Greg: Well, welcome everyone to the latest episode of Streaming Income, a podcast from Barings. This is a show where we talk about all things alternative investments from credit and real assets to capital solutions and emerging markets. You can follow Streaming Income on Apple Podcasts, Spotify and YouTube and subscribe to our LinkedIn newsletter, Where Credit Is Due.
I'm your host, Greg Campion, and I'm delighted to be joined today by Trevor Slaven, Barings Global Head of Asset Allocation and Multi-Asset Portfolio Solutions. Trevor, how's it going?
Trevor: It's going great. Happy to be here. First podcast, so looking forward to this. Hopefully not the last. We'll see.
Greg: I have a feeling you're gonna be a repeat guest already, and obviously, we've done some stuff together in the past with some of our outlook content, which has been awesome. All right, so the reason we-- the kinda impetus for this discussion was you and your team just wrote a super interesting paper, replacing equity beta with high carry credit.
Really caught my attention. I think it's catching the attention of a lot of others as well. So I thought, why don't we have a conversation where we kinda run through the key conclusions of this piece and give people an idea of kind of, you know, how you got to these conclusions and, you know, some of the key takeaways.
So let's start very high level. Like, talk to me just about your overall thesis for the paper and, let's start there.
Trevor: Yeah. I would say, you know, the very kind of like, sixty-second direct answer to that is, I think for the first time in probably ten or fifteen years, I think you can make a really compelling case for why, if you take a strategic view, so let's just say strategic view is two years out, three years, four years, something like that, that over the next two, three, four years, that things like high yield credit, can outperform what I'm just calling generic equity beta.
Let's just say the S&P 500 or S&P equal weight, something like that, can outperform over the next, let's call it three years. Which has obviously not been the case for really the last fifteen. And so, I think maybe there's a sense of people have been lulled into a really, really good run of equity performance.
You know, at the same time that fixed income, partly because of low rates, which we'll talk about for much of the last decade, you know, the opportunist- opportunities, that hasn't been as exciting. And I think that the tide is turning here where you're really raising the probability of, I think, getting pretty attractive returns from credit because of where yields are and because of some potential total return tailwind. If we get lower yields over the next, say, three years, at the same time that, you know, comparing that to the equity market, you know, we have really good earnings today, but part of the enthusiasm around that earnings growth has brought forward PE multiples, you know, in certain parts of the market.
And so even though I think earnings will continue to be strong over the next, again, let's say three years, I think you're raising the probability of getting a headwind to return from potential multiple compression. And so that's where I think there's a dynamic at play of replacing some generic equity beta with credit.
And maybe one other point there too is because of this AI boom that's so incredibly influential from an economic perspective, and therefore certainly for equity markets, you're getting this historic earnings growth that's heavily concentrated in a few names. You know, one or two sectors.
And so a big part of the piece isn't, hey, let me just get rid of equity and replace it with credit. It's as we think about those relative allocations, let's also talk about within your equity allocation, concentrating even more of that risk in the parts of the market that can grow. Because there, I think you-- there is gonna be this ability to capture, you know, if investors have always looked for, "Hey, how do I get eight, nine, ten percent out of equities?"
I think if you can get twenty percent from these, you know, rapidly growing sectors, then you actually only need, you know, half the allocation, if you will, to get the same sort of portfolio outcome from that equity piece. And so I think that's the big conclusion.
Greg: Yeah. Okay. Okay, cool. That's, that's a great, great sort of intro and overview and gives me so much to dig into, because I have so many follow-up questions on the back of that.
But, I would say, and of course, when we're talking about returns, this is, I would say just like a disclaimer here. Obviously, past performance is no guarantee of future results.
So if we're quoting, you know, the potential for a twenty percent return in equities or something like that, you know, of course, we're looking at historical performance, but just wanted to reiterate that. Certainly, no guarantees of future performance. One of the things I wanna talk about is the long-term nature of this call, it seems very much more of a strategic shift than a tactical shift.
And I wanted to quote something that you wrote in the paper.
So you say in the piece, "Secular changes in asset allocation may only arise once a decade. Today, we are seeing conditions to build toward a major rethink of portfolio construction for the years ahead, specifically the potential for high carry credit to outperform generic equity beta over the next three to five years, especially on a risk-adjusted basis."
Basically, what you just told me. But, so what I want to ask you about, though, is what's-- like take us back for a second and, look at the conditions over the last fifteen years. And, like, what is true today that wasn't true over the last fifteen years?
Trevor: Yeah, for sure. So. I think in so many ways, you know, you go back to, let's just say, two thousand and ten, to pick a point in time.
There've been the, I think an incredible set of conditions that have mostly benefited the equity market through time. And, you know, in no particular order, you know, for much of the last fifteen years, Fed policy was held at you know, zero rates, or you know, at or below neutral rates.
We saw that globally, with most central banks, certainly leading up to twenty twenty-two. We saw, you know, massive central bank balance sheet expansion, upping liquidity into the system, trying to foster kinda more risk-taking sentiment. You know, we had, you know, corporate tax rates were cut in, I believe, twenty seventeen from thirty-five to twenty-one.
And so you've had a number of kind of macro influences that I think have benefited. You know, it pushed people down the capital stack and made it comfortable to take, you know, take equity risk. But I think maybe the biggest evolution, and you're seeing this play out today- is this emergence and proliferation of these asset light, digital, tech-oriented, business models.
And so, that has created a very real fundamental tailwind for equities. And so, you know, that's where I would say, that's no different today, that piece of it. And in fact, we're seeing kind of, you know, maybe a denouement of excitement around the, the potential profitability for some of these companies, but that's where I would just maybe point out a couple things.
One is, you know, PE multiples tend to be procyclical with earnings growth, meaning as earnings accelerate, you know, enthusiasm picks up and multiples, you know, tend to expand. And that's where I think, again, with a longer term perspective, that's where you're sort of starting to tilt the probabilities to some potential future compression after we get through what is this incredible excitement of twenty twenty-six and twenty twenty-seven, earnings.
And then I think the other, you know, part on the fixed income side is you've moved from a period where base rates were held incredibly low. You know, all the QE, all the bond buying held down term premi. And now you've done a total reversal there of obviously central banks tightened dramatically in twenty two, twenty three.
We're still, you know, at or near kinda the high levels of interest rates for the last fifteen years. And so you've put much more attractive nominal and real interest rate yields into the market, and you've attached some term premi to that as well for the first time in, again, fifteen years.
And I think maybe the beauty of fixed income is, you know, this idea that your carry, you go back to those two, you know, potential sources of return. I can earn carry, I can get total return. Your carry and your total return potential are correlated positively in fixed income of the higher my yields are today, the higher my carry, and the greater the probability, at least in theory, that I have room for potential yield compression going forward to generate those returns.
Greg: Yeah. So as you look at-- if, as you do that sort of equities fixed income comparison. I mean, talk to me just about, you know, what is the, you know, PE multiple today imply for, you know, future performance for equities?
