#3 Athan Tolis - Founder and CEO of Actium Liquidity Partners / Algorithmic Bond Research

The Nalu Finance Podcast

In this episode of Nalu Finance, we sit down with Athan Tolis, President of Bonds Goggle Inc., to explore how interest rates, central banks, and bond markets function beneath the surface.

Athan shares sharp insights into:

• Why US bonds trade at higher yields than European ones

• The real reason central banks have been successful

• How to extract alpha in bond markets despite low yields

• Why credit market liquidity remains elusive

• Why passive vs. active bond management isn’t a clear-cut choice
  

He also challenges the belief that economists and central bankers add no value and explains why Trading Places is the best finance movie ever.

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🎙️ Transcript: Intro: 00:00

Nalu FM, finance podcast. Insight into the financial markets. But first, a word from our founding sponsor. Are you missing the sun? Always wanted to go to Hawaii? Go to HaleCapri.com.

Stefan Wagner: 00:17 Hi, Athan. Thank you very much for taking the time this afternoon. I'm here with Athan Tolis, president of Bonds Goggle Inