[Offering a different and competitive fixed income option in the asset management industry is the result of many calculated and purposeful decisions. It requires the ability to ask a great deal of challenging questions and the patience to rethink everything about traditional business models and processes. It is not an easy exercise.
We luckily had the opportunity to explore and understand some of the thinking and steps that need to be taken when we were recently introduced to Matthew Duch, managing partner and CIO, of Channel Investment Partners—an Arlington, Va.-based registered investment advisor that manages collective investment trusts, separate accounts, and is the advisor to the Channel Short Duration Income Fund (CPSIX). We asked Matthew to outline how he structured his fixed income firm and investment process so that it was non-traditional and “built for what comes next.”]
Bill Hortz: What was the thinking behind how you purposely designed your firm and its investment culture into a “partnership of diverse skillsets”?
Matthew Duch: It is no secret that in a smaller firm you must do more with less. We cannot be a firm of specialists and compete with a smaller AUM base, as it is an expensive structure. Beyond keeping costs low, diverse skillsets also help to make better investing and business decisions. With the rise of certain outsourced business functions, i.e., administration, legal, some compliance, marketing, and distribution, etc., we can utilize top-notch shared resources at a competitive price and focus on investments and investor relationships.
Within this focus, we need portfolio managers with trading backgrounds who can communicate with investors, credit analysts with diverse research backgrounds and the ability to manage third-party research, and distribution partners that can market existing strategies but also engage us in finding solutions to investor needs that may lead to new products.
Hortz: Why do you have a mandate around what you characterize as the efficient Portfolio Manager/Trader model? What do you see as beneficial outcomes to this investment team structure?
Duch: Bond trading is often nuanced driven by technical levels and relative value analysis. Part of being a Portfolio Manager is absorbing massive amounts of commoditized information, digesting it in a unique way, and then expressing views in the portfolio based on risk/reward analysis. I believe there is an implicit bias in overly combining the Portfolio Manager/Research functions because if you spend a lot of time researching an investment, buy and hold it, but then you are inclined to continue to like it, thus selling becomes harder to do. Selling something you like is the hardest thing to do but price often dictates it.
For that reason, a PM/Trader function can constantly assess relative value, act quickly in volatile situations, and recognize liquid and illiquid situations. This last point is extremely important because illiquidity premiums play into relative value analysis.
My experience has been there are many portfolio managers who do not properly value illiquidity premiums and that is because they are not close to the trading function. Perceived liquidity can become no liquidity quickly in a volatile environment.
It is for those reasons that we have elevated the trading function to a key component of the fixed income investment team versus other firms that may outsource their trading function.
Hortz: As you have pointed out, certain inefficient processes and structures exist at firms which does lead to various cost cutting efforts. How do you think this has impacted the investment process and ability to recognize investment opportunities?
Duch: A lot of leadership looks at various department costs and see fixed income groups as a very expensive operation with high headcounts - Bloomberg terminal expense, trade order management and risk systems, rating agency and research service costs, no “soft dollars,” conference travel, etc. To cut costs, cutting headcount is the easiest way to do it as it also cuts several other attached costs. And when deciding where to cut, Traders are usually the first because it is not recognized as a source of Alpha and has often been relegated to an execution function that uses impersonal electronic trading platforms at many firms.
Further, if strictly an execution function, younger and less experienced people can fill the seats. With just an afternoon of closed-door HR meetings and key card submissions, firms can close their eyes and ears to liquidity, trading and syndicate desk sponsorship, and all sense of relative value. Take for example times of market stress, as we saw in March 2020. The electronic trading algorithms get turned off and electronic platforms become far less efficient. I heard several stories of buy side trading desks that did not know who to call or how to transact trades because they lost relationships. Could you imagine needing to get liquidity and not even knowing who to call? "
Hortz: How does this perspective inform your investment decisions and translate into relative investment benefits for your fixed income portfolios and clients?
Duch: When I started in the business, the “Three-Legged Stool” of Trading, Research, and Portfolio Management held equal value and were their own career paths. Each complemented the other with unique views of value and strategies. To reduce expenses, the pecking order became Portfolio Management, Research, and a skeleton trading desk. Most Portfolio Managers now started in Research out of business school and run portfolios almost entirely on creditworthiness, a very equity research approach. This approach ignores the bond trader motto of “No bad bond, just bad price.” Price is everything. A great credit bought wrong can underperform and a bad credit bought right can make all the difference in performance.
I maintain if you are going to connect two functions of the “Three-Legged Stool” to reduce headcount expenses, it is portfolio management with a trading background and not portfolio management with a research background. There are many trading opportunities to generate returns that have nothing to do with fundamentals. It is always a reconciliation of whether pricing drives fundamentals or fundamentals drives prices. So often, in debt financing, pricing drives fundamentals as it gets cheaper or more expensive to borrow.