And then similarly, you know, what's that metric, you know, that whether it's earnings yield or something else that you, that makes that comparison with fixed income easiest for investors to get their heads around?
Trevor: Yeah, for sure. And maybe just briefly again, in the last fifteen-- you know, we, we've gotten for the last ten, fifteen years about eight and a half, nine percent earnings growth on average from the S&P, pretty darn impressive. But we also had multiples expand from fourteen to twenty-two. So a nice, again, major tailwind to performance on the total return side.
Today, now that you're at, call it twenty-two, twenty thir- twenty-three times PE- You know, you're, you're, you're getting somewhere of like a four and a quarter, four and a half type earnings yield, so one over twenty-two or one over twenty-three. And so your earnings yield in equities, again, call it four and a quarter, four and a half.
At the same time, again, your treasury is coming in this morning. I think they're at four fifty-seven, as we do this. And so you're actually at a place where you're getting technically more yield from just your treasury market alone relative to equities. That's something that hasn't really been true since, again, almost twenty years ago.
Greg: Yeah.
Trevor: And so I think that's kind of the foundational, like, observation, and then I think going forward, again, you go back to this point of, okay, well, let's say earnings growth continues to be, you know, really good for the next three, four years, and I'm getting-- let's say you get ten, twelve percent earnings growth for them, which would be incredible.
To the extent that you take any multiple compression on top of that, you end up with a you know, a sort of an annual return that's like sevens, maybe eights. That's what you're getting in the high yield market today, but you're getting that high yield risk on one third of the volatility.
And so that's really part of the framework.
Greg: Okay. Maybe to play devil's advocate for a second. You could argue that, you know, what we're going through right now, like may-- there, there may be a this time is different- Sure... type of argument right now. So, with the just rapid acceleration of these revenues first from the likes of OpenAI, Anthropic, et cetera. You know, these guys are eating different industries, right? And, it is, you know, probably the closest we've seen to exponential growth in our lifetimes in terms of, you know, how rapidly we're seeing things evolve. It's always dangerous to say- is this time different?
But I just wanted to pose that question to you.
Trevor: So, I think there's a couple things to unpack here. One, I think absolutely, you know, some of these valuations are you know, defendable and justifiable, because of the reasons you described. You have these businesses that are able to have global, you know, instantaneous distribution of their business model or their service, you know, in an incredibly asset light way.
It's massively profitable. There's this, I think this growing list of concentration risks. I think there's also a huge difference between what's happening in terms of how the market's trying to think about, you know, OpenAI or Anthropic or SpaceX, versus some of the suppliers today.
So the SK hynix, the Samsungs, the Microns, et cetera. And so on the concentration risk one, you know, yes, we have really good earnings growth today, and I think that can sustain in all these, you know, brilliant CEOs who know way better than I do, you know, are saying, "Hey, look, we got two, three, four years of backlog here to go."
But you're getting so much of the index level earnings growth is heavily concentrated in five names, ten names. I mean, and so you're seeing like thirty-five, forty percent of the earnings growth come from the Mag Seven or coming from the chip manufacturers. And so it's heavily concentrated.
And again, remember, part of the-- a major part of the piece here isn't, hey, get out of equities and onto credit. Within equities, concentrate in those names that have this incredible, impressive growth. And because the growth potential is so massive there, but is likely more volatile, which I'll come back to in a second, you can build a really efficient portfolio on a smaller kind of market value allocation, and then you're getting a really good kind of portfolio, you know, vehicle for return on low volatility, high yield credit. So high concentration of earnings, therefore, I think you can focus on the tech. The, you know, the tech components or the EM components that are levered to tech as well. I would say, you know, again, coming with that earnings concentration is the return concentration that we've seen of, you know, a handful of names driving the vast majority of returns.
But then you also start to see these sort of circularity questions and things like Nvidia, where 80% of their revenue is concentrated in six customers. And of those six customers, I think four of them are other Mag Seven type names. And each one's profitability and spending is facilitating the other's profitability and spending.
And so it's this very competitive build-out that I think creates just ultimately a little more volatility, a little more vulnerability to it over a three, four year period. I think the other sources of concentration risk, and sorry, this is a long-winded answer, is, you know, you've gone from a moment in time attached to the incredible performance of these tech equities.
You've seen the wealth concentration in the country increase dramatically, and globally as well, where whether you wanna look at the top one percent or top ten percent, you know, they've gone-- top one percent's gone from twenty percent of all the wealth to now over fifty, and it's, you know, and it's exploding every month.
And so I think that increases your risk of... We talked about, you know, we lowered corporate taxes in twenty seventeen. As you start to get into political season here at the end of this year, obviously you're gonna have a new administration of some sort in twenty twenty-eight.
I think you're gonna raise the odds for, you know, wealth tax discussions, corporate tax discussions. And so, we're seeing some of that. And that'll in theory be a hindrance to the equity market. And then the final thing, and this is a little wonky, which so I apologize, is, and this gets back to the idea of talking about, you know, the AI models versus the kind of the input providers.
In these tech equities, you're seeing so much of the value is embedded in the terminal value of these entities in terms of thinking about like kind of, discounted cash flow. And so when you're looking at a SpaceX and you say, "Okay, are they gonna have impressive growth?" Almost certainly they're gonna have unbelievably, you know, impressive growth.
But trying to value that today implies putting a big multiple on a number that's ten years out in the future. And when you do that, just quantitatively, when so much of the value is embedded ten years out, that is an inherently more volatile.
Greg: Data centers on the moon are worth a lot of money in twenty years or whenever it is, right?
Yeah.
Trevor: And so any little change in the expectation of that growth leads to dramatic volatility in the present value of those cash flows. Yeah. And so, and then same thing with the the chip manufacturer. You know, the chip manufacturers today is they're printing money today, but they're historically incredibly cyclical businesses.
And so how durable is their cash flow generation today given this is... You know, I don't wanna say it's a one-time build-out. It's a multi-year build-out, but we're not gonna be building data centers like we are today in ten, twenty years. I don't... You know, would be my suspicion. And so we're extrapolating a lot of value onto the companies that we're hoping do well or that are doing well today, and that just makes for a more volatile construct.
Greg: Yeah. That point about so much of the value being sort of you know, in the out years essentially is... Really resonates with me. I think one thing that's, you know, potentially increases the risk of volatility is just how rapidly this whole landscape is evolving and all of the players and the business models is-- seems to be changing so rapidly.
And so, like, one thing that's, you know, I think we've, we've kinda thought about, okay, OpenAI and Anthropic, these are model companies, right? You have NVIDIA, okay, this is a chip company. But now the lines are really starting to blur, right? And there's, there's partnerships that are coming together.
Partnerships that are splitting apart, right? I know we've just had NVIDIA and Palantir have a partnership now on NVIDIA's open source model. So you're like, all of a sudden you're like, "Oh, okay, so NVIDIA's gonna compete as a model-" Sure "... you know, at the model layer as well." So you've got the kind of the hardware level, you've got the model level, you've got the application layer as well.
