Fallen angels – In conversation with Mellon’s¹ Paul Benson
Paul Benson discusses his route to a career in fund manager and why he believes fallen angels matter.
Paul Benson is Head of Fixed Income Efficient Beta at BNY Mellon. Based in the company’s San Francisco office, he is responsible for managing quantitative, factor-based fixed-income strategies. Before joining the business, Paul was a senior fixed income portfolio associate at PIMCO, where he managed active US and global fixed income portfolios. Paul obtained a bachelor’s degree from the University of Michigan and is a member of the CFA Institute.
How would you describe your role at BNY Mellon?
I head up the fixed income efficient beta portfolio management team, which at the heart of it is about providing our clients with efficient exposure to areas of fixed income where both fundamental active as well as pure passive approaches have historically been challenged. During market hours we are highly focused on rebalancing portfolios to desired weights and risk exposures, and very importantly, on investing all cash flows entering or leaving our portfolios on a same-day basis. A central pillar of our approach is the ability to offer our investors a high degree of liquidity in illiquid asset classes.
For the remainder of the day, we are working on enhancing the efficacy of our models, which includes careful consideration of implementation – how we would actually trade to the model. This process is a circular loop between the portfolio managers and the quantitative research team, who, armed with their PhDs, engage in the heavy lifting of building robust signals that can really compete in the marketplace.
Why did you choose to pursue a career in asset management?
Life is a random path – there are certain forks in the road and we generally (hopefully) end up in a good place. I started my career in Japan, where I was initially a market maker for Japanese government bonds. I then had the chance to engage in proprietary trading, which got me thinking about quantitative applications within markets and attempting to harvest alpha from relative-value opportunities.
Eventually, I returned to the US and a position with PIMCO, which was my first engagement on the buy side. I learned a lot from my time there, seeing how a large institution actively manages large sums of money for its clients. It also gave me both experience and exposure to all asset classes.
I joined BNY Mellon in 2005. It offered the perfect business culture, which was highly appealing. I was particularly interested in working with smart people in a company guided by a strong ethical compass. That is why I’m still here 16 years later!
How would you characterise your style as a portfolio manager?
When we designed our fixed income efficient beta suite, we were determined not to follow what many of our competitors were doing: utilising quantitative factor-based investing in fixed income to build small, concentrated portfolios tilted toward the best possible factors. These strategies may look great in simulation, but are practically un-implementable in the illiquid world of credit. Instead, we took the opposite route. This involved building large, diversified portfolios that leverage our innovation in portfolio trading, and allow us to accumulate the risk premium inherent in whatever the asset class our clients want, without all of the idiosyncratic risk of a concentrated portfolio.
As a quantitative portfolio manager team, while we’re all immersed in day-to-day operations, focusing on how and when bonds are traded, we also carefully review and vet the models; we don’t simply assume everything that comes out of the research department is gold plated. That means our portfolio managers are typically also well versed in coding and understanding the metrics that emerge from the research side. Ultimately, it allows us to dive in and understand how each model is generated.
Can you tell us more about your work with fallen angels?
Managing the so-called fallen angels, which are hitherto highly rated bonds that have been reduced to junk status, is a specialty that brings our talent and skills to the fore. When we launched our flagship high yield beta strategy in 2012, it was early days for factor-based investing, and our clients were understandably cautious. After delivering on our promises for more than eight years, we have developed a client set that has become more evangelistic. They understand what we do and know that it makes a lot of sense.
In 2019, we introduced our fallen angel beta plus strategy. By doing so, we were telling our clients that the factor tools that we have, work. It’s a highly active strategy where we’re not looking to generate benchmark-like performance. Rather, we’re seeking to outpace the already aggressive fallen angel benchmark by 100 basis points.
What’s the market outlook for this asset class?
While spreads have tightened inexorably, and one could certainly argue that valuations may look stretched through a traditional lens, there is tremendous technical support for high yield bonds globally as central banks remain focused on keeping rates low and providing additional stimulus. We believe high yield default rates will remain low in this environment, and due to their higher-quality nature, fallen angel defaults will be even scarcer.
There is understandably much debate around when rates will rise, however as a quantitative team we do not take discretionary duration bets in our high yield and fallen angel strategies. Our clients want to be invested in high yield, so we focus on providing the most efficient exposure to this asset class. Betting on something like duration is essentially market timing. That’s one of the hardest things to get consistently right, so we’re generally going to match the benchmark in terms of duration and sector allocation. We’re not going to try to decide, for example, whether energy is going to outperform consumer cyclicals over the next three months. If it’s a global portfolio, we’re going to match the benchmark currency allocation.
What’s the broad appeal of this asset class for investors, including yourself?
If you look at it on a risk-return or even a total-return basis, then it’s a fantastic asset class relative to, say, equities or government bonds. Why? Because markets are still incredibly inefficient. The transfer mechanism that happens when investors have to move from investment grade to high yield is very jagged, and that’s why there’s a lot of harvestable risk premium.
What responsible investment factors do you consider when making investment decisions?
As quantitative managers, we’re primarily looking at third-party vendor environmental, social, and governance (ESG) metrics that we can apply on a broad base. There is a flipside to this – if you’re a fundamental manager, you might want to take a close look at some of the individual companies you’re tilting towards.
What we do have is a set of exclusionary criteria. In other words, ESG constraints that exclude companies with certain negative metrics. An example would be businesses with more than 30% of their revenue from coal, or firms with the lowest-quality scores within the MSCI universe when measured along certain key metrics. We’re able to screen out some of those companies and provide a well-diversified strategy that still targets fallen angels but within a higher ESG-quality universe. At this point, we don’t have an overt bias toward enterprises with better scores, though it is something that our research team is considering.
What are the strengths of BNY Mellon in this asset class?
A typical manager involved with quantitative, systematic investing and fixed income probably has a siloed background. What underpins our success in this area is our team’s diversified background: we have an active and systematic history, our team members are proficient with modelling, and our direct experience managing ETFs provides us with additional tools to trade bonds more effectively than the over-the-counter mechanism.
On top of that, we also have an index fund management background, which matters in terms of value preservation. As an index manager, you learn to think about where every fraction of a basis point goes. You develop your system and portfolio management tools to account for that. A significant factor in our strategy is understanding where we spend every basis point and ask whether we can find a smarter way to avoid costs or mitigate any risk.
¹ Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.
The value of investments can fall. Investors may not get back the amount invested.
The fixed income capability, including managers and analysts, of Mellon Investments Corporation (Mellon) is transitioning to Insight Investment, which is expected to be completed by Q3 2021. This includes the group’s Fallen Angels strategy. There will be no change to the firms’ investment approaches, processes or managers to the Mellon-managed fixed income strategies or funds during the transition period. Neither are there any plans at this time to merge or rationalise any BNY Mellon Investment management-branded Mellon and Insight-managed funds.
For more information please visit www.bnymellonim.com.
Objective/Performance Risk: There is no guarantee that the Fund will achieve its objectives. – Derivatives Risk: New Fund Liquidity Risk: This Fund is not expected to hold investments which would be considered illiquid, however, while the Fund is being established, it is possible that the liquidity profile of the Fund may fluctuate.