuries actually is probably today at between 4 75 and five.
00:31:20 So in fact I think there’s more for us treasuries to sell off. And thus this is, this is the backdrop. Now why do I think this? I think all these complaints about where the Fed is, you know, the Fed should cut rates, cut rates, cut rates. Well I think the neutral Fed funds rate is actually between four and 4 25 or so. So I don’t think the Fed has that much room to cut rates. Why do I think it’s 4%? Is there a magic number? Well, if I, again abstract from these post GFC 15, 17 years that we’re looking at where we’ve had this very abnormal unorthodox monetary policy for a large part of this period. And I look at the decades prior to that neutral fed funds was around four 55%. That was what this economy took. What does that neutral fed funds rate consist of inflation and what do you think productivity growth is gonna be? I think inflation is around two, two and a quarter and productivity growth, we’re kind of cruising back towards that two percent-ish level that we were, gives you your Fed funds.
00:32:24 [Speaker Changed] So inflation is softening, productivity is gaining, that sounds like a very productive environment for both the economy and the fixed income market.
00:32:35 [Speaker Changed] Well I think it’s a good time for fixed income from the following perspective. You’re getting yield from fixed income and I think you’d probably sell off a bit more. You’re getting income from fi fixed income, let’s put it that way. And again, talking about generations of people who were used to getting one or two, two and a half percent for their, you know, we, there was a point where given where inflation was and given where tenure treasuries were, we were paying the government in real terms for the privilege of lending the government money, which is what you’re doing every time you buy a treasury, right? But at least we’re not there anymore. We are getting positive real returns. I think it is a constructive environment for fixed income. But you can’t expect equity like returns from fixed income. And again, because of liquidity flows and so on, people have become a little bit married to the idea of fixed income delivering massive outperformance. And what it should really be doing is giving you boring returns. You know, boring returns. It should be the ballast in your portfolio when you are equity market delivers equity like returns. And that is the future state that I anticipate for fixed income.
00:33:40 [Speaker Changed] So. So let’s stay with the issue of liquidity, which keeps coming up. How does that affect how you look at fixed income, whether you want to go out for further duration or maybe even higher credit risk. What is all of this, both from the Fed and elsewhere, what does all this liquidity do to how you construct a portfolio of fixed income products?
00:34:01 [Speaker Changed] I think it actually makes it a little bit more difficult. We talked earlier about the issue of pricing risk. When you have this much of liquidity, those spreads, people will get forced into riskier products. You can’t stay out of the market because you need to clip that coupon. So you are present. But like I said, you are not getting massively over your skis in terms of adding on extra risk because things are priced to perfection in a market like this one. So what I mean by this is my baseline is that we don’t get a recession as we spoke about it. Nobody has perfect foresight Sure. Into what, what this looks like. You could get anything coming out of left field COVID came from somewhere. None of us anticipated very short recession, but it had very meaningful consequences. Clearly there are many areas of uncertainty and these are the reasons why from my perspective, my baseline on the fundamentals, economic fundamentals is no recession. But given how assets are priced right now, I would not go overboard loading up on risk at current levels. There are many reasons to anticipate, for example, additional corrections including on the equity markets. Frankly, just from a macro perspective, which we don’t have right now.
00:35:20 [Speaker Changed] We’re gonna, we’re gonna keep it modest on the credit risk side. What about duration? Yes, we had, we had an inverted yield curve for a couple of years. The yield curve more or less un inverted. Yeah. So you’re getting paid a little bit for a longer duration, but you’re not getting paid a whole lot. How do you look at, at the long-term choices for, where’s the sweet spot? Is it four to
00:35:44 [Speaker Changed] Seven now? No, I’d say it’s, it’s shorter, right? Really now I’d say it’s, it’s shorter than four to seven. So I’d say I’d stay a little bit shorter right now because I, like I said, we are at four 40. I don’t think it would take us very much to grind higher over here. And then if you’ve taken on a lot of duration, it’ll hurt you. Now if you’re taking some of that credit risks, should you be hedging it out, that is something which you can consider, but outright simply going long, I wouldn’t do too much in terms of, we actually still think that there is an enormous amount of cash still sitting on the sidelines and everything from money markets onwards. And perhaps one of the best things to do is to at least dip your feet in and get, at least to ultra short, get yourself comfortable with ultra short. So you could start moving out the yield curve as opportunities present themselves.