And so I think it's, you know, I think just today there was an announcement of, you know, Microsoft is going to use their own models in some versions of Excel and Outlook as, and kinda sunset OpenAI and Anthropic models. And you're like, "Wow, okay." So anyways, my point is just that the landscape is just, you know, it's almost like a musical chair situation where you're like, "How is this all gonna play out?"
And so to me, that whole concept is supportive of the point that, it seems like high growth all over the place, but like, how does it pan out for all these specific companies? And it is probably is gonna be a bumpy ride along the way.
Trevor: I think that's right. And it's because it's such a competitive dynamic and this competitive kind of build-out that almost necessarily leads to, you know, overextension, or overspending at some point in time.
And I think Mark Zuckerberg, I don't wanna misquote him, but, you know, said something to the effect of, you know, "If I have to-- If I spend in excess," you know, I can't remember if he said a hundred billion or some, some large number- but I win, then that will have been worth it." And I'm not saying that's, that's wrong.
I think that's actually probably the right mentality to have, but it demonstrates that his competitors are going to have the same mindset as well. And so I think that's where you have to just be a little mindful or wary of, again, that circularity and then extrapolating too much, you know, too far into the future.
And again, to your point, it's gonna be a more volatile ride. I feel very strongly about that, and that's where I think you get into the portfolio construct of, okay, if tech equities are gonna be the tail that wags the dog on equity volatility, but they deliver two, three, you know, magnitudes more growth potential.
Well, let me look for ways to, one, be really tactical with my equity exposure over the next two years, much more so than I have been the last ten, because of that volatility. But also let me make sure that I'm taking equity risk in places that can actually deliver that earnings growth.
And then when you separate out the, you know, a Russell 2000 or something like that, where those earnings yields are kind of on par with credit, that's where I think it really makes a ton of sense of, okay, I'll hold on to some of my tech equity, maybe a little bit of my EM equity, but I can really start to replace that generic equity volatility, with a much lower vol, high yield, you know, carry
Greg: So the non-tech sectors, non-EM sectors perhaps are giving you not the... Are not pulling their weight in the portfolio in terms of what they're generating earnings growth-wise relative to the volatility. I know you're looking at through, all of this through, like, a portfolio construction lens.
Yep. I think you've already, you know, done a really nice job of explaining the rationale. But anything else you would say just from a portfolio construction standpoint in terms of this idea that you're proposing?
Trevor: I mean, is it helpful to maybe just, like, throw out a couple high-level numbers sort of.
Yo know, so again, and as our anchor, we'd say, okay, the, you know, you take a traditional, you know, risk parity sixty/forty, you know, equity fixed income, and let's say that fixed income piece is in things like the ag. And again, if you assume, let's say my earnings growth for this generic equity beta is gonna be good, you know, eight percent or so for the next several years, you know, but maybe I don't get any multiple expansion from here.
Maybe I even have a risk of compression, but I get eight percent. Which by the way, that's... You look at Russell 2000, you look at the MSCI World, things like this, you know, 20, 25, 30, 40 years, that's their return profile.
Greg: And I say for our compliance colleagues, again, past performance, no guarantee of future results.
But this, is all very hypothetical, but I think it's a really interesting hypothetical scenario.
Trevor: Yeah. And just sort of putting anchors around the, you know, how we're thinking about the quantitative side of it. So okay, I get my eight percent from my, you know, 60% equity piece, and I get maybe five percent from my 40%, you know, fixed income piece.
Okay, so that gives me, you know, eight percent on sixty is about four point eight, you know, close to five. I get close to two, on my fixed income piece. So I've got this portfolio that's a seven percent returning portfolio, but with a decent amount of volatility because of the 60% weight in equities.
Again, if you say, "Okay, you know what?" I'll accept that equity volatility and maybe even a bit more in this really high growth tech, but because the earning-- the earnings growth potential there is in... It's twenty, it's thirty. You know, Samsung was up nineteen X quarter over. Like, it's, you know, these crazy numbers.
You know, there, maybe I can get an eighteen, a twenty, a twenty-five percent type return. And by the way, we've been seeing these little windows of, you know, the Nasdaq was up thirty-three percent in two months in, in April and May, which maybe I can come back to as well. But I'll take a smaller allocation, say thirty percent.
If I can get twenty out of that, because that's the level of earnings growth, that contributes six to the portfolio. I take the thirty that I don't have in generic equity beta, put it in things like high yield at seven. Thirty on seven gets me a little more than two, so now I'm at eight, and then I still have that forty percent of the portfolio left over.
Let's say that's in a low risk thing like the ag, you know, low credit risk I should say. And again, that gets me five percent on forty, that's two. All of a sudden now I've gone from a seven percent portfolio to a nine and a half percent portfolio, and I'm actually doing so with a lower volatility construct.
And so I think- So much of this is rooted on for the reasons that we described. I think equities can still have a good run over the next two years in particular. Let's just say eighteen months, two years. I don't wanna be too prescriptive there. I think it will be driven by tech, by AI, things of that nature.
But for the reasons we talked about, I think it's going to be tremendously more volatile going forward. And we've already seen that the last few months. We've seen, you know, Nasdaq equity volatility has doubled, you know, in just the last month or two. And so I don't need as big of an allocation that will allow me to have a more flexible mindset to play offense into the volatility instead of, you know, having a risk of panicking or being defensive.
And I have this really nice kind of income-generating machine in the rest of the portfolio that makes me even more comfortable about, you know, being able to play offense and be tactical with the equity piece. And my return contribution from the credit piece is the most compelling it's been in, you know, again, in ten, fifteen years on an absolute and relative basis.
Greg: Yeah. Okay. So, really interesting. I think it's interesting to put some numbers around that, even if they're hypothetical. And I know in the paper you go through an example too where you're, you know, looking at, okay, then what happens if you add, you know, a direct lending private credit exposure to this, and it looks like that moves you, you know, potentially to even more favorable position on a efficient frontier.
So it looks like there's some potential diversification benefits there as well. I do wanna ask you a couple of devil's advocate questions if you're okay. One of which is, I guess, you know, you had mentioned, the concept of diversification. Wanna talk about that because, you know, as you think about portfolio construction, obviously diversification is kinda the core tenant of traditional, you know, portfolio construction.
So I guess my devil's advocate questions in terms of thinking about this are a couple fold. One, are we giving enough credit to diversification, or are we focusing enough on diversification with this idea? Two, I guess, if you think about the exposures that you're advocating for, you know, how do you know, for instance, that the energy sector won't be the top performing sector over the next ten years? And then finally, you know, you brought up the volatility of tech, and we talked about that. But I guess, is there a risk in this strategy that you're advocating, that you end up owning the piece of equities with the highest volatility, potentially highest downside risk, depending on market conditions?
So, how would you kind of answer all of those?
Trevor: Yeah. I would say, try and get them in order. But I would say in terms of the diversification within equities, I think it's-- there's so many empirical studies of the benefits of adding, you know, of having a portfolio with a one hundred names is actually no more diverse than a portfolio with thirty names.
