Talk Your Book: Cash Was Easy… Now What?

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Welcome to Animal Spirits, I'm Michael and Ben. On today's show we spoke with Brandon Clark, ETF business director at Federated Hermes about income and how investors are behaving and responding to the shape of the yield curve today. My read on the situation is that investors are thinking Too much. About income. And not enough about what might happen.

If the economic and market environment shifts. Meaning they're pushing out on the on the risk curve, essentially? No, the opposite. Okay. They're getting too comfortable with cash because Oh. They're more on the short term side of things. Yeah, they're like, Oh, I don't want

I don't wanna go out on the curve, look how much volatility there is and I'm still getting paid, but that's That's missing a really key part of the equation. So peop people have gotten comfortable in a rising rate environment essentially. That they're pretend they're Investing like that is going to last much longer than it might.

Right. So not thinking about Well, wait a minute. What happens if Fed fund rates goes down by fifty basis points and I miss

The ability to lock in. Rates for a longer period of time. What happens if the economic environment softens and uh inflation comes in lower and then the five percent is now down to four percent and the bonds are Up three percent.

Like I just think they're just hyper focused on the income component. That's fair. If you would have said Six or seven years ago. Hey, the 10 years going to be at 4.7 and the 30 year is going to be at 5.3. Would you lock that in now? Yeah, give me give me all of it. Everyone would have said yes, give it and now we're there, people are going, Whoa, whoa, whoa, but what if the thirty year goes to six? And what if the five the ten year goes to five and a half?

People want to catch the uh The top or the bottom in this case, I suppose. Yes. That makes sense. But it is hard to believe. that we've gotten to this place where we call it more normalized or just r rising or stable yields, and you're right, and no one wants to touch them.

So I definitely comfort. I definitely am not of the opinion that Hey hey uh Dingling. Take your money out of cash and put it into thirty year bonds. It's not what I'm saying.

Right. But I you know, it's not it's I don't think all I don't think all or nothing is the right approach here. Um, and all of it being in cash is probably not the right approach either. I I don't think most people are doing that. But I think there's a lot of money that is that is Very comfortable in cash. Yeah, to your point.

If the Fed does low rates because growth slows and we go into recession, or whatever whatever the reason it doesn't even have to be a recession, really. It could just be inflation slows and the Fed Cuts rates. Because they're worried about AI Bubble bursting or whatever it is.

Uh by that point it's probably too late and you miss the moving bonds. Correct button. Right. And then you're sitting in lower cash and you go, Oh no, what and the people who are in the option income stuff, that's a different type of risk, obviously. There's equity related risk there. Right. Anyway, we talked about all these different angles of income. Here's our talk with Brandon Clark, Confederate Hermes. Brandon, welcome to the show. Thanks for having me.

Alright, so today we're gonna be covering all things income related. Not just on the fixed side, but how uh how clients and their advisors are structuring portfolios to deliver income. Before we get into that, I th I believe that you're the first person we've had on from the firm Federated Hermes. Not to be confused with the luxury brand or Maze.

Tell us a little bit about The background of the firm. We're a global asset manager focused on active strategies. I'll start there. We've got about nine hundred billion dollars in assets under management, which uh puts us In a mutual fund uh context, you know, we're we're inside the top ten. And uh so we're we're a large business that's been around for almost seventy years.

Our focus, I'd say, primarily has been around money market or where most of our assets are concentrated around money markets. So you know, just given our or um capabilities around money markets. Um that being said, I mean we're we we're largely intermediary ha or have been intermediary sold. So you know, I'd say our our client base largely knows us from the advisor world.

Uh, given the fact that that's been our main source of distribution And really we focus on Trying to help advisors solve problems. Right. And so when we think about this, it's like

How what can we do to best serve um serve you in a way of s creating solutions. And so a lot of our investment strategies are based around how do we solve certain problems for clients or their clients. Um, that being said, we recently entered ETF business about five years ago. And um that obviously opens up a whole new world for us when it comes to retail, right? So

Um, where most firms, I'll say traditional asset managers, have gotten into this business If they have been intermediary sold. The ETF world is just kind of opens up the entire investment universe in terms of clients. So what are the biggest solutions that you're providing today? Where are people coming to you with? What what are they trying to solve? Yeah, I think it's multifaceted, um, just given kind of more background.

