Mitchell Garfin, Co-Head of Leveraged Finance, BlackRock

[00:00:01] Hello, this is Dean Curnutt and welcome to the Alpha Exchange, where we explore topics in financial markets associated with managing risk, generating return, and the deployment of capital in the alternative investment industry. With nearly three decades at BlackRock, Mitch Garfin brings a deep well of experience to his role as Co-Head of Leveraged Finance, overseeing high yield and leveraged loan strategies for the firm.

[00:00:31] In this episode, we explore the evolution of the credit landscape, from structural shifts in the high yield market that leave indices of higher credit quality to managing risk in a world of tight spreads but always shifting macro narratives. Mitch shares how his team navigates dispersion, with recent focus on considering the implication of tariffs on different sectors.

[00:00:52] His team positioned for tariff-related volatility by reducing exposure to sectors like autos and consumer products, perceived as most exposed to trade risk policy. Conversely, Mitch saw better value in tech and insurance sectors. Next, we discuss advancements in trading technology and the implications for liquidity.

[00:01:13] Here, he argues that the electronification of credit markets and the growth in portfolio trading is having a profound impact on risk transfer, reducing frictions and transaction costs. In the process, he shares how his team leverages tools like ETFs and the CDX product to manage exposures. I hope you enjoy this episode of the Alpha Exchange, my conversation with Mitch Garfin. My guest today on the Alpha Exchange is Mitch Garfin.

[00:01:42] He is the co-head of Leverage Finance at BlackRock, where he oversees high yield leverage loan strategies. Mitch, it's great to have you on the podcast today. Great to be on, Dean. Thanks for having me. Just looking a little bit at your background, I saw you joined BlackRock in 1997 out of the University of Michigan. Did you catch the Fab Five there? I think they were finishing up in maybe 92 or 93. I got the Fab Four. I missed out with Chris Weber. After he called the timeout, that never was.

[00:02:10] And we lost the championship. He left and I entered my freshman year. Okay, interesting. Well, you're coming up on your 30-year anniversary at BlackRock. Not a short period of time. And, of course, three decades of tremendous evolution in markets around the world, across the asset classes. And I'd love just to learn a little bit about your career trajectory, where you started, and the ascendancy to your current role.

[00:02:37] Yeah, it's hard to believe, reflecting back on it, that's been nearly 30 years. A lot has happened over that time. I've had a few different roles. I've been in my current seat since 2007, taking on full responsibility with my partner, Dave Delbos, back in 13 or 14. So I've been doing this for 12 or 13 years, running the group and running the high-yield funds and overseeing leveraged loans and CLOs. But when I first started my career, I was in an account management role.

[00:03:05] It was more like an investment banking opportunity where we were preparing pitch books and trying to help the senior people raise money for the organization. It seems like we did a reasonably good job knowing that we were relatively small in 1997 and where we are today with north of $11 trillion in total assets. So that worked out reasonably well. In 2000, I transitioned to a research role focused on energy, utilities, basic materials, paper and packaging on the investment-grade desk.

[00:03:35] And in 2005, I transitioned to more of a portfolio management role, both in the investment-grade to start and then later transitioning to high-yield in 2007. And as you might imagine, the transition of the energy crisis happened or the global financial crisis happened. Well, of course, markets are just always changing, always evolving.

[00:03:57] Technology has become a real kind of underpinning to some of those trading-oriented changes, especially in, I would say, credit and fixed income recently. The equity market was ahead on some of the basket trading and algorithmic trading. And so I'd love to make that at least some part of our conversation.

[00:04:17] But really, what I want to do is explore just risk with you and just how you think about finding opportunity and, of course, being careful of all the minefields that are out there for us as investors. Maybe just to set the stage, we ended 2024 with what I would just call maybe not the tightest spreads on record, but pretty darn tight.

[00:04:41] And the other thing was that credit volatility was extremely low. These spreads were not just low, but they were incredibly range-bound for the bulk of 2024. And so maybe just start with the outlook as you guys saw it at the beginning of the year. Of course, a tremendous amount has happened in the last five months and even the last two days.

[00:05:06] But what was the outlook coming out of 2024 in terms of expectations from a corporate default standpoint and how you guys were positioned? And then we can run through the incredible vol of 2025. Sure. What's interesting is our view at the end of 2024 was very similar to the prior three or six months. It was likely going to be a continuation of the environment that we had seen.

[00:05:36] Fundamentals had been strong. There was an expectation that that was going to continue. We agreed that spreads were relatively tight at, call it, 250 or so, but did not expect that to change materially. And I think that goes back to really thinking about the overall construction of the high-yield market. Not a lot of people focus on it, but there's been a tremendous evolution over time in terms of the overall credit quality of the high-yield market.

[00:06:04] So you go back 10 or 15 years ago, BBs were some 35% of the market. Today, it's about 50%. CCCs were 20% of the market. Today, it's about 12%. And so the point I'm making here is credit quality has significantly improved in the current environment relative to where we were historically. I think that's supportive of tighter spreads, lower all-in yields for the asset class.