And so the diversification benefits, you know, drop off, quickly after, you know, those first thirty, forty names. And so I think, you know, point being, I think most equity exposure is probably overly diversified if you wanna use that term to begin with. You know, to your point on could energy be the best sector for the next ten years, absolutely.
Like, you know, who am I to say that it's not? But what I would say from a portfolio construction standpoint, a couple things stand out. One, you know, that sector, healthcare, staples, these other sectors, one, they're GDP type businesses. They tend to grow kind of, you know, their volumes in line with GDP.
There's no, like, outsized growth opportunity. They're very small weights in the sectors, and so, the benefit to your portfolio is gonna be pretty marginal, even if they are the outperformer. And because of that first point, what I would say is, if you told me that energy's the great performer of the next ten years, it's either because of poor performance in the equity market elsewhere in general, in which case I would say I'm glad we've gone from sixty percent to thirty. Or it's because of massive kind of price inflation in oil prices, which is not gonna be good for fixed income.
It's not gonna be good for rates or credit. It's gonna be even worse or certainly, you know, episodes like, twenty twenty-two with Russia, Ukraine. It proved to be worse for equities because that's the longest duration asset. And so, you know, that's a scenario that I think you're supposed to be willing to underwrite for those reasons.
And then in terms of, you know, what about the downside just being in tech. You know, could that be the case? Absolutely. What I would say is, certainly in the recent history, the last three, four, five years is, we've seen this kind of point six, point seven beta on the downside to the other low growth sectors.
And so, if you had equities, tech equities down twenty, you had the rest of the market was down, you know, twelve, fourteen, something like that, but with much, much less earnings growth, right? And so again, I would say that, you know, just be glad, I would be glad having a bit less equities in all those downside scenarios.
But then, you know, to me, if you told me, "Hey, what's the scenario where it's just tech that's falling and everything else is doing great?" It strikes me that because of the earnings backdrop, that would have to be on the backside of a situation where you've had an incredible run-up first, which I think is certainly very possible over the next, you know, year or two.
And that's where I would go back to this whole construct of, I think there's gonna be a lot of volatility. It's gonna be both down and up. You can-- but you're gonna get really, really good earnings growth from tech. And so if I can capture that in a more concentrated way, but be more tactical in my portfolio with all of my equity exposure, now I can weather the storm of that volatility.
I can play offense along the way, and have this really good kind of foundation of lower vol, you know, high carry credit at the same time.
Greg: Yeah. Yeah. And kind of one more related kinda devil's advocate question for you is that, you know, tech is not just an equity story, right? So we're talking about having, you know, the equity exposure concentrated in tech.
But as you look over to what's going on in credit markets, increasingly, we're seeing more and more, you know, it started it with IG, with data center paper. That's we're seeing that more in high yield now. So I guess the question is like, are you getting too much exposure to tech because that tech exposure is now growing in the credit markets as well?
Trevor: It's-- So the, you know, the financing that's needed to-- for this AI build out is massive, and as you say, it's permeating every market, and there's questions around like, "Is the next data center-- Is it an infrastructure deal, a real estate deal, an asset-based deal? Is it, you know, is it, you know, just, just corporate paper?"
And so- What I would say, and by the way, we saw early, you know, a couple of days ago, this Amazon, you know, was the latest iteration of doing a big bond sale. So what, what I would say is there sort of that pervasive risk across all financial markets right now? There is. It's most dramatic in equities.
And then I would say it's next kind of biggest imprint is in the investment grade market because of all these hyperscalers. They're all, you know, A-rated, or investment grade-rated companies. And so while there's a little bit of exposure and certainly some probably, you know, derivative exposure in things like high yield, the high yield market is a market that has grown much, much less over time, therefore, a much lower supply headwind, a much better technical aspect for buyers there.
And I think overall, a better technical environment on the supply perspective there.
Greg: Okay, cool. Covered a lot of ground here. So I appreciate you talking me through this. Closing question for you is just how do you think, you know, investors should action this piece of work that you've done?
I'm curious, just practically speaking. You put out a really thoughtful piece here. Just curious of how you think they may actually implement it, or think about it.
Trevor: So I would say, you know, one thing I've learned over the course of my career is the, you know, an individual's timeframe matters just as much as, you know, as the call, if you will.
And, you know, the old sayings like, "Bears make money, bulls make money," and, you know, it depends on the timeframe. And we've have-- we have investors here at Barings that, you know, go from the very, very long-term- certainly with insurance to, you know, intermediate, and near term.
And so, I would say, you know, one, it depends on the investor, but I think to me, maybe part of the highest sort of conviction piece of this or the, you know, the amalgamation of those conviction views is I think we're supposed to expect more volatility in equities over the next two, three, four years.
You know, higher volatility, in theory, you're supposed to lower some exposure there a little bit. At the same time, again, you're getting these-- this very attractive competitive yield from fixed income, from high yield credit, from direct lending, on much, much lower volatility. And so to me, I think there's this very real argument for, you know, whether you wanna think about it on my marginal dollar, or a wholesale portfolio, you know, allocation change.
I think there's a lot of to think about, and I think there is a very real case to make on making that wholesale allocation change. And I think the important thing is for investors not to forget, you know, what is their mandate? What are their portfolio goals? And it's, is my goal to make 8% a year? Is it to make 6? Is it make 10? On what kind of volatility profile? Because you can get lost along the way when you have markets like we're in right now of, you know, immense earnings growth in equities. And so that's where I think keeping that mindset of, okay, you know what? I'm never gonna call the exact top, I'm never gonna call the bottom, but if I'm gonna get a lot more return from my equity piece, then I don't need as much to meet my portfolio goals.
If it's gonna be a lot more volatile, then I probably shouldn't have as much. And by having less today and having a really good alternative to replace that return and on lower vol with credit, that gives me a more flexibility to then be able to survive, and again, I would say play offense in this environment that we're saying it's gonna be more volatile.
And so I think that, you know, I think there's a really coherent argument there for, you know, considering a bigger, um, you know, wholesale change to constructing portfolios.
Greg: Yeah. Awesome. Well, if nothing else, I think that you're probably sparking some thought here for our clients out there.
And so, I'm sure everybody appreciates that. Let's leave it there. I would say thank you to everyone for listening. You can go and find this piece on barings.com. Again, it's called Replacing Equity Beta with High Carry Credit. So check that out on barings.com. It's also, we'll link to it in the show notes of this episode.
Go follow Trevor on LinkedIn. He's, doing some really thoughtful posts out there. He's got his LinkedIn newsletter now called The 10 Count, where he is, roughly monthly putting out a newsletter with 10 of the most interesting charts that kind of reveal themes and markets for the months ahead.
So very, you know, thoughtful piece of work there every month or so. You can also follow Barings on LinkedIn and subscribe to our monthly credit-focused newsletter, Where Credit Is Due. And finally, make sure you're following Streaming Income on Apple Podcasts, Spotify, or YouTube to stay up with- to stay up to date with our latest episodes.