What I would say is You know, I think right now there's a lot of uncertainty. We we can talk all about the uncertainty that's out there, whether it's around the geopolit climate, whether it's around rates. inflation. You can go through all the different uh you know, potential issues that are out there that uh clients and advisors are having to navigate. Um, what they really focus on or where we're you know, where we've been looking or or trying to solve solutions, definitely on a fixed income side, kind of two year and in space, having some attractiveness.

in terms of your risk of retor risk return opportunities. And so we're having a lot of conversation with advisors around how to best manage we'll say that income sleeve for portfolios. Brandon, you mentioned the short term. There was an article in the Wall Street Journal. Uh talking about How individual investors don't want to get off cash.

There's three trillion dollars in money market funds. And they don't find the opportunity set attractive in bonds. I think a lot of that is PTSD from two thousand twenty two. Uh you mentioned uncertainty. I I would say um the number one area in the market right now, or at least top five, I don't know if number one is is is fair.

area of the market that I see uncertainty is in Long dated treasuries. So We're recording this on Monday, Monday, August seventeenth. And the thirty year.

Is breaking out to new highs. We haven't been at five point two nine five percent since June two thousand seven. So it has been a long, long time. I do find it interesting. that

The Income. On long dated bonds. as I just mentioned, is at the highest level it's been in a long, long time. And nobody seems to want any part of it.

Now I understand. that you could have said this for the last year, last five years. And there's been negative returns, a lot of vol all volatility to no upside. At some point do they become attractive? Because I know we're gonna talk about income. But I feel like the

The uh The potential price appreciation on bonds. Is something that I'm not hearing anybody talk about. Like recessions do exist. It's possible. that you get a boost from bonds if if if the economy

Softens. What's your take on where we are short? long and the opportunities in between. Again, going back to there's a lot of uncertainty. Oh, like your PTSD from you know this last four or five years here where we saw What was a traditional sixty, forty portfolio working for most and then

twenty twenty two happens and we sold rates Yeah, obviously obviously go up and it really hurt the overall You know, th there was a lot of challenges on the fixed income size term in terms of negative returns. To your point around the Wall Street Journal, money and money markets, obviously we are a benefactor of that. Uh so it's

Not necessarily a the worst thing in a world for us, but what I would say is At some point You know, the the the challenge I always think about when when we talk to advisors and and when we talk about clients is um I think the challenge at some point is you've got to move. You're not gonna be able to necessarily catch the bottom. on a lot of this stuff. So

It's where we start to see that risk reward trade off out Call it a little bit further out in the curve, call it two years and in. starting to try to find ways to capture some of that yield and lock it in for longer. is definitely uh I I think some benefit. I think the challenge is there's just so much volatility on a long end of the curve right now, right? And so advisors have the challenge of trying to have their clients stay the course.

And so there's a lot of behavioral finance in that um When it comes to managing clients' expectations around kind of On the on the on the go forward side of this.

You know, I think the question becomes out on that far end of the curve. Are we there yet? Right. You know, is it is it something that we want to be Moving clients out into or do advisors, do some clients want to move their clients out there only to have rates go up again, like we saw here over the last couple of weeks. And then you know, next thing you know, they're

go back into money market, go back into cash. That makes sense to me. because it's a it's a long term asset, it's gonna be more volatile. If people want income, they're looking for more stability. Is that what you're trying to provide with your products? Are you are you looking more from stability? Are people looking for no, I want the income to put piece of the pie to grow, you know, and and Go up with inflation or beat inflation.

I want higher yields. Like what exactly are people looking for in terms of income these days? So I think in terms of income, it's uh there's a couple of different approaches and and we're really seeing it in terms of I'll say Brawly in the ETF industry. Raleigh in terms of flows. Um

I think folks are looking for income. How they're getting there, um, to as we just discussed, the long end of the curve may not be the uh that might be a bit challenging for people to move all the way out there and lock those in, but These shorter duration products that that's definitely of interest for clients. So we see people looking at that shorter end.

We also see a lot of people and and we've seen this in industry, we see a lot of people looking at This covered call derivative income. category and folks looking at that category as A new bucket or a new way to generate income.

uh and taking that from potentially their fixed income and or equity portfolio. How do we best build a portfolio on a risk adjusted basis that generates income? Keeps my client invested. And solve all the challenges that that you know normal portfolio construction. Uh poses for advisors.

Brandon, before we get into that Category. It's worth mentioning, and I know we're talking about an income. But investors cer a certain cord of investors obviously The older

Uh The on the older side of clients. They Love income. And I totally understand why. I mean, it's not you don't have to like scratch your head and figure out what's going on here. I don't know what the level is where people stop thinking in in real terms.

But I found that People think about income. Nominally. They don't think like Oh.

Um Oh man, my cash is giving me three point two five percent. But inflation's still running at three or whatever it is. I'm only actually getting twenty five percent twenty five basis points above inflation. They never think like that. And I'm not saying that's like uh wrong or anything. It just it's a it's a fact. You might not like it. You might say it's not rational. It doesn't matter.