[00:06:29] A lot of the small and medium-sized leverage buyouts, they were financing themselves in the leveraged loan market or the private credit markets. And so more of what we had seen come to the high-yield market is higher-quality type paper, which I ultimately think has been very supportive of the tight spreads that we saw at the end of 2024 and the beginning part of 2025. So it really was a continuation in our view. The risk profile of our funds continued to have betas right around one, slightly north of one.

[00:06:58] We can talk a little bit more of that as we get into the overall portfolio construction. For us, it was much more of a focus on where and how to allocate risk capital, right? So across quality buckets, across the different industries where we believe fundamentals were more resilient, sectors that were going to be less impacted by potential tariffs. One thing that's interesting is we all spend time looking backwards at data.

[00:07:23] We know that history never repeats itself, but there's some guidance that we can learn just by looking at the historical time series. I'm coming from the equity derivatives side of things. And so when we look at the VIX as an example, we see periods where it's super high, crisis episodes when it's super low.

[00:07:41] But there's not really a lot of attention paid to changes in the VIX that are a function of changes in the composition of the S&P, which I think is interesting, right? Because the banks were dominant in 05, 06. Now it's extremely tech heavy. So those have a different ball profile. And so what you just talked about in terms of the upgrade of the credit quality, I found really interesting. And I'd love just to explore it with you a little bit more.

[00:08:10] This idea that it's a different index now than maybe 10 or 20 years ago. Can you just talk about maybe how that is materialized, what that's a function of? And then just as someone like myself, who's just going to go up on Bloomberg and hit up a time series of maybe CDX IG or CDX HY, how do I need to think about the composition of the index as changing? Yeah.

[00:08:36] So maybe let's first explore how and why it's changed. You had more and more issuers looking to finance themselves in the leveraged low market. But for, I guess, the primary reason, there's a lack of call protection in the leveraged low market where, as you know, there is call protection in the high yield market.

[00:08:56] And what this means is for a private equity sponsor or an issuer that has recently done a transaction, if they're expecting to go out and sell an asset and improve their credit fundamentals, delever the balance sheet, they can materially alter the composition of their balance sheet by issuing leveraged loans, given that you can reprice after a six month period of self-call protection.

[00:09:19] So you have the flexibility to reprice the debt that you just issued effectively, whereas that's not the case in the high yield market. You also had many of these lower quality issuers move to the private credit markets. So as you know, the demand for higher yields is robust. And we've seen that play out in the private credit markets where a tremendous amount of capital has flowed to that space.

[00:09:44] And as issuers, we're looking to get deals done quickly with relatively few investors. They access the private credit markets to facilitate that transaction. So it was fairly simple. It happened over a long period of time, call it 10 to 15 years. But really, each and every year, we saw more and more of that transition. And ultimately, that has led to a construction within high yield that is of better credit quality.

[00:10:12] The other part to the story is at different points in time over the last 15 years, and there's been more than a few periods of volatility and stress in financial markets, we've seen downgrades from the investment grade market to the high yield market. And that also increased the overall size of the WB market relative to lower quality cohorts. If we go back five years, so we're sitting here five years post the teeth of COVID,

[00:10:39] the emergency of March of 2020, perhaps the market side of things is behind us. Some of the Fed's defense, its mechanisms for trying to push back on financial calamity are now in place. Some of them involve intervening, maybe modestly, but intervening in private markets. And so we have one of the lowest base level of interest rates on record, right? Basically, a 0% policy rate.

[00:11:09] And I mean, I think 10-year yields got down to 50, 70 basis points, really outrageously low levels. And throughout 2020 and maybe into 2021, and perhaps even the next year as well, there was a lot of refinancing that occurred in the high yield market. And so the story was, well, there's still risk, but they've been able to term out this debt at very attractive levels. Where do those trades stand?

[00:11:36] If you're the typical corporate that took advantage of that low yield environment that existed for a period of time, how long was that debt? And there's always the talk of the maturity wall, probably too much talk of it. But I'd love to just kind of get an understanding of the debt that was refinanced in that period. What does that look like now? Is that coming due or what are the refi prices that corporates face at this point?

[00:12:04] So we've seen a massive refinancing wave take place over the past few years, in addition to what you're referring to. So many of the issuers that issued debt in the heart of COVID, many of them have ultimately refinanced once again. So that original supply, a healthy amount of that came in secured form, right? And so we saw secured issuance going back 10, 15 years at roughly 10% of the market. Today, it's 35, 40% of the market.

[00:12:34] And that really picked up speed during the COVID environment. Issuers were able to access financings at obviously lower all-in yields relative to an unsecured deal that they could have done. And what we've seen over the last few years is many of those higher coupon type deals that got done, they have been refinanced as the seven non-call three or five non-call two deals that were done in COVID ultimately became callable.