Trevor, thank you for joining me. Thanks for having me. And thank you for our listeners and our viewers for spending some time with us. We will see you next time
I'm your host, Greg Campion, and I'm delighted to be joined today by Trevor Slaven, Barings Global Head of Asset Allocation and Multi-Asset Portfolio Solutions. Trevor, how's it going?
Trevor: It's going great. Happy to be here. First podcast, so looking forward to this. Hopefully not the last. We'll see.
Greg: I have a feeling you're gonna be a repeat guest already, and obviously, we've done some stuff together in the past with some of our outlook content, which has been awesome. All right, so the reason we-- the kinda impetus for this discussion was you and your team just wrote a super interesting paper, replacing equity beta with high carry credit.
Really caught my attention. I think it's catching the attention of a lot of others as well. So I thought, why don't we have a conversation where we kinda run through the key conclusions of this piece and give people an idea of kind of, you know, how you got to these conclusions and, you know, some of the key takeaways.
So let's start very high level. Like, talk to me just about your overall thesis for the paper and, let's start there.
Trevor: Yeah. I would say, you know, the very kind of like, sixty-second direct answer to that is, I think for the first time in probably ten or fifteen years, I think you can make a really compelling case for why, if you take a strategic view, so let's just say strategic view is two years out, three years, four years, something like that, that over the next two, three, four years, that things like high yield credit, can outperform what I'm just calling generic equity beta.
Let's just say the S&P 500 or S&P equal weight, something like that, can outperform over the next, let's call it three years. Which has obviously not been the case for really the last fifteen. And so, I think maybe there's a sense of people have been lulled into a really, really good run of equity performance.
You know, at the same time that fixed income, partly because of low rates, which we'll talk about for much of the last decade, you know, the opportunist- opportunities, that hasn't been as exciting. And I think that the tide is turning here where you're really raising the probability of, I think, getting pretty attractive returns from credit because of where yields are and because of some potential total return tailwind. If we get lower yields over the next, say, three years, at the same time that, you know, comparing that to the equity market, you know, we have really good earnings today, but part of the enthusiasm around that earnings growth has brought forward PE multiples, you know, in certain parts of the market.
And so even though I think earnings will continue to be strong over the next, again, let's say three years, I think you're raising the probability of getting a headwind to return from potential multiple compression. And so that's where I think there's a dynamic at play of replacing some generic equity beta with credit.
And maybe one other point there too is because of this AI boom that's so incredibly influential from an economic perspective, and therefore certainly for equity markets, you're getting this historic earnings growth that's heavily concentrated in a few names. You know, one or two sectors.
And so a big part of the piece isn't, hey, let me just get rid of equity and replace it with credit. It's as we think about those relative allocations, let's also talk about within your equity allocation, concentrating even more of that risk in the parts of the market that can grow. Because there, I think you-- there is gonna be this ability to capture, you know, if investors have always looked for, "Hey, how do I get eight, nine, ten percent out of equities?"
I think if you can get twenty percent from these, you know, rapidly growing sectors, then you actually only need, you know, half the allocation, if you will, to get the same sort of portfolio outcome from that equity piece. And so I think that's the big conclusion.
Greg: Yeah. Okay. Okay, cool. That's, that's a great, great sort of intro and overview and gives me so much to dig into, because I have so many follow-up questions on the back of that.
But, I would say, and of course, when we're talking about returns, this is, I would say just like a disclaimer here. Obviously, past performance is no guarantee of future results.
So if we're quoting, you know, the potential for a twenty percent return in equities or something like that, you know, of course, we're looking at historical performance, but just wanted to reiterate that. Certainly, no guarantees of future performance. One of the things I wanna talk about is the long-term nature of this call, it seems very much more of a strategic shift than a tactical shift.
And I wanted to quote something that you wrote in the paper.
So you say in the piece, "Secular changes in asset allocation may only arise once a decade. Today, we are seeing conditions to build toward a major rethink of portfolio construction for the years ahead, specifically the potential for high carry credit to outperform generic equity beta over the next three to five years, especially on a risk-adjusted basis."
Basically, what you just told me. But, so what I want to ask you about, though, is what's-- like take us back for a second and, look at the conditions over the last fifteen years. And, like, what is true today that wasn't true over the last fifteen years?
Trevor: Yeah, for sure. So. I think in so many ways, you know, you go back to, let's just say, two thousand and ten, to pick a point in time.
There've been the, I think an incredible set of conditions that have mostly benefited the equity market through time. And, you know, in no particular order, you know, for much of the last fifteen years, Fed policy was held at you know, zero rates, or you know, at or below neutral rates.
We saw that globally, with most central banks, certainly leading up to twenty twenty-two. We saw, you know, massive central bank balance sheet expansion, upping liquidity into the system, trying to foster kinda more risk-taking sentiment. You know, we had, you know, corporate tax rates were cut in, I believe, twenty seventeen from thirty-five to twenty-one.
And so you've had a number of kind of macro influences that I think have benefited. You know, it pushed people down the capital stack and made it comfortable to take, you know, take equity risk. But I think maybe the biggest evolution, and you're seeing this play out today- is this emergence and proliferation of these asset light, digital, tech-oriented, business models.
And so, that has created a very real fundamental tailwind for equities. And so, you know, that's where I would say, that's no different today, that piece of it. And in fact, we're seeing kind of, you know, maybe a denouement of excitement around the, the potential profitability for some of these companies, but that's where I would just maybe point out a couple things.
One is, you know, PE multiples tend to be procyclical with earnings growth, meaning as earnings accelerate, you know, enthusiasm picks up and multiples, you know, tend to expand. And that's where I think, again, with a longer term perspective, that's where you're sort of starting to tilt the probabilities to some potential future compression after we get through what is this incredible excitement of twenty twenty-six and twenty twenty-seven, earnings.
And then I think the other, you know, part on the fixed income side is you've moved from a period where base rates were held incredibly low. You know, all the QE, all the bond buying held down term premi. And now you've done a total reversal there of obviously central banks tightened dramatically in twenty two, twenty three.
We're still, you know, at or near kinda the high levels of interest rates for the last fifteen years. And so you've put much more attractive nominal and real interest rate yields into the market, and you've attached some term premi to that as well for the first time in, again, fifteen years.
And I think maybe the beauty of fixed income is, you know, this idea that your carry, you go back to those two, you know, potential sources of return. I can earn carry, I can get total return. Your carry and your total return potential are correlated positively in fixed income of the higher my yields are today, the higher my carry, and the greater the probability, at least in theory, that I have room for potential yield compression going forward to generate those returns.
Greg: Yeah. So as you look at-- if, as you do that sort of equities fixed income comparison. I mean, talk to me just about, you know, what is the, you know, PE multiple today imply for, you know, future performance for equities?
And then similarly, you know, what's that metric, you know, that whether it's earnings yield or something else that you, that makes that comparison with fixed income easiest for investors to get their heads around?