00:36:31 [Speaker Changed] So one of the questions, anytime we discuss hedging either credit or duration risk, what are the prices of that look like these days? Because I recall pre-financial crisis, it was wildly mispriced and turned out to be really cheap to hedge credit risk. What about today in duration risk? Is it cheap or expensive to hedge
00:36:51 [Speaker Changed] That it’s still expensive. Still expensive? Yeah, I would say it’s still, it’s still expensive, huh? But you can’t do it. You can do it in option space for example. But yeah, I would
00:36:59 [Speaker Changed] Say that that’s really, that’s really interesting. We hinted at, but really didn’t spend a lot of time talking about geopolitical risk. How do you factor that into your investment decisions? How does this drive fixed income choices?
00:37:16 [Speaker Changed] I think the interesting thing about geopolitics is increasingly it’s become a backdrop. And I think that markets are not capable of remaining in a heightened state of panic and anticipation indefinitely. What I mean is when Russia went into Ukraine, we all thought this was gonna be a short period. And you know, geopolitics became very central to everyone’s thinking. It’s gone on for three years and it’s not unclear when, if ever it’s going to go away. And I think what’s happening is that geopolitical uncertainty has become so much a part of the backdrop that you can’t actually manage your portfolio to that geopolitical risk. You can, when risks get sharply higher, you can try doing something, but you cannot position your portfolio for these geopolitical risks. So what are the geopolitical stress points? The Middle East is, frankly it was a forever geopolitical stress point, which has to give this administration, its due come markedly lower based on what we have seen so far.
00:38:31 I think actually things are looking a lot better in the Middle East than they have over a very long period of time. So that’s, that’s a positive. I think the issue of China, you have different geopolitical stress points, you have the trade tensions, but then separately there’s the eternal question of what happens with Taiwan. And that is always going to be a part of the backdrop. And I think a lot of people take a great deal of comfort from the fact that the Chinese authorities are extremely, extremely careful. And so we don’t anticipate shooting from the hip, so to speak, you know, so this is something which we will continue to see stress points go up and down. And so I, I do think that in the early days of this administration, you know, certainly early days post liberation day, there was a thought that somehow you have a complete realigning of the geopolitical environment with the US not being credible or dependable. I don’t, I think that was overstated. The US is more important than any one administration or any one single set of policies.
00:39:41 [Speaker Changed] We talked a little bit about Europe and the Euro area, at least in the equity side, Europe is finally outperforming the US after a long period of underperformance. What are your thoughts on the Euro area and and emerging markets in, in today’s environment?
00:39:58 [Speaker Changed] So, you know, the Euro area. So if I look at the equity markets, I think you can’t really talk about the equity markets without talking a little bit about the dollar. And that actually impacts em as well. And I see a lot of discussion again, and it’s somewhat related to our previous comments on geopolitics, that somehow the dollar is no longer fit to be the world’s reserve currency. It is the end of us exceptionalism, et cetera, et cetera. I think it’s mixing up a whole bunch of things. Number one, when we entered this year trade in trade weighted terms, the dollar was at its strongest level since the Plaza accord. Right? Did, do you know that since the Plaza accord, I didn’t realize we’re talking about the absolute strongest levels in trade weighted terms since in, in something like close to 45, 50 years, really strong.
00:40:47 Then what happened, we came into this year and the first thing that happened, frankly was deep seek, you know, deep seek burst and somehow, oh my god, the US is not exceptional and people were putting us exceptionalism hand and glove with the mag seven I think. However, if you were a European investor, right, last two years you got 54% just on the s and p and then you got, what was it, 10, 15% in dollar appreciation you made out like a bandit. If you were smart, you took some profits, right? As soon as you got deep sea happening in short order afterwards you’ve got the German suddenly talking about 1 trillion euros over 10 year period in terms of spending. So the last fiscal man standing like I like to say, goes toppling down and we all go, yay, yay that happened. But more seriously it meant that potentially European growth would not look as lackluster, frankly as it has been for a while.
00:41:44 So that happened and then you had liberation day, you had three sets of reasons and the European equity market had been lagging so much more than even the Nikkei in Japan. It was obviously a good time for people to go put money back there and I think there’s a little bit of catch up going on. So I don’t think it’s anything deep and amazing and quite frankly, if I look at European growth, European growth is not yet showing. German growth is not yet showing any impact from the $1,000,000,000,010 spend. It’s not yet showing up. I personally think that perhaps it’s gone a bit too far because if I look at funds which had been approved during COVID time five years ago, five years ago, they still have not been able to deploy them. The Europeans that’s amazing are tied up in red tape at a level which makes me have a certain degree of, I’m not gonna go as far as saying skepticism, but caution in terms of how quickly this money will actually show up.