Um people love nominal income. I agree. I and I think we see that in uh a lot of these cover call strategies, that derivative income space. You know, y you can you can divide that bucket up into different uh Strategy types.

Right, we've seen the single stocks which have these Mind boggling, distribution, uh payouts. Yeah, eighty percent income. Which, by the way, when you think about it on a total return basis, I mean, uh from my perspective, I always think about it on total return. Because you can generate a lot of distribution yield, but you're still exposed to the equity. Right. So you've got that cohort and th those those types of products where people are

Chasing a distribution. Which may not necessarily um may or may not be Right for them. I think you also have this other cohort of folks who are Thinking about income from the standpoint of

It is just a a nominal number. And and I think uh, you know, from a financial planning standpoint, we always have those targets. Right, I need to generate Two hundred thousand dollars a year to meet my retirement goals. And so

The nominal number is what folks That's what they focus on. That's Yeah, I I'd say to some extent that's what that's what folks are kinda trained to to think about. I had I I think that part makes sense. I don't disagree. You gotta you gotta budget, right? You do have to budget a hundred percent. And people budget not people budget nominally. I mean Obviously.

Agreed. And so You know, to me the the big thing is how do we Create solutions for them. to mix and mash, right? I always think about ETFs become have become much more of a toolkit. Right. I I'm running a whole portfolio.

How do I want to tilt my portfolio, whether it's fixed income, whether it's equity, whether it's some alternative bucket, um, how do I tilt my portfolio to To achieve those outcomes. Right. And and generally speaking, especially when you're on the retirement side, for those who are in the retirement side, they're definitely thinking about Yeah, how do I how do I meet that number at the end of the year? So I'm curious.

If you could talk about how ETFs have kinda changed the game here, because you mentioned that you started out in money market funds and then mutual funds and now ETFs And there's just been this explosion in recent years. In using Tools like options. And th this is still relatively new for a lot of people. People have been, you know.

selling calls or selling puts for to generate income, but now that you can do it in this ETF wrapper, just talk about what the ETF has done to the income space. So I think it's very interesting. So I've been in the ETF business for almost twenty years. So I I've uh I've I've been working on ETS for a long time. I've seen a lot of the evolution from the indexing world to No, I'll call that smart beta or alternative indexing to where we are in active. This income bucket I think is very interesting.

on on several levels. One I think investors as a whole have become much more thought about how that income comes to them. And and as an example. twenty years ago as I was getting in the UTF world, um you know the return of capital

seemed to be a very negative term when it came to paying out return of capital from a fund. Now It's almost something that people are s they're seeking. When it comes to

uh this income. So I think The ETF world. Being able to manage capital gains, being able to manage taxes, having all these different um levers at its disposal. You're you have the ability

Um Potentially take a distributions and turn them into Return of capital. And and I think clients are

Um I think we have some investors who gravitate towards those types of strategies. And we're and we're again we're seeing it in the Whether it's in the product development side. Whether it's in um the asset flows You know, you we kind of saw a couple different cohorts of the uh Drive Income come out. We had some who were just playing paying out income.

Then we had another cohort who was um the that came out I'll say the next iteration. They came out looking to Yeah, I'll say basically transform the dividend income or that distribution income into return of capital. And now you're starting to see, I'll say the alternatives to what are those S P five hundred.

and Q strategies, which is changing the equity comp uh composure. Right. So if I have S P five hundred or Qs as my base equity. That's what I'm exposed to, especially on the downside. I I think it's probably more impactful on the downside. We haven't really seen a

an environment where we had really large drawdowns for for extended periods of time. But this these new cohorts coming out that are, I'll say alternative equities were uh different views of equity. What they give the exposure to is where ETFs are starting to, you know, again, iterate through the different Um styles that are out there.

Brandon, I'm gonna ask you a question that I don't think you could possibly answer, but I'd be curious to hear your opinion. These alternative equity strats. Uh, let's talk about the uh The option overlays that are generating income. What percentage of investors in these products do you think are actually using the income?

versus just reinvesting and just having it as part of their portfolio. Because I would suspect actually you know what? I don't want to call your thinking. What do you think? So obviously don't know. I mean it's very hard to put a put a finger on it. I'll just start from my personal view on this. When you start to look at the the composite of feedback that we hear from clients and or

Um I'll I'll say that, you know, the direct DIY type investors. I I think there is definitely a cohort using them for income. I do think there are investors out there who are probably looking at these strategies as a way to kind of get them further down that path. It's hard. It's really hard to tell.

where where a lot of these assets are, but I do think there are that yeah, there are probably some investors out there who are using these more as a means to an end to get somewhere in the in the future versus where they are right now in terms of retirement. All right, Ben Carlson, I'll set the over under for you. Uh thirty percent. of people that are actually taking the the income from these products.