Trevor: Yeah, for sure. And maybe just briefly again, in the last fifteen-- you know, we, we've gotten for the last ten, fifteen years about eight and a half, nine percent earnings growth on average from the S&P, pretty darn impressive. But we also had multiples expand from fourteen to twenty-two. So a nice, again, major tailwind to performance on the total return side.
Today, now that you're at, call it twenty-two, twenty thir- twenty-three times PE- You know, you're, you're, you're getting somewhere of like a four and a quarter, four and a half type earnings yield, so one over twenty-two or one over twenty-three. And so your earnings yield in equities, again, call it four and a quarter, four and a half.
At the same time, again, your treasury is coming in this morning. I think they're at four fifty-seven, as we do this. And so you're actually at a place where you're getting technically more yield from just your treasury market alone relative to equities. That's something that hasn't really been true since, again, almost twenty years ago.
Greg: Yeah.
Trevor: And so I think that's kind of the foundational, like, observation, and then I think going forward, again, you go back to this point of, okay, well, let's say earnings growth continues to be, you know, really good for the next three, four years, and I'm getting-- let's say you get ten, twelve percent earnings growth for them, which would be incredible.
To the extent that you take any multiple compression on top of that, you end up with a you know, a sort of an annual return that's like sevens, maybe eights. That's what you're getting in the high yield market today, but you're getting that high yield risk on one third of the volatility.
And so that's really part of the framework.
Greg: Okay. Maybe to play devil's advocate for a second. You could argue that, you know, what we're going through right now, like may-- there, there may be a this time is different- Sure... type of argument right now. So, with the just rapid acceleration of these revenues first from the likes of OpenAI, Anthropic, et cetera. You know, these guys are eating different industries, right? And, it is, you know, probably the closest we've seen to exponential growth in our lifetimes in terms of, you know, how rapidly we're seeing things evolve. It's always dangerous to say- is this time different?
But I just wanted to pose that question to you.
Trevor: So, I think there's a couple things to unpack here. One, I think absolutely, you know, some of these valuations are you know, defendable and justifiable, because of the reasons you described. You have these businesses that are able to have global, you know, instantaneous distribution of their business model or their service, you know, in an incredibly asset light way.
It's massively profitable. There's this, I think this growing list of concentration risks. I think there's also a huge difference between what's happening in terms of how the market's trying to think about, you know, OpenAI or Anthropic or SpaceX, versus some of the suppliers today.
So the SK hynix, the Samsungs, the Microns, et cetera. And so on the concentration risk one, you know, yes, we have really good earnings growth today, and I think that can sustain in all these, you know, brilliant CEOs who know way better than I do, you know, are saying, "Hey, look, we got two, three, four years of backlog here to go."
But you're getting so much of the index level earnings growth is heavily concentrated in five names, ten names. I mean, and so you're seeing like thirty-five, forty percent of the earnings growth come from the Mag Seven or coming from the chip manufacturers. And so it's heavily concentrated.
And again, remember, part of the-- a major part of the piece here isn't, hey, get out of equities and onto credit. Within equities, concentrate in those names that have this incredible, impressive growth. And because the growth potential is so massive there, but is likely more volatile, which I'll come back to in a second, you can build a really efficient portfolio on a smaller kind of market value allocation, and then you're getting a really good kind of portfolio, you know, vehicle for return on low volatility, high yield credit. So high concentration of earnings, therefore, I think you can focus on the tech. The, you know, the tech components or the EM components that are levered to tech as well. I would say, you know, again, coming with that earnings concentration is the return concentration that we've seen of, you know, a handful of names driving the vast majority of returns.
But then you also start to see these sort of circularity questions and things like Nvidia, where 80% of their revenue is concentrated in six customers. And of those six customers, I think four of them are other Mag Seven type names. And each one's profitability and spending is facilitating the other's profitability and spending.
And so it's this very competitive build-out that I think creates just ultimately a little more volatility, a little more vulnerability to it over a three, four year period. I think the other sources of concentration risk, and sorry, this is a long-winded answer, is, you know, you've gone from a moment in time attached to the incredible performance of these tech equities.
You've seen the wealth concentration in the country increase dramatically, and globally as well, where whether you wanna look at the top one percent or top ten percent, you know, they've gone-- top one percent's gone from twenty percent of all the wealth to now over fifty, and it's, you know, and it's exploding every month.
And so I think that increases your risk of... We talked about, you know, we lowered corporate taxes in twenty seventeen. As you start to get into political season here at the end of this year, obviously you're gonna have a new administration of some sort in twenty twenty-eight.
I think you're gonna raise the odds for, you know, wealth tax discussions, corporate tax discussions. And so, we're seeing some of that. And that'll in theory be a hindrance to the equity market. And then the final thing, and this is a little wonky, which so I apologize, is, and this gets back to the idea of talking about, you know, the AI models versus the kind of the input providers.
In these tech equities, you're seeing so much of the value is embedded in the terminal value of these entities in terms of thinking about like kind of, discounted cash flow. And so when you're looking at a SpaceX and you say, "Okay, are they gonna have impressive growth?" Almost certainly they're gonna have unbelievably, you know, impressive growth.
But trying to value that today implies putting a big multiple on a number that's ten years out in the future. And when you do that, just quantitatively, when so much of the value is embedded ten years out, that is an inherently more volatile.
Greg: Data centers on the moon are worth a lot of money in twenty years or whenever it is, right?
Yeah.
Trevor: And so any little change in the expectation of that growth leads to dramatic volatility in the present value of those cash flows. Yeah. And so, and then same thing with the the chip manufacturer. You know, the chip manufacturers today is they're printing money today, but they're historically incredibly cyclical businesses.
And so how durable is their cash flow generation today given this is... You know, I don't wanna say it's a one-time build-out. It's a multi-year build-out, but we're not gonna be building data centers like we are today in ten, twenty years. I don't... You know, would be my suspicion. And so we're extrapolating a lot of value onto the companies that we're hoping do well or that are doing well today, and that just makes for a more volatile construct.
Greg: Yeah. That point about so much of the value being sort of you know, in the out years essentially is... Really resonates with me. I think one thing that's, you know, potentially increases the risk of volatility is just how rapidly this whole landscape is evolving and all of the players and the business models is-- seems to be changing so rapidly.
And so, like, one thing that's, you know, I think we've, we've kinda thought about, okay, OpenAI and Anthropic, these are model companies, right? You have NVIDIA, okay, this is a chip company. But now the lines are really starting to blur, right? And there's, there's partnerships that are coming together.
Partnerships that are splitting apart, right? I know we've just had NVIDIA and Palantir have a partnership now on NVIDIA's open source model. So you're like, all of a sudden you're like, "Oh, okay, so NVIDIA's gonna compete as a model-" Sure "... you know, at the model layer as well." So you've got the kind of the hardware level, you've got the model level, you've got the application layer as well.