[00:13:01] And it was very accretive for many of his issuers to access the market and refinance. Even though all-in yields seemingly were higher than where they were five or 10 years ago, these were still relatively attractive levels for many of these companies that were looking to refinance. You have to remember that the entire capital structure wasn't refinanced during COVID. Maybe you had one or two bond deals, a $500 million or a billion dollar bond deal out of a $5 billion or $10 billion capital structure.

[00:13:29] So call it 10% of an issuer's capital structure. To the extent they have a higher cost of capital for that sliver of the balance sheet, doesn't necessarily have a massive impact on the overall credit quality or income statement of an issuer. So the takeaway here is a lot of what got done during that period were at fairly high coupons that has since been refinanced. If I look at near-term maturities, so thinking about the balance of 25 and the entirety of 26,

[00:13:59] you're looking at relatively small amounts of debt that ultimately need to get refinanced, called $75 billion or so for the balance of this year. Put it in perspective, an active month for high-yield supply is $30, $35 billion. And we haven't necessarily seen those levels, although it's picking up now, over the last few months for the obvious reasons given the volatility. But, you know, I suspect over the next few months, to the extent we do have stability, we'll see a lot more of that get done later this year.

[00:14:29] 2026, the number goes up to $175 to $200 billion. It may sound like a large number. I suspect that will be sub-$100 billion by the time we turn the calendar, 2026. And so I'm not too concerned at all about companies' access to the capital markets. It's... We've seen periods where there's been stress, where the markets shut down or closed for a bit. But as soon as things pick back up, you tend to see some of the higher-quality issuers come back to market, and that paves the way for some of the lower-quality deals to get done.

[00:14:59] And there's, of course, lots of discussion on good old USA, Inc. and its fiscal issues, a lot of discussion around debt unsustainability, refinancing. It's essentially ongoing debt at higher levels. The typical profile of a high-yield borrower, is that corporate, when they do refinance, is that going to be into a considerably higher all-in cost of financing? Or is it kind of a break-even? Not really.

[00:15:28] We're seeing deals come to market. Let's call it on the high-quality side of things, 6% or even inside of it. There were three deals last week that priced at 5 and 7 eighths. And I would say the majority of deals that come to market are anywhere from 6% to 7.5%, 8%, with the majority of it in that 6% to 7% range. So no, I don't think that's going to be a burden for the majority of issuers within our space. Got it.

[00:15:54] And then one of the things we talked a little bit about last time we connected was just on not just the evolution of the credit quality, but just some concept of dispersion. That I think the statistic was a substantial portion. I want to say 10% of the high-yield universe had a yield above 12%. So that you do have kind of a chunky piece that's just way outside the boundaries of most others,

[00:16:22] even as you've migrated towards an overall higher credit quality. Just I'd love to learn a little bit about how you and your team think about navigating something where there's really not a lot of homogeneity. There's a lot of dispersion. Dispersion is great for us. We actually look forward to opportunities where there's dispersion across the high-yield market. That creates more opportunities for us to actively manage the portfolio and to have sector views and issuer views

[00:16:49] versus a benchmark versus our peers that's ultimately going to lead to outperformance. When there is dispersion, that's a very ripe time for us to make money for our clients. And I think we've done a reasonably good job of that over time. With respect to tariffs, which is kind of an ongoing thing for the markets, April 2nd, April 9th, yesterday with the court ruling, it's really, I'm sure, difficult to get a sense as to how to steer the portfolio.

[00:17:18] You had talked about underweighting those sectors that you thought had a particular, almost negative beta or positive beta, I guess the best word to say, around tariff uncertainty, i.e. they'd be hurt by tariff uncertainty. You talked about autos, consumer. How did that manifest itself during the period where tariff uncertainty was at its highest? And then I always call it the climb down day of April 9th, when Trump basically said,

[00:17:47] you know, we're going to delay these things for 90 days. The market obviously ripped on that. Love to just understand how different sectors have behaved throughout this period, and then how you guys have navigated from a portfolio standpoint. Sure. Maybe taking a step back, thinking about where we were towards the end of last year, we definitely had an eye towards tariffs being a risk factor would be in focus as this new administration began.

[00:18:15] And so as we thought about the overall portfolio construction, well, two things. One, we tend to focus on sectors and issuers that have strong stability of cash flow. And what we've observed over time is sectors like autos, retail, chemicals, building products, they tend to have more volatile cash flows. And that happened to coincide with a view around tariffs that these are the sectors,

[00:18:42] I'm leaving out a few, but these are primarily the sectors that are going to be most impacted in a tariff-related environment. And so I think the portfolio was well set up going into April 2nd as a result of our core focus on stable cash flow and the stability of that cash flow throughout a period. With the tariff-related news at the beginning of April, that initially led to a risk-off period with very little dispersion across the board.