For spending purposes. That's probably yeah, that's probably pretty close to good odds. Oh, thank you. We won't even answer. No, it's not bad. I I I was thinking this too on the

On the taxable side of things. Like How how much do you think people care about the taxes on these on this income? Like d d does that come into Or or is it just no I care about the amount of the yield. So you don't think I'm I think taxes are a totally separate bucket.

Like mentally. Brandon, what do you think? How like I think I would disagree with that. I think I take the uh I think taxes are important. Oh, I think they're very important. But I I I think you might be giving investors too much credit. No offense to us investors, but go ahead. But he he's he's also working with advisors though. So I think the advisors probably care about how these the treatment of these taxes are'cause it's True. I'm not I'm not I'm thinking of I'm thinking of the end investor and maybe not the advisor of the retail. But yeah, good good point. Well maybe why don't you talk a little about the the the tax side of things and and how that works for people on these.

Yeah, I I think the tax side of it. So I uh so I do think people um I look, I think we can all collectively say everybody cares about taxes, right? Um, I think most people are always thinking about taxes. I think the flows into this category. Reinforce a bit of the you know, there is a there is a care about taxes on this. So th there's a couple of different ways that I'll say the industry has developed these products. So

We we developed a strategy and and I'm and I'll cover that in a second. which is kind of why I think where most of the assets are going now. But I'll say um you know, one of the early iterations of this was where Uh the ink the the Uh you can use equity link notes. So equity link notes are basically I'll say coupon payments, bond payments out of a portfolio. Uh when that comes out it's income. So it's treated as income.

The next iteration of this, which is the the path we had taken or or have taken when we developed so payer, P A Y R is the ticker. Um, when we develop that, we use options. The benefit of options is you have the ability to take that option income. and treat it as return of capital to the extent that what you're paying out If you have an option uh if you have an option that was Y you distributed it, but it actually lost

I'll say if the option was in the money. Uh and we had to close that out. You have the ability to basically it it becomes a return of capital if you distribute it. And so clients look at that and say, I can generate income. For my clients, especially now when you think about all the You know, the all the things that advisors having to think about. If I can generate some income

That is We'll call it another leg of the stool, but when you think about it, you have your tax deferred, you've got your, you know, your raw tax, we'll call taxes that then you have your taxable accounts. If I have a taxable account that can generate some income that's Essentially additional income. Where additional distribution

As an advisor, that creates a very powerful tool. Right. That's a that's a very powerful tool when it comes to planning In retirement Um this de cumulation phase. Right. So I have my I need to manage my Roth distributions. I uh I have my Roth distributions kinda help my overall income. I got my

My IRA slash four okay, which is taxable, right? Then you get into R and D's and All the things that come together that advisors have to think about. to manage taxes and keep their clients whether it's you know, under an income limit for Irma, whether it's you you think about all the things that they have to they have to manage through.

Um It it's it's a great tool for them. at the end of the day, it's a great tool for them. So talk to us about what your you guys are doing. using options. Because

As I said, it's it's a huge category now. And it seems like there's a lot of growth there. There's a lot of interest from investors. So how do you guys think about using options in your strategies? Yeah. So here's how we do here's how we do that. Um so we have again, we start with a high dividend yielding portfolio. Again, there's benefits to a high dividend yielding portfolio. One, because just the equity exposure is very different than the SP or S P five hundred or the Qs, right? So when you're trying to generate income. Having a uh

high new portfolio gets you potentially you know, some direction where you where you're trying to target. Do you all when you you use those dividends, is there also is that strategy also based on the idea that These aren't highly volatile stocks that are gonna ha see some huge moves and they're not going to get taken out very easily and get called. We don't write'em on the underlying strategy, but the The benefit of using those is they do tend to have a lower beta to the portfolio, right? So they they have less volatility.

So using dividends tax and what than using index options, essentially. Yeah. So we have, you know, again, that high di that that high dividend yielding portfolio has the potential to create just less volatility for the client. Again, if you think about that S P five hundred. So we we generate a portfolio or we run a portfolio. Matter of fact, it's based off of a uh mutual fund strategy that's just a dividend portfolio that we've been running for decades. So we jet we we utilize those stocks and and this is your, you know, think about your blue chip securities. Um

We don't have the you know, it's not necessarily the SP five funder with the Mag seven, et cetera. This is just uh high debt. Blue chip portfolio. We then use index options. to generate additional distributions, right?'Cause it's not always income.

uh but but to generate that additional income. So we use index options as an overlay on top of it. What What we do know and and I'd say how we've iterated this strategy is we do know that if you're writing S P five hundred options. At some number.