And so I think it's, you know, I think just today there was an announcement of, you know, Microsoft is going to use their own models in some versions of Excel and Outlook as, and kinda sunset OpenAI and Anthropic models. And you're like, "Wow, okay." So anyways, my point is just that the landscape is just, you know, it's almost like a musical chair situation where you're like, "How is this all gonna play out?"
And so to me, that whole concept is supportive of the point that, it seems like high growth all over the place, but like, how does it pan out for all these specific companies? And it is probably is gonna be a bumpy ride along the way.
Trevor: I think that's right. And it's because it's such a competitive dynamic and this competitive kind of build-out that almost necessarily leads to, you know, overextension, or overspending at some point in time.
And I think Mark Zuckerberg, I don't wanna misquote him, but, you know, said something to the effect of, you know, "If I have to-- If I spend in excess," you know, I can't remember if he said a hundred billion or some, some large number- but I win, then that will have been worth it." And I'm not saying that's, that's wrong.
I think that's actually probably the right mentality to have, but it demonstrates that his competitors are going to have the same mindset as well. And so I think that's where you have to just be a little mindful or wary of, again, that circularity and then extrapolating too much, you know, too far into the future.
And again, to your point, it's gonna be a more volatile ride. I feel very strongly about that, and that's where I think you get into the portfolio construct of, okay, if tech equities are gonna be the tail that wags the dog on equity volatility, but they deliver two, three, you know, magnitudes more growth potential.
Well, let me look for ways to, one, be really tactical with my equity exposure over the next two years, much more so than I have been the last ten, because of that volatility. But also let me make sure that I'm taking equity risk in places that can actually deliver that earnings growth.
And then when you separate out the, you know, a Russell 2000 or something like that, where those earnings yields are kind of on par with credit, that's where I think it really makes a ton of sense of, okay, I'll hold on to some of my tech equity, maybe a little bit of my EM equity, but I can really start to replace that generic equity volatility, with a much lower vol, high yield, you know, carry
Greg: So the non-tech sectors, non-EM sectors perhaps are giving you not the... Are not pulling their weight in the portfolio in terms of what they're generating earnings growth-wise relative to the volatility. I know you're looking at through, all of this through, like, a portfolio construction lens.
Yep. I think you've already, you know, done a really nice job of explaining the rationale. But anything else you would say just from a portfolio construction standpoint in terms of this idea that you're proposing?
Trevor: I mean, is it helpful to maybe just, like, throw out a couple high-level numbers sort of.
Yo know, so again, and as our anchor, we'd say, okay, the, you know, you take a traditional, you know, risk parity sixty/forty, you know, equity fixed income, and let's say that fixed income piece is in things like the ag. And again, if you assume, let's say my earnings growth for this generic equity beta is gonna be good, you know, eight percent or so for the next several years, you know, but maybe I don't get any multiple expansion from here.
Maybe I even have a risk of compression, but I get eight percent. Which by the way, that's... You look at Russell 2000, you look at the MSCI World, things like this, you know, 20, 25, 30, 40 years, that's their return profile.
Greg: And I say for our compliance colleagues, again, past performance, no guarantee of future results.
But this, is all very hypothetical, but I think it's a really interesting hypothetical scenario.
Trevor: Yeah. And just sort of putting anchors around the, you know, how we're thinking about the quantitative side of it. So okay, I get my eight percent from my, you know, 60% equity piece, and I get maybe five percent from my 40%, you know, fixed income piece.
Okay, so that gives me, you know, eight percent on sixty is about four point eight, you know, close to five. I get close to two, on my fixed income piece. So I've got this portfolio that's a seven percent returning portfolio, but with a decent amount of volatility because of the 60% weight in equities.
Again, if you say, "Okay, you know what?" I'll accept that equity volatility and maybe even a bit more in this really high growth tech, but because the earning-- the earnings growth potential there is in... It's twenty, it's thirty. You know, Samsung was up nineteen X quarter over. Like, it's, you know, these crazy numbers.
You know, there, maybe I can get an eighteen, a twenty, a twenty-five percent type return. And by the way, we've been seeing these little windows of, you know, the Nasdaq was up thirty-three percent in two months in, in April and May, which maybe I can come back to as well. But I'll take a smaller allocation, say thirty percent.
If I can get twenty out of that, because that's the level of earnings growth, that contributes six to the portfolio. I take the thirty that I don't have in generic equity beta, put it in things like high yield at seven. Thirty on seven gets me a little more than two, so now I'm at eight, and then I still have that forty percent of the portfolio left over.
Let's say that's in a low risk thing like the ag, you know, low credit risk I should say. And again, that gets me five percent on forty, that's two. All of a sudden now I've gone from a seven percent portfolio to a nine and a half percent portfolio, and I'm actually doing so with a lower volatility construct.
And so I think- So much of this is rooted on for the reasons that we described. I think equities can still have a good run over the next two years in particular. Let's just say eighteen months, two years. I don't wanna be too prescriptive there. I think it will be driven by tech, by AI, things of that nature.
But for the reasons we talked about, I think it's going to be tremendously more volatile going forward. And we've already seen that the last few months. We've seen, you know, Nasdaq equity volatility has doubled, you know, in just the last month or two. And so I don't need as big of an allocation that will allow me to have a more flexible mindset to play offense into the volatility instead of, you know, having a risk of panicking or being defensive.
And I have this really nice kind of income-generating machine in the rest of the portfolio that makes me even more comfortable about, you know, being able to play offense and be tactical with the equity piece. And my return contribution from the credit piece is the most compelling it's been in, you know, again, in ten, fifteen years on an absolute and relative basis.
Greg: Yeah. Okay. So, really interesting. I think it's interesting to put some numbers around that, even if they're hypothetical. And I know in the paper you go through an example too where you're, you know, looking at, okay, then what happens if you add, you know, a direct lending private credit exposure to this, and it looks like that moves you, you know, potentially to even more favorable position on a efficient frontier.
So it looks like there's some potential diversification benefits there as well. I do wanna ask you a couple of devil's advocate questions if you're okay. One of which is, I guess, you know, you had mentioned, the concept of diversification. Wanna talk about that because, you know, as you think about portfolio construction, obviously diversification is kinda the core tenant of traditional, you know, portfolio construction.
So I guess my devil's advocate questions in terms of thinking about this are a couple fold. One, are we giving enough credit to diversification, or are we focusing enough on diversification with this idea? Two, I guess, if you think about the exposures that you're advocating for, you know, how do you know, for instance, that the energy sector won't be the top performing sector over the next ten years? And then finally, you know, you brought up the volatility of tech, and we talked about that. But I guess, is there a risk in this strategy that you're advocating, that you end up owning the piece of equities with the highest volatility, potentially highest downside risk, depending on market conditions?
So, how would you kind of answer all of those?
Trevor: Yeah. I would say, try and get them in order. But I would say in terms of the diversification within equities, I think it's-- there's so many empirical studies of the benefits of adding, you know, of having a portfolio with a one hundred names is actually no more diverse than a portfolio with thirty names.
