Kotok: Be Nimble At Markets' Turning Point

February 07, 2017

ETF.com: Interest rates are expected to go up. Is that changing your approach to the fixed-income space at all?

Kotok: There are two component parts of interest rates—the short-term interest rate and the long-term interest rate. And then there's the relative change; with a tax-free bond, the relative change is very, very important.

Look at what's happened in the last few months. We had a situation in which the long-term muni reached a yield lower than the long-term taxable Treasury. That’s what you would expect because we have an income tax code, so a high-grade muni should yield less than a high-grade or the very-highest-grade taxable.

Now, we've had an election—the muni market got clobbered, bonds went down in price, up in yield, and the 30-year Treasury may have backed up 40, 50 basis points. At the same time, munis backed up over 100. It went from being richly priced to a cheap bargain.

You can seize those opportunities in the ETF. We're going to be able to move those things around a little bit. Our anticipation is, if we have volatile changes, we'll be able to do so even more easily, because of the nature of a total return ETF. You're not just buying an old-fashioned pool of bonds and holding them forever.

ETF.com: Do you see any major risks that investors should be watching for right now?

Kotok: Generally speaking, we have a huge inflection point here. Doing an inventory, the U.S.—the largest economy in the world—is slowly raising interest rates, with a new regime in power talking about trade and protectionism and altering the tax structure.

The second-largest economy in the world is China—it's more of a closed, controlled market, not a free-market pricing system, trying to establish itself in a world order.

With the third-largest economy, Japan, the policies are anchoring two points on the yield curve at near-zero. It’s in a confrontation with the second-largest economy over a piece of real estate that’s been turned into a military base and is disputed.

The fourth bloc in the world, with 500 million people, is Europe, where the interest rate is negative. They're trying to get to some inflation, and they hope to have growth of 1-1.5%. And their banking system is riddled with difficulties, particularly in Italy.

That's the world. This is a very, very different world, where you don’t have correlated economies. You don’t have interest rates aligning all at zero anymore. And you have differing degrees of economics: slowdown and recovery. And now there’s regime change in a political sphere that is now adding trade and protectionism.

So what do we have? A huge inflection point, a massive inflection point. There are a lot of characteristics that support that notion.

What don't we know? What is the direction of change and how rapidly will it exist?

 

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