00:42:50 [Speaker Changed] What about the defense spending that we’re hearing about? That’s probably weaponized key Zionism, that’s probably gonna be a little quicker to find its way into the economy. I think
00:43:01 [Speaker Changed] It could be, but the only thing is the multiplier for defense spending is one of the lowest multipliers you have. Your highest multiplier is going to be what we did, which was to helicopter drop checks right? During co COVID to everyone that has a very high multiplier eventually. But if you look at defenses the multiplier 0.4, it’s a, it’s a low, low, low multiplier. Separately, you have other issues which I think are not discussed enough. And that is, I think there are some that somebody was telling me it’s close to 17 different arms manufacturers in Europe. How many arms manufacturers do you need? If you have multitudes of people making tanks? The problem is the demand for tanks is not infinite. Right? Right. And so you have a lot of relatively inefficient defense expenditure, which is likely to take place as well. I think it will make its way, I don’t want to come across as being overly negative. I think it’s very positive that the Europeans are taking their own defense in hand. I think we and markets need to be cautious in terms of the speed at which we think this will show up.
00:44:07 [Speaker Changed] Sure. So the European Central Bank has cut rates, we’ve seen other central banks around the world cut rates. We talked a little bit about the Fed. What do you think they’re paying attention to? Are they legitimately tight? Especially now with QE ending and QT beginning? How, how do you look at the role of the Fed here,
00:44:29 [Speaker Changed] Barry? Look, we talked a little bit about what I thought a reasonable fed funds rate was. When I call it neutral, I mean the economy’s neither falling into recession or overheating IE inflation accelerating. I think that number is four to 4 25, given where rates are right now, last year before all of these ups, downs and ins and outs, I thought the Fed had within its gift around 125 to 150 basis points of rate cuts in all. And they did a hundred basis points already. So I think there isn’t an unlimited amount that the Fed really can or should do. Will they do more? Probably, you know, I don’t know whether it’s this fed or next year at some stage they can, it won’t be catastrophic. I don’t think it’s particularly wise to cut rates dramatically. Are they messing up right now? No, actually I don’t think they’re messing up. I, this is a very dovish fed, by the way everyone says that. Oh, markets will panic if we get a dovish fed chair. Hello. The last non dovish fed chair we had was Paul Volcker. We haven’t had a hawkish fed chair in an enormous amount of time and I don’t see it happening now. It’s not in the fed’s DNA huh.
00:45:43 [Speaker Changed] Really, really interesting. Let me throw a curve ball question at you. What do you think investors are not talking about, but perhaps should be?
00:45:53 [Speaker Changed] So that’s a really excellent question. In this day and age, I think you can’t talk about what’s being overlooked without talking about time horizon. I think that we are all talking about fiscal, but in very vague terms. And the mistake we are making is acting as if we suddenly got a fiscal deficit. We have been running ridiculous deficits for the last close to five years now. And it’s very much like the excesses we saw with QE in the sense of monetary policy, which lasted long after it should have been withdrawn. Right. And we’re seeing that now, I, I don’t see any desire on either party’s side to do something serious about that deficit, which implies we won’t fall into a recession. But I do think at some stage there, there needs to be some change in policy which reduces that deficit meaningfully. And I’m not sure you can do that without actually reducing growth. This is an additional reason why I don’t think the Fed should go too far today. So are we, and I, I think this is a long way of saying there’s almost nothing that we don’t talk about. It is a question of the timing. I think today we are probably looking at most of the important things that need to be looked at.
00:47:11 [Speaker Changed] Huh, really interesting. So I only have you for a certain amount of time, but let me jump to my favorite questions. Tell us about your early mentors who helped shape your career.
00:47:22 [Speaker Changed] So, you know, my earliest mentor, I’d have to say is, is my father. I grew up in India. In India. The path that I followed is not very traditional and I have two brothers and my father always treated me exactly the same as my brothers. And so in a sense, when people ask me even today, how do you get, you know, more women into the workplace? And I get asked this question around the world when I go to our different offices, I tell everyone, you know, encourage your daughters, your sisters, your wives to be in finance and they will be in finance. My father did not encourage me to be in finance. He did encourage me to think exactly the way frankly my brothers were thinking in terms of what the future held. So he was my earliest mentor. Second mentor, I would have to say is one of my first mission chiefs at the IMF Paul Thompson, who subsequently actually led missions to Greece and became the director of the European Department. He was my first mission chief and he is an amazing negotiator. And I still find myself using hand gestures that I’ve see, I’ve learned from him and I still find myself doing this. How amazing is that? ’cause now you’re talking about a very long time ago and he definitely shaped how I work in the workplace.
