Inflation ETF Pioneer Says Investors Need More Interest Rate Risk

(Bloomberg Markets) – Nancy Davis was a trader at Goldman Sachs Group Inc. and founder of funds before making a splash with IVOL, an actively managed exchange-traded fund that allows investors to bet on inflation and rate volatility. ‘interest. The Tampa native says she has enjoyed the non-linear risk of options trading since attending George Washington University. Today, his company, Quadratic Capital Management, no longer manages hedge fund money. Instead, Davis is focusing on overseeing the IVOL strategy, which had around $ 3.56 billion as of mid-November, and a deflation strategy, BNDD, which opened in September. Davis, 45, spoke to Bloomberg Markets in October about his career, why fixed income investors need exposure to volatility, and his relationship with fellow ETF manager Cathie. Wood from Ark Investment Management. The interview has been condensed and edited for clarity. (Bloomberg terminal users can participate in a TopLive Q&A with Davis at 10:00 a.m. in New York City here.)

How did you get started in finance?

I started my career at Goldman Sachs right out of college. I had no connection with Wall Street. I remember telling my dad that I was moving to New York to work for Goldman Sachs, and he thought it was a horrible idea, “They’re going to eat you alive, why do you wanna go?” I was very fortunate to have a trading seat in the owner office managing Goldman’s own capital. We had no clients. It was a great learning opportunity to invest in all asset classes and gain exposure to a lot of different things. It was also a great place to be a woman, a trader, an investor.

Have you always wanted to get into finance?

I didn’t know anything about this industry, nor did I think that was what I wanted to do when I grew up. I was a stock market kid, and I also had a job [a paid internship at Ernst & Young’s consulting business] where we were doing a lot of things with derivatives. Thanks to my scholarship, I was able to take courses in graduate school, so I ended up taking, I think, five master’s courses as an undergraduate student. I learned all about derivatives for my job and personally started trading options. I think it made my resume stand out when I applied to Goldman as well as other companies. I have always been very interested in the options. There are many types of derivatives. Most investors use linear derivatives like futures, forwards, swaps. These are derivatives that go up a dollar, go down a dollar, right? I don’t really have an interest in linear derivatives. I am 100% an asymmetrical girl. So all the options, all the asymmetric payments.

Why do you like the options so much?

Most portfolio managers manage their portfolios with stop losses. They create a portfolio, then stop the portfolio by selling their long positions after selling, hedging their short positions after they rise. But to me it always seemed silly. You need to create your stop loss early. And that’s what we do with options, right? We know our downside. Most portfolio managers lose investors’ money first and then manage it for risk.

Why did you leave Goldman?

I found myself doing three and a half hours round trip each day to Lower Manhattan from Connecticut. I wasn’t looking for a job. But I remember being recruited by the JPMorgan Highbridge hedge fund and [being] asked, “What could be better in your life?” And I said, “I want to see more of my kids.” And he said, “We’re going to open an office in Greenwich for you. So it was all for flexibility. So that’s the only reason I left. It was only for my trip.

Why did you start your own business?

I felt like I was making a bet on myself, which never seemed risky to me. I was just like, what I’m doing is awesome, it’s really different, and I’m going to do it for myself. You have to be a little optimistic as an entrepreneur, and if you don’t believe in yourself, no one else will believe in you.

I’m very mathematical as a financial person, but you can tap into a whole bunch of other aspects of the creative process when running a business. I learned a lot. This is something that excites me.

As a woman, you are sometimes put in those buckets of emerging managers. Personally, I take offense because I am not an emerging manager. I have been a portfolio manager for a long time.

Why did you create an inflation ETF?

TIPS [Treasury Inflation-Protected Securities] are defined with an index. Why would you use the Consumer Price Index as the only way to measure something as important as inflation? And the TIPS are long lasting. If you look at the first quarter, everyone was talking about inflation. TIPS lost money because they are bonds and they have time exposure. IVOL really solves a problem that investors have.

I had the kind of light bulb moment that having public liquid securities inside a private fund wrapper didn’t make sense. The fees were too high. You had neither liquidity nor transparency.

And many fixed income investors are short of volatility in their fixed income portfolio due to their exposure to mortgages. And they don’t necessarily think about it. If you own a mortgage, you are a short option for US homeowners because US homeowners can prepay whenever they want. When you run out of options, you run out of volatility.

So creating IVOL and BNDD are solutions, don’t take my hedge fund and turn it into an ETF. They’re long-only strategies – they’re just positively convex long-only strategies rather than mortgages, which are, you know, negatively convex strategies. I feel like I’m like the Lew Ranieri of modern times, don’t I? He was the guy who packed mortgages [into mortgage-backed securities]. There are only two types of bond risk. There’s the interest rate risk, and then there’s the spread risk. Both BNDD and IVOL take an interest rate spread risk. It is not correlated with AGG [the Bloomberg Aggregate Bond Index]. It is not correlated with high yield bonds. It’s not even correlated with the VIX, gold, or the stock market.

Who are your clients ?

Most of our clientele was on the institutional side — a lot of endowments, a lot of very sophisticated investors. March 2020 was really a pivotal time for IVOL as we had a positive performance when many bond funds with credit spread risk lost money. I think that was a bit of a wake-up call for investors. TIPS also sold off as oil turned negative and inflation expectations fell.

How has the pandemic changed things?

I think the pandemic was kind of a flash in a bottle for inflation because now we have budget spending plus we all have labor shocks. The Fed has hit an average inflation target. Before the pandemic, people didn’t really think about inflation. IVOL does more than inflation, it can also do well when the Fed cuts rates, which usually happens in an environment of risk aversion for equities. But I think that at least opened the door for people to be like, “Oh, maybe I should look at this. “

How did you decide on the 0.99% expense ratio for the two ETFs?

A fixed cost product is really ideal for investors. This is one thing that differentiates active ETFs from hedge funds. Hedge funds are blended funds that have a management fee plus incentive fees, and an active ETF is also a blended fund that is actively managed, but our fees are fixed. Our fees include all fund expenses such as administrator, custodian, audit. All of these fees are paid by the issuer of the ETF, not by the fund.

Why did you choose to work with Krane Funds, majority owned by China International Capital Corp. ?

I started doing things with China in the Goldman days, then I wrote an article that was published in a book in China. I was the keynote speaker at a conference. They had given to the CRO [chief risk officer] from BlackRock about 15 minutes. The CEO of CIC [China Investment Corp.], their sovereign wealth fund, he had about 15 minutes. I had an hour and 45 minutes. It was just amazing to have so much support. At this conference, the Asset Management Association of China, I met someone who ended up working at Krane. We reconnected when I was thinking of starting an ETF, and we also had a lawyer in common. There are a lot of operational and compliance things that are very important, and with any growing business you can build it in-house or you can partner with specialists. I really wanted to focus on the wallet side. It was a crazy, crazy coincidence that it was through China that I originally connected to them.

You’ve been compared to Cathie Wood. What do you think about that?

I don’t know if I’ve ever been compared to Cathie, but I love Cathie. He is a fabulous person and a great investor. I started Quadratic a little before the creation of Ark. She was a huge inspiration and a sounding board, and I think I was for her too. I didn’t embrace social media like Cathie. I don’t have a Twitter account.

Maki reports on currencies and rates and Ballentine covers personal finance for Bloomberg News in New York.

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