[00:19:11] To some extent, the tariff-related sectors underperformed, but everything was ripped down, similar to what you saw across risk assets, whether it's high yield, investment grade, loans, equities, et cetera. And then over time, we started to see much more in the way of differentiation, of dispersion, people realizing these are the sectors and issuers that are going to be more impacted versus the others that are going to be less impacted. So that second week is really where we really took advantage of the opportunity and the relative

[00:19:41] value. You have these periods, maybe these events that are really just difficult to defend against when something as, I don't want to say random, but really hard to handicap as tariffs and the start-stop of the way in which this policy has been put on and then taken off and so forth. It's got to be pretty difficult to find diversifying sources of credit risk. As you said, there was very little dispersion.

[00:20:10] I'm just wondering, just without tariffs, when you don't have the overhang of something that's so global and something that is implemented in a random fashion, from a portfolio construction standpoint, are there sectors that tend to be good in tandem with each other, where there's a kind of a zigging and zagging? In the S&P, as an example, tech and healthcare can go through periods of, this is on the equity

[00:20:37] side, can go through periods of almost negative correlation, which again, is a great thing if you own both sectors at once. Does it work that way in credit where you kind of look at sectors and say, okay, these two are going to give me a little bit more balance because they don't exactly move together? Yeah, there's a lot of examples of that. We work very closely with our risk team and they've done a tremendous amount of work for

[00:21:03] us over the years in terms of understanding correlations in the portfolio, what it means for our active return over time versus the total return of the index, the correlation of our beta to return, the correlation of industry overweights and underweights to each other, which I think is exactly what you're talking about. And we have found, at least for some of the analysis that we've done more recently, there

[00:21:28] really is very little correlation between, let's say, technology, aerospace and defense, autos, retail, chemicals to one another. Right now, some of those have a higher correlation to one another, but the overweights that we have to a technology or to aerospace and defense or to insurance brokers have generally been fairly low correlated with the underweights that we have to retail, chemical, consumer oriented.

[00:21:57] And I think that makes sense just given the more simplicity of some of those sectors that were underweight versus the strong, stable cashflow generators like software companies, like insurance brokers, like aerospace and defense companies. So it definitely is the case, maybe not to the same extent or magnitude that you're highlighting in the equity markets, but it's certainly the case within the high yield market as well. And then just going back to your earlier point, when there are unique challenges like tariffs,

[00:22:25] and there's been many over the last 10, 15, 20 years, where we benefit is we try to underwrite through a cycle. These are longer term views that we have in place that are not just one week, one month, one quarter. We tend to have overweights at the sectoral level or at the issuer level that are longer term in nature, that are multiple quarters, three, four, six quarters, if not longer. The composition of risk that exists within those sectors is going to change much more rapidly,

[00:22:54] and that's a function of relative value. But we're trying to look through the near term periods of volatility where markets are up, markets are down. And we think over time that our credit underwriting to certain sectors and to certain issuers will ultimately lead to outperformance. And this, going back to your question around correlation, around the idea that we're an all weather strategy, that our active returns and our returns relative to peers as compared

[00:23:22] to the total return of the high yield market is very lowly correlated. Even as we've been just having our conversation, we've gone back to 2020. And so, of course, that's one of the biggest risk events in market history. 2022, a lot of spread widening amidst a Fed tightening cycle that folks had really difficulty seeing where it was going to end, given how far behind the Fed seemed on the inflation front.

[00:23:49] And then this last recent period, right, maybe short-lived, Trump kind of started on April 2nd and perhaps put it to bed, at least temporarily, but the protracted part of it on April 9th. So those are all very different. I would love to learn how you think about the base level of interest rates, right? So if credit and high yield credit is a spread product, you're spreading it to treasuries.

[00:24:15] So, you know, we go back to 2022 and we have a definitive Fed tightening cycle. The back end is rising as well. We don't have a tightening cycle now. In fact, most of the discussion is around when the Fed's going to start easing. But we do have the back end of the bond market getting a lot of analysis. I would say most of it not really favorable. Folks are worried, as I said earlier, about debt sustainability. How does that make its way into the process of underwriting?

[00:24:44] You know, you're spreading to an asset itself that feels riskier than it used to. How does that impact your thinking? Well, we focus on spreads to treasuries and also all in yields. And at different points in time, one may be more relevant or more important in the overall analysis. We try not to take a significant amount of duration risk or interest rate risk in the portfolio.

[00:25:10] And that's to say our active duration positioning relative to the benchmark is generally not a substantial number. It's relatively small relative to the index. When you're talking about underwriting credit, we're thinking about the volatility of cash flows and what we're getting paid for those cash flows. And so I think it's important to understand what's going on at the macro level and how ultimately that's going to impact the rate market.

[00:25:36] But is there a sufficient amount of spread risk or liquidity premium and spread that we're getting above treasuries to compensate us for those risks? And obviously, the concern around rates today is real. There's uncertainty there. There's uncertainty for the forward path of inflation and how sticky or not that may be. And that obviously is going to have implications for rates in general and ultimately the path that the Fed pursues.