Obviously as the S P f as the S P Yeah, if it goes through that. It uh you start to have a negative return profile. So what we've done is we actually u we We

So Calls and And then turn around we we run a call a we'll call it a call spread, right? So We're basically selling calls and then buying calls a little bit further out to target a certain amount of income. The benefit of writing

calls and then buying calls is the S P continues to go higher. We don't you know, we're not losing all the way until that next option. Yeah, until we Until we roll that next at all options.

Just stepping back. to the earlier part of the c conversation about where we are, what type of environment we're in today. As advisors and investors, this is a Much Much

Better healthier environment for generating income. I remember Early in my career, we took a meeting in twenty thirteen. With somebody who was

Talking to us about not buying stocks, about buying junk bonds as as a way to like dip our toe back into stock market water. And I feel like we are so far on the other side of that environment. Now that That toe dip had nothing to do with where interest rates were at the time.

But just the like the the nature of investor behavior and fishing in the pond that you're in. And so From twenty thirteen to twenty nineteen. eighty twenty was a new sixty forty. because interest rates were zero. It there was really very little upside.

And it's funny how Advisors, investors feel burned by bonds. At the time where You should be looking for opportunities, I think. The Fed funds rate went from the lower bound at at basically zero

Up to five percent. That environment is over. So it's not to say that the price of bonds can't hurt you again. But there's a big difference between going from Four eight.

Up to five two. Then zero to five. Agreed. Yeah, I think again, this is that idea of starting to find ways to lengthen or move out the Move out the curve.

Um you know, at at the end of the day Could the Fed ri uh raise rates? Yes, but I would agree with you. That's zero to five. Highly unlikely. that we are gonna go from five to ten. in rates, right? So on the fixed income side.

Yeah, the I think the challenge is always just how do we get um clients or how to how do advisors How do they have clients think about Now's the time in this

Now's the time to start moving into more duration and start walking those yields in. Uh, especially again when you're when you're in this search for yield. I think it'd be challenging for us to see rates go um had that dramatic of a shift when you're start when you were starting off zero. I mean we were starting off zero. If you think about like it's been since the The GFC, right? We we seem to always struggle to get off of zero for the longest time. So now we're off. Yeah.

We we finally did. Right now I you know I think the Fed has some dry powder now if if we have any kind of additional rate shot or any kind of additional uh systemic shocks that they have to manage. It was always, you know tough when you're at zero, but I think we're kind of maybe a little bit back more in normal times versus where we maybe we were when we were running at You know, close to zero for for A long, long time.

Michael talked about that Wall Street Journal article. But you know, and you talk about you your history of your firm is money market funds and you guys have, you know, short duration bond funds. Do you think more investors are actually open to having those sort sort of in between intermediate term and sh and ultra short term? Are they more open to the having that as a core position now? Because they see like, well, actually that's a good hedge against rising rates or rising inflation, and maybe I need that part of my portfolio now. Or

Do you think well if the Fed cuts rates back to two percent or something, that money's gone. And it's gonna go back into something. Like bonds or in you know, something that it has a higher yield. Yeah, I think so, you know, the mutual f the mutual fund business we've have here is seventy, you know, seventy plus years at this point. So the ETF business is still we're still in our emphasis of like growing that out.

I think what we're seeing is Um, there there's that move into that ultra short space. There's a move a little bit further out the curve. Uh we are definitely seeing a movement towards The longer duration, I say longer, you know. in relative terms, right? Out of cash.

We're definitely seeing clients move in that direction. And um again, it's a lot of behavior fine. It's just trying to get it trying to for advisors. they needed their their clients to understand that There is risk of potentially being in cash. Right, because the the risk there is

rates come down and again money markets are the quick they're gonna be the quickest to reset. So the more you can get a little further out the curve and start to lock those in, is is net net better for investors, better for you know advisor clients. So I so there's definitely we're starting to see that. We're seeing that in our old short on the Like in our shorter duration mutual funds, we're having a lot of conversations on the advisor side around that. Uh for sure.

Brandon, for people that want to learn more about Federated Hermes, how do they find you guys? So it's Federated Hermes H E R M E S dot com. Alright, perfect. Thanks, Brandon. Alright, thanks to brand and member, check out FederatedHies.com to learn more about all of their strategies and email us animalspirits at compoundnews.com. Before investing, carefully consider the funds investment objectives

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