Convexity Strategies

October 28, 2022

In this episode of Engaging Alternatives Spotlight, Elana Margulies-Snyderman, Director, Publications, EisnerAmper, speaks with Nancy Davis, Chief Investment Officer of Quadratic Capital Management, a Greenwich, Connecticut-based investment advisory firm focused on convexity strategies.    

She shares with us her outlook for investing in convexity strategies, including the greatest opportunities and challenges, her experience being a woman investment manager in the industry and how the firm is embracing DEI.


Transcript

Elana Margulies-Snyderman:Hello and welcome to the EisnerAmper podcast series. I'm your host, Elana Margulies-Snyderman. And with me today is Nancy Davis, Chief Investment Officer of Quadratic Capital Management, a Connecticut based investment manager that invests in convexity strategies. Today, Nancy will share with us her outlook for investing in convexity strategies, including the greatest opportunities and challenges, and also how the firm embraces DEI. Hi Nancy, thanks for being with me today.

Nancy Davis:Thanks for having me. This is so exciting.

EMS:Nancy, to get started, tell us a little about your firm and how you got to where you are today.

ND:The firm was founded in 2013, so we're very excited about being around for almost a decade now. And prior to founding Quadratic, I was with Goldman for about a decade where I rose to become the head of credit derivatives and OTC trading for the internal prop team. And that was a great place to be, a great training ground, and it's been really fun to start my own firm and create our really diverse strategies.

EMS:Nancy, given your focus on convexity strategies, I wanted you to share your outlook for the space.

ND:Well, I think the challenge for a lot of bond investors on the fixed income side of the equation is that most people use core fixed income. And the problem with core fixed income is it's typically referencing the Agg index. It used to be the Lehman Agg, and then it was the Barclays Agg, and now it's called the Bloomberg Agg, but it's a really old index and it's market cap weighted. And about a third of the Agg is actually short convexity, sometimes called negative convexity, and that's from the mortgage exposure. So, I can't think of a more important time in our careers really, Elana, because the Fed is embarking on quantitative tightening now, not quantitative easing, and that's been pushing fixed income volatility higher this year, whereas equity vol has been very contained. So, I think it's a really important time for investors to understand what their convexity profile is in their bond portfolio.

EMS:And Nancy, to further elaborate, what are some of the specific opportunities you see in your investment strategy?

ND:Well, both of our strategies at Quadratic are bond funds. Most of them, they're just treasury funds. But then we try to fix the problems that exist with treasuries by themselves. So for instance, inflation protected treasuries called TIPS, they were created by the US Treasury in 1997. That's when the treasury first started issuing them. And the problem with TIPS by themselves is, A, they have duration exposure, so they will lose money based on when yields go higher based on that duration. And then B, the only index to measure inflation is the consumer price index. That's the only way that TIPS get reset. And I think the best comparable would probably be looking at equity indices. Nobody would ever buy, say the Brussel or the Dow Jones or the NASDAQ and say, "Ta-da! I have the US equity market." So, it seems kind of silly to do that with something as big and as hard to measure as inflation.

EMS:And Nancy, to shift gears a little bit, what are some of the greatest challenges you face when it comes to investing?

ND:I think it's definitely hard as a smaller asset manager, especially because we've begun about three and a half years ago, Quadratic started to compete in the ETF arena and that is a bit of an oligopoly with some of the very large issuers who dominate the ETF world in terms of AUM. So, I think it's been harder as a smaller issuer, but we're competing and we're doing well. So, it's been a lot of fun to be in such a competitive market and to be really performing well.

EMS:Nancy, we'd be remiss if we fail to discuss DEI and how your firm is embracing it, so I'd love to hear your thoughts on that topic.

ND:Well, I do think founding a firm that has a diverse strategy is super important. I know a lot of the DEI initiatives are really focused on bringing different, whether it's different socioeconomic groups or backgrounds or genders to the table. I think the whole point of these diversity initiatives are really to have diversity of thought. You don't want to have everybody who has the exact same thing in their portfolio and the exact same portfolio construction. So, I'm really a big advocate of helping investors really think on their own and think about what are diverse strategies, not just diverse in name only. And so that's been a lot of fun to... A lot of the asset management world is the same old stuff. It's different blends of... Maybe it's a short duration manager or a high yield bond manager or a private credit manager. So, you have different shades of alpha within those strategies, but there's a lot of bucketing in our industry. So, I really enjoy being outside of a bucket and really trying to do something different for people.

EMS:We've covered a lot of ground today and I wanted to see what your future plans are for the firm.

ND:Well, I do think one important thing to highlight for your viewers, your audience, is definitely that a lot of people are concerned about inflation right now. That's such a hot topic. But I think it's so important to understand that inflation expectations in the future are really contained and that can present an opportunity to investors. So, even though the last CPI print was 8.3, the one year forward inflation expectations, if you look at where market expectations are, are for CPI index to be 1.7. So, it's really a dramatic time where the market is very complacent that the Fed hiking rates is going to reduce future inflation. And I think that presents a unique opportunity for investors who are looking for differentiated strategies, especially because the Agg index has no inflation protected bonds and it's only short fixed income volatility from the exposure to mortgages.

EMS:Nancy, I want to thank you so much for sharing your thoughts with our listeners. And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.

Transcribed by Rev.com

About Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.


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