[00:26:06] We need to look past that, right? We need to be cognizant of it, but we need to look past it and be thoughtful about the types of risks that we're underwriting in high yield that are more focused around credit risk, default risk, liquidity risk, as opposed to just interest rate risk. And so thinking about spreads, thinking about all in yields, there's a lot of different things going on there that are part of the analysis. So, you know, I've talked about the S&P as a benchmark and how it evolves over time.

[00:26:35] Its tech weighting is, I think, near an all-time high and certainly it's extremely top heavy. Banks were gigantic in 2006. They're considerably smaller, maybe half that size now. And the high yield benchmark or credit benchmarks, they go through evolution as well. And you said something that I wanted just to get you to expand on, which is the duration component.

[00:27:00] The duration exposure of the benchmark, I believe, is down a fair amount. I'd just love to learn, number one, maybe give us a little bit of how that happens, what's going on underneath the surface. And then it seems to me that your product would expose you less to the vagaries of the back end of the yield curve, just given that this has occurred. Yeah, that's absolutely the case. Interest rate risk or duration of our asset class is in the low threes.

[00:27:29] It's come down over time. It's largely a function of the type of supply and what's getting underwritten in the high yield market. So if you go back 10, 15, 20 years ago, most of the supply that we had seen would be 10 non-call five, maybe 8 non-call three. We've really seen a shortening in the type of issuance that has gotten done in the high yield market. Now it's mostly seven non-call three and potentially five non-call two.

[00:27:56] So what's coming to market has a significantly shorter maturity profile than what was the case 10 or 15 years ago. The overall construction of the market today has a lot more in the way of shorter dated maturities as things have rolled down the curve. We're going to see that extend at some point down the road, but not significantly so. As near-term maturities, as bonds become more callable, which there's a healthy amount out there right now,

[00:28:23] I would expect issuers and private equity sponsors to look to the high yield market to push out some of those maturities. Like I mentioned earlier, not much in the way of near-term 2025 or 2026 maturities, but many of the 2027 and in some cases the 2028 paper that's outstanding is currently callable. And I would expect when it's economic to do so, companies will be fairly proactive in looking to refinance that. The high yield market, however, and this is similar to what we were talking about a moment ago,

[00:28:53] there's just not a tremendous amount of interest rate risk in the high yield market, especially as compared to the investment grade market or other more fixed income sectors. Double Bs for sure have more interest rate risk and sensitivity to rates as compared to lower quality credits, single Bs or triple Cs. As you go down the quality spectrum, there's very little in the way of duration risk associated with much of the triple C market. And as you might imagine, a bond that's trading at 10%, 15%, 20%, that's more stressed or distressed,

[00:29:22] movements in the rate market is going to have very little, if any, impact on the fundamentals or the pricing of that low-quality stressed issuer. Versus a high-quality credit that trades at 5%, 5.5%. As you see volatility in the rate market or Fed activity, raising rates or cutting rates, that's going to have a bit more sensitivity. So when I look at spread widening events,

[00:29:47] and I just compare it to the periods where the VIX spikes and then comes down, you get a couple of different reasons for that. There was this technical event in the VIX last August, August 5th. It was really a liquidity shortfall that happened in a short period of time. But you have a big mismatch of buyers and sellers, and the market clearing price is going to move a lot. You'll recall, and I'm sure you guys had done a ton of work into the election,

[00:30:14] there was a lot of movement in implied vols ahead of the election, especially in rates, this view that Trump presidency is going to be maybe pro-growth, but also higher interest rates. And so there was a lot of handicapping there. And then this last period, VIX skyrocketed, spreads widened a lot, they've obviously come back. And that's some version of anticipating something. And then the last one is, and this is where I would love just to get your thoughts,

[00:30:41] is the realization of whether it's realized volatility in S&P or in your market, realized defaults, which still, I think, are on the pretty darn low side. They were low last year. It feels like they're going to, unless something changes dramatically, I don't know what that high yield default rate is going to be. But talk to us about the environment for defaults.

[00:31:07] And then what would it take for that default rate to materially move higher from your standpoint? Sure. So default rates are low. Going back over the last 12 months, call it sub 1%. So historically low levels. And a lot of people, especially over the last month or two, were pounding the table that defaults have to increase, especially given what's going on in markets. And that may be the case, but I don't think defaults are going to increase substantially.

[00:31:35] There's been an evolution over time as to how lower quality credit, stress credit, distress credit ultimately handles themselves. We're seeing fewer companies ultimately defaulting and filing for bankruptcy. What we're seeing more of are distress exchanges and liability management exercises. So just to give you an example, if an issuer has a near term maturity, call it an early 2026 maturity, and the bond is trading at 60 cents in the dollar,

[00:32:05] it's highly unlikely that that issuer is going to pay you back par in six months time. So what will happen is the issuer, the sponsor, restructuring advisor, and the investors will get together and talk about a potential solution. And what we have seen, and they come in all different sizes, shapes and colors, but the reality is effectively what the issuer is doing is saying, I'm not going to pay you par, but I'll take you out of the existing unsecured bond.