00:48:48 [Speaker Changed] Completely. Huh. Really, really interesting. Let’s talk about books. What are some of your favorites? What are you reading right now? Okay,
00:48:55 [Speaker Changed] So some of my favorites, I’ve got an enormously varied, the only thing I don’t read is horror of any kind. I I, it scares me too much, my imagination’s too real. But if I think about things I always go back to, I will throw, throw out. There’s the master in Margarita, which is Mikhail ov, which was the first first book which actually seen it. It was Transcend transcendental, I think Love, pride and Prejudice. I love the Lord of the Rings. And currently I’m reading Urban Fantasy, it’s called the, the author’s names are Elona Andrews, Kate Daniels. It’s very escapist. It’s about as, as escapist as anything I think you would watch on Netflix. It is absolutely fantastic. What’s,
00:49:43 [Speaker Changed] What’s the title?
00:49:44 [Speaker Changed] So it’s a series of books. The protagonist is called Kate Daniels, and I think the first one was Magic Bites or something like that. It’s set in a dystopian Atlanta where you have a mixture of various types of supernatural elements and things like that. It’s really cool,
00:50:02 [Speaker Changed] Huh, really interesting. Our final two questions. What sort of advice would you give to a recent college grad interested in a career in either fixed income or investing?
00:50:14 [Speaker Changed] Number one, be extremely curious. Right? Extremely curious. I would note that learn to do research. I’m not talking about research I, what I’m saying is, especially today with Gen ai, I think one of the worst things is immediately having answers. Because if you don’t learn to spend the time to dig really, really deep into different areas, I don’t think you’re going to find answers. You’re not going to be able to find the answers all written in the first three lines of a Google search. Actually, I do think that people coming fresh into the markets that we have, they need to read a little bit more about what has gone before them. I think there are some brilliant books out there. I would call out Ken Roff and Carmen Reinhart have a couple of them. It’s just a good, this
00:51:11 [Speaker Changed] Time is different.
00:51:12 [Speaker Changed] Yeah. This time. This time it’s different. It’s fantastic. And, and your book, Barry, I’m gonna give you that shout out because I think it’s good to actually read practitioners books because we live in bizarre times and many people will not have seen the various cycles. Hi
00:51:30 [Speaker Changed] History. You know, those of us who don’t learn from history are condemned to, to repeat it.
00:51:36 [Speaker Changed] There’s that part of it. And I think the other piece I would say is, it’s very hard. I know, but try not to be too impatient. Hmm. If you can’t go through a few market cycles, it’s very difficult to really understand my markets. Right. So I, I don’t believe in time and grade. I’m all for people jumping ahead, but sometimes nothing substitutes for actually living through different market cycles in our business.
00:52:08 [Speaker Changed] Huh. Really, really interesting. What do you know about the world of investing today? You wish you knew 30 years or so ago when you were first getting started?
00:52:17 [Speaker Changed] You know, the biggest thing I’d say is that nothing, while in the moment it feels like the catastrophe is going to end the world. Number one, it won’t. Number two cycles end. I would’ve had a lot fewer sleepless nights if I could have just calmed myself down and said, okay, this too will pass. And so I think, I think that there is a, there is an element of just knowing that, you know, this is a part of what we do.
00:52:51 [Speaker Changed] Really. So interesting. Thank you Sonal for being so generous with your time. We have been speaking with Sun Desai. She’s Chief Investment Officer for Franklin Templeton’s Fixed Income Group. If you enjoy this conversation, well check out any of the 500 we’ve done over the past 11 years. You can find those at iTunes, Spotify, YouTube, Bloomberg, wherever you find your favorite podcast. And be sure and check out my new book, how Not to invest the ideas, numbers, and behavior that destroys wealth and how to avoid them, how not to invest at your favorite bookseller. I would be remiss if I did not thank the crack team that helps us put these conversations together each week. Meredith Frank is my audio engineer. Anna Luke is my producer. Sean Russo is my researcher. Sage Bauman is the head of podcast at Bloomberg. I’m Barry Ltz. You are listening to Masters in Business on Bloomberg Radio.
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