And so the diversification benefits, you know, drop off, quickly after, you know, those first thirty, forty names. And so I think, you know, point being, I think most equity exposure is probably overly diversified if you wanna use that term to begin with. You know, to your point on could energy be the best sector for the next ten years, absolutely.
Like, you know, who am I to say that it's not? But what I would say from a portfolio construction standpoint, a couple things stand out. One, you know, that sector, healthcare, staples, these other sectors, one, they're GDP type businesses. They tend to grow kind of, you know, their volumes in line with GDP.
There's no, like, outsized growth opportunity. They're very small weights in the sectors, and so, the benefit to your portfolio is gonna be pretty marginal, even if they are the outperformer. And because of that first point, what I would say is, if you told me that energy's the great performer of the next ten years, it's either because of poor performance in the equity market elsewhere in general, in which case I would say I'm glad we've gone from sixty percent to thirty. Or it's because of massive kind of price inflation in oil prices, which is not gonna be good for fixed income.
It's not gonna be good for rates or credit. It's gonna be even worse or certainly, you know, episodes like, twenty twenty-two with Russia, Ukraine. It proved to be worse for equities because that's the longest duration asset. And so, you know, that's a scenario that I think you're supposed to be willing to underwrite for those reasons.
And then in terms of, you know, what about the downside just being in tech. You know, could that be the case? Absolutely. What I would say is, certainly in the recent history, the last three, four, five years is, we've seen this kind of point six, point seven beta on the downside to the other low growth sectors.
And so, if you had equities, tech equities down twenty, you had the rest of the market was down, you know, twelve, fourteen, something like that, but with much, much less earnings growth, right? And so again, I would say that, you know, just be glad, I would be glad having a bit less equities in all those downside scenarios.
But then, you know, to me, if you told me, "Hey, what's the scenario where it's just tech that's falling and everything else is doing great?" It strikes me that because of the earnings backdrop, that would have to be on the backside of a situation where you've had an incredible run-up first, which I think is certainly very possible over the next, you know, year or two.
And that's where I would go back to this whole construct of, I think there's gonna be a lot of volatility. It's gonna be both down and up. You can-- but you're gonna get really, really good earnings growth from tech. And so if I can capture that in a more concentrated way, but be more tactical in my portfolio with all of my equity exposure, now I can weather the storm of that volatility.
I can play offense along the way, and have this really good kind of foundation of lower vol, you know, high carry credit at the same time.
Greg: Yeah. Yeah. And kind of one more related kinda devil's advocate question for you is that, you know, tech is not just an equity story, right? So we're talking about having, you know, the equity exposure concentrated in tech.
But as you look over to what's going on in credit markets, increasingly, we're seeing more and more, you know, it started it with IG, with data center paper. That's we're seeing that more in high yield now. So I guess the question is like, are you getting too much exposure to tech because that tech exposure is now growing in the credit markets as well?
Trevor: It's-- So the, you know, the financing that's needed to-- for this AI build out is massive, and as you say, it's permeating every market, and there's questions around like, "Is the next data center-- Is it an infrastructure deal, a real estate deal, an asset-based deal? Is it, you know, is it, you know, just, just corporate paper?"
And so- What I would say, and by the way, we saw early, you know, a couple of days ago, this Amazon, you know, was the latest iteration of doing a big bond sale. So what, what I would say is there sort of that pervasive risk across all financial markets right now? There is. It's most dramatic in equities.
And then I would say it's next kind of biggest imprint is in the investment grade market because of all these hyperscalers. They're all, you know, A-rated, or investment grade-rated companies. And so while there's a little bit of exposure and certainly some probably, you know, derivative exposure in things like high yield, the high yield market is a market that has grown much, much less over time, therefore, a much lower supply headwind, a much better technical aspect for buyers there.
And I think overall, a better technical environment on the supply perspective there.
Greg: Okay, cool. Covered a lot of ground here. So I appreciate you talking me through this. Closing question for you is just how do you think, you know, investors should action this piece of work that you've done?
I'm curious, just practically speaking. You put out a really thoughtful piece here. Just curious of how you think they may actually implement it, or think about it.
Trevor: So I would say, you know, one thing I've learned over the course of my career is the, you know, an individual's timeframe matters just as much as, you know, as the call, if you will.
And, you know, the old sayings like, "Bears make money, bulls make money," and, you know, it depends on the timeframe. And we've have-- we have investors here at Barings that, you know, go from the very, very long-term- certainly with insurance to, you know, intermediate, and near term.
And so, I would say, you know, one, it depends on the investor, but I think to me, maybe part of the highest sort of conviction piece of this or the, you know, the amalgamation of those conviction views is I think we're supposed to expect more volatility in equities over the next two, three, four years.
You know, higher volatility, in theory, you're supposed to lower some exposure there a little bit. At the same time, again, you're getting these-- this very attractive competitive yield from fixed income, from high yield credit, from direct lending, on much, much lower volatility. And so to me, I think there's this very real argument for, you know, whether you wanna think about it on my marginal dollar, or a wholesale portfolio, you know, allocation change.
I think there's a lot of to think about, and I think there is a very real case to make on making that wholesale allocation change. And I think the important thing is for investors not to forget, you know, what is their mandate? What are their portfolio goals? And it's, is my goal to make 8% a year? Is it to make 6? Is it make 10? On what kind of volatility profile? Because you can get lost along the way when you have markets like we're in right now of, you know, immense earnings growth in equities. And so that's where I think keeping that mindset of, okay, you know what? I'm never gonna call the exact top, I'm never gonna call the bottom, but if I'm gonna get a lot more return from my equity piece, then I don't need as much to meet my portfolio goals.
If it's gonna be a lot more volatile, then I probably shouldn't have as much. And by having less today and having a really good alternative to replace that return and on lower vol with credit, that gives me a more flexibility to then be able to survive, and again, I would say play offense in this environment that we're saying it's gonna be more volatile.
And so I think that, you know, I think there's a really coherent argument there for, you know, considering a bigger, um, you know, wholesale change to constructing portfolios.
Greg: Yeah. Awesome. Well, if nothing else, I think that you're probably sparking some thought here for our clients out there.
And so, I'm sure everybody appreciates that. Let's leave it there. I would say thank you to everyone for listening. You can go and find this piece on barings.com. Again, it's called Replacing Equity Beta with High Carry Credit. So check that out on barings.com. It's also, we'll link to it in the show notes of this episode.
Go follow Trevor on LinkedIn. He's, doing some really thoughtful posts out there. He's got his LinkedIn newsletter now called The 10 Count, where he is, roughly monthly putting out a newsletter with 10 of the most interesting charts that kind of reveal themes and markets for the months ahead.
So very, you know, thoughtful piece of work there every month or so. You can also follow Barings on LinkedIn and subscribe to our monthly credit-focused newsletter, Where Credit Is Due. And finally, make sure you're following Streaming Income on Apple Podcasts, Spotify, or YouTube to stay up with- to stay up to date with our latest episodes.
Trevor, thank you for joining me. Thanks for having me. And thank you for our listeners and our viewers for spending some time with us. We will see you next time