[00:32:32] I'll give you the equivalent of 70 cents on the dollar, but I'll swap you into a secured bond that has a new five-year maturity. So you went from a bond that was trading at 60 cents on the dollar, but you had a par claim. They're giving you 70 cents, and now you have a 70 cent claim. Your 70 cents becomes par for your new secured instrument. What's happening here is the issuer is buying time and optionality for the macro backdrop,

[00:33:02] for fundamentals, for cyclicals to change, to grow their way out of their over-levered balance sheet and over-levered capital structure. This is structurally different than what took place years ago. So in the example that I just gave, let's say that was a $500 million deal out of a $5 billion capital structure, so 10% of their capital structure. And that's distressed exchange or liability management exercise. Just that one bond is considered to be a default.

[00:33:32] The rest of the capital structure, the other $4.5 billion, is not. Previously, if a company could not pay their principal back on a bond, the capital structure defaulted. All $5 billion of debt were restructured, and that $5 billion would go into the default calculation. So it's a fundamental shift and change in how the market has both treated lower quality and stressed and distressed credit, but also how the default rate is calculated. I think it's artificially pressed down

[00:34:02] as a result of these distressed exchanges, which I think is an appropriate action from the issuer's perspective. It may not be what we're looking to accomplish in some of these transactions. It may be the best possible outcome today, but it definitely is a shift in investor behavior or issuer behavior, I should say. Well, if we go back 30 years, almost 30 years when you started at BlackRock, there certainly wasn't any HYG or options on it. It was all voice brokerage.

[00:34:30] There was no electronic trading. There was no portfolio trading. And so the way in which risk is transferred evolves over time. And at least as I've tried to keep up with these developments and you're inside this market, it seems to me that there's been a great deal of progress on the credit side. Again, as an outsider, I would always read, and I kind of bought into it, that even one issuer had so many different types

[00:35:00] of instruments out there, whereas IBM has one stock. All the indentures were different and all these different nuances in language would make it really difficult to do anything like what seems to have made its way into the market in terms of electronic trading. Give us a little overview of how those developments took place. Was there some acceleration in the pace of change? And then again, as a super tanker managing quite a pool of assets,

[00:35:31] it seems to me that these developments in how risk is transferred are critical to folks like you in just trying to manage risk and modify what's in the portfolio. For sure. The biggest thing in recent years has been portfolio trading. In the investment grade market, that's a substantial amount of the activity that happens in a given day. Less so in the high yield market, but still a really important tool and increasingly so over the last five or 10 years.

[00:36:00] Just to give you an example, when there's risk and volatility out there that ultimately results in inflows or outflows, using portfolio trades ultimately gets us really competitive, in some cases best execution with very little in the way of bid-ask spread being paid. So if I think back over the last month with the volatility that we saw and the risk-off sentiment, a lot of model-based or momentum-type investors,

[00:36:28] they were quick to sell high yield and come out of the market. And so we, as a large player, saw our fair share of outflows. We've since seen much of that come back. But the way we dealt with some of those outflows were through the use of portfolio trades. And even on the days where there was the most stress and most pressure in high yield bonds, we were out there selling three or 400 million of risk in the form of a portfolio trade

[00:36:56] with one or two counterparties getting done fairly close to mid-market when transacting. The ease of execution is phenomenal. The ability to transfer risk quite timely, we can get that done. We can put that list out and within a half an hour or an hour, move three to 400 million of risk. The alternative to that is having our traders sort of going hand-to-hand combat and selling a million of this bond, 500,000 of that bond,

[00:37:25] one and a half million of another bond. And that's time-consuming. And ultimately, your counterparties see that you're the seller of risk, right? They don't know how much, they don't know where it's going to end, but they're going to ultimately, at some point, factor that into their pricing as they show it to you. Here, it's relatively seamless, it's massively competitive and results in tremendous execution. So we've been a big believer in it. We've increasingly utilized it as we have inflows or outflows into the portfolio.

[00:37:55] Or if we're looking to significantly transition the portfolio from a risk profile standpoint, right? If we're trying to increase WBs and sell lower quality credit, we can do hand-to-hand combat or we can engage in a portfolio trade where we can get the majority of what we're trying to accomplish done in the half an hour or an hour period of time. The other thing that is extremely relevant and we were at the forefront of as well is the use of liquid products.

[00:38:23] So the CDX index, ETFs, you mentioned HYG and others, as well as total return swaps. We are active users of these tools. These are liquid products, traditionally thought as beta products. They all trade at premiums or discounts to their intrinsic value. And we try to generate alpha through the use of these products in our portfolio. So if the ETF is trading at a discount or the CDX is trading at a discount, we're going to look to buy it. And if another product is trading at a premium,

[00:38:52] we're going to look to sell it, right? We like to have these tools in the portfolio as a liquidity tool. So just like I said, we engage in portfolio trading when we saw some outflows. We also use some of these liquid tools to quickly access the market, sell CDX or sell the ETF with bid-ask spreads that are a penny or two. It's a really competitive execution during periods of stress or volatility. I would say, as you think about our portfolio construction, our management style,

[00:39:20] engaging in these products and these tools, that's central to how we allocate and manage our overall risk. You mentioned earlier in the conversation, CLOs, and they're kind of sitting in the background of part of the architecture of risk-taking, as are the ETFs, as are some of the derivative-related products. There are these almost mechanical index-like products that exist that didn't exist earlier.

[00:39:49] It sounds to me, and again, I think there's a corollary here to the equity space where there's just new entrants and new products that are ramping up trading volumes and probably reducing frictions in the process. What's the ecosystem look like in terms of your ability to lay off risk or find new sources of how you're trying to source risk relative to where it was a decade ago?

[00:40:20] It's much bigger. The tools that I alluded to in the high-yield market similarly exist in the leveraged loan market, also exist in the CLO market with CLOA as an example, an ETF, the AAA ETF that is used. But there are tools across all these asset classes now that enables us to put risk on or take risk off or express a view in an asset class much more quickly, much more efficiently than was the case over the last five or 10 years.

[00:40:49] So the ecosystem is that much bigger. You alluded to some optionality that has been created in some of these products. That is very much the case in the ETF world as well as the CDX world where there are options on many of these products that allows investors to customize outcomes and trades to those outcomes. And so I think the evolution, much like the high-yield market has changed over time, so have financial tools and instruments to take advantage

[00:41:18] of these changes in the industry. As we've had this conversation, we've talked about risks both micro and macro in nature. A large part of what your team is doing is trying to assess maybe industry fundamentals and even corporate-specific fundamentals, balance sheet fundamentals, but also it's very clear you have to pay very close attention to the overhang of macro uncertainty, which clearly at times can overwhelm

[00:41:47] any good business if the macro uncertainty is that significant. We touched on the default rate and I guess my question is going to be what keeps you up at night in that realm of the things that you are kind of worried about from a tail risk standpoint. Obviously, a credit investor, you're only getting back 100. You're clipping a coupon along the way, so you're sort of short of put in the Merton model framework, and so you're short vol. What are those sources of vol

[00:42:16] or uncertainty that you're wrestling with and on the lookout for? Yeah, I think it's a continuation of the world that we've recently been living in. A massive amount of uncertainty created, which was a significant surprise to the market. An additional bout of uncertainty that was layered into things overnight with the ruling around tariffs. For us, I'd like to have a clearer understanding of what the macro environment

[00:42:46] looks like. I'd love to see some of these trade deals, agreements, get implemented or agreed upon and ultimately implemented and know that they are longer term in nature so we don't have some of these near term hiccups like we've recently experienced. I think for businesses, for consumers, for investors to have confidence, we need to see that backdrop, that overhang, maybe not get completely resolved but we need to be

[00:43:14] significantly further along in terms of the path forward. It's hard to imagine companies, businesses engaging in significant amounts of CapEx when they don't have a clear understanding of what the world is going to look like three months, six months, 12 months out. So, having more clarity around that is going to be a core part of our focus. Another part, and this was alluded to in some of our conversation

[00:43:43] but the Fed, just making sure that monetary policy maintains the independence that we've witnessed for so long and making sure that they continue to have credibility that we feel comfortable in what that forward-looking view is and that's going to be an independent, unbiased view I think is really important to financial markets not just for fixed income markets or high yield but certainly for the equity markets as well. Last question I'd love to just get your thoughts on is maybe

[00:44:13] your constituency, the buyer base of the assets that you're managing. I had a couple months ago on the podcast Dominique Toublant who's the head of credit research at Barclays and he was making the point that it was the all-in yields so spreads not super wide this was late 2024 but the combo of reasonably high treasury rates plus some spread got you to a comfortable all-in yield

[00:44:42] and he was really making the point that the foreign buyer base he mentioned Korea a couple times was a big constituency in the credit markets and so I just was curious if you could reflect on the evolution of the buyer base what does that look like? are these folks that entities that'll kind of stick it out through a cycle or are these actively managed traders that really think more tactically that you've got to convince to stay put

[00:45:12] or are they more long-term in nature? Yeah I think increasingly over the last 10, 15, 20 years we've seen steadier hands investing in the high-yield market that's not to say we don't have model-based or momentum-type investors that I alluded to earlier that are going to come into the market or exit the market based on momentum based on volatility or lack thereof we certainly do see that but the overwhelming majority of investors today are longer-term in nature

[00:45:42] we've seen more and more insurance companies getting invested in high yields focusing on the higher quality part of the market a lot of private banks have increased their allocation over the better part of 10 or 15 years it's been much stickier in allocation to high yield than what we witnessed 15 or 20 years ago and I think that's a function of what I was describing earlier as the evolution of high yield and the composition of risk has changed so significantly I think you're

[00:46:12] starting to see more of an appreciation for that right so a less volatile asset class than what was the case 25 or 30 years ago when it was more of the junk bond high yield market if you will so greater stability in our market has resulted in more and more investors pension funds insurance companies I'll call the private bank investor as more institutional retail this has become an increasingly core part of their portfolio

[00:46:41] you do tend to see the private banks be a little bit more active maybe once a year once every other year modifying their allocation but it feels much stickier than it did historically the other point is there's a tremendous amount of capital multi-asset type capital that we have here at BlackRock but also that exists across other mutual fund complex and other asset managers and we are seeing more and more of those investors thinking about

[00:47:10] the asset class and allocated to the asset class particularly during times of stress or volatility so we think about what we saw a month ago yes there was outflows yes there was model-based pressure we saw insurance companies buying double B's at yield 7 or 7.5% we saw a few pension funds allocating more capital to the asset class some on-balance sheet corporate cash investors some gave us money some were really considering allocating more capital to the

[00:47:40] asset class and a lot of these multi-asset investors saw that the 200 basis points of spread widening all in yields 8.5% and viewed that as quite attractive relative to other parts of the market one of the things that we observed during that period of time was a real cheapening in high yield relative to investment grade so we saw investors focus on that in particular the double B part of the market relative to triple B's you look back on a three and five year basis we were trading on the 85th

[00:48:09] to 90th percentile over time for high yield versus investment grade or double B's versus triple B's so I think that was a pretty interesting time that if you did have a longer term view allocated to the asset class was something that really worked out in the short term but you're also going to benefit from the next 6, 12, 18 months of relatively healthy all in yields and that's I think one of the interesting parts as I look forward here

[00:48:39] an interesting stat we're just inside of 8% today maybe closer to 7.5% but one of the things that we've observed over the last 25 years there's been 300 instances on a weekly basis where all in yields have been north of 8% 85% of the time that results in a forward 12 month return that is positive with the median return being 14% a similar stat is yields north of 7% the starting point there's been 600 or so

[00:49:09] instances where that's been the case the forward 12 month return again roughly 85% of the time is positive with the median return 10.5% or 11% so the point here is that all in yields carry income generation in the high yield asset class is really the story yes there'll be periods of spread winding and periods of spread tightening but if you can weather the storm and you can think 12 or 18 months out and

[00:49:40] you low double digit type returns in the asset class one thing that we didn't talk about that maybe I'll throw in here is we are and you alluded to it we are much more micro oriented we are generally focused on our fundamental view at the sectoral level the bottoms up analysis at the issuer level that's going to generate the majority of our alpha over time

[00:50:10] and so you think about in any given year about two thirds throughout a cycle two thirds of our alpha generation is coming from that single name credit under right and that bottoms up analysis there are many other alpha streams as well one would be our active data positioning so are we risk on or risk off relative to a benchmark our asset class relative value and most of the portfolios that we manage which traditionally invested in high yield but we'll understand the pricing of risk in our market

[00:50:39] relative to the investment grade market relative to the leveraged loan market one to give us greater conviction in our view and two if there is an opportunity to look to the investment grade market for a small part of the portfolio we may take advantage of that another alpha tree would be industry relative value we alluded to a

[00:51:24] level but as you alluded to a difference between the bond market and the equity market there's one stock there are multiple layers of a capital structure we secured unsecured there are different maturities that exist and being thoughtful as to how and when we deploy capital at the front end of the curve or the back end of the curve to really maximize beta maximize our spread duration in an issuer is critical to how we think about the market and how we ultimately construct portfolios the final point I'll make here is that

[00:51:54] all of these different alpha streams they are very much uncorrelated with one another and that's intentionally so it's both intentional and as we look backwards to test it to see how we've done the correlations over a five year period of time on a weekly portfolios that are not market directional that allows us to be really all weather and generate substantial active returns despite

[00:52:23] the market environment fantastic so putting together those different streams which are not correlated to one another but kind of utilizing those in tandem to try to earn alpha without necessarily taking on any real market direction yeah that is the intention obviously we're going to have a view at the macro level have the fundamentals look like broadly but the idea here is that independent of whether the market is

[00:52:53] doing well or the market is doing poorly we have trades on in place that are going to lead to significant alpha generation without being market directional at a macro level we generally don't take versus the benchmark we're looking to take macro risk we're looking to take credit risk issuer risk

[00:53:23] sector risk liquidity risk and hopefully minimize default risk well Mitch I really appreciated the chance to get your views on all things in credit products and appreciate you being a guest on the alpha exchange thanks Dean I really enjoyed it appreciate it you've been listening to the alpha exchange if you've enjoyed the show please do tell a friend and before we leave I wanted to invite you to drop us some feedback as we aim to utilize these conversations to contribute to the investment community's

[00:53:53] understanding of risk your input is valuable and provides direction on where we should focus please email us at feedback at alpha exchange podcast dot com thanks again and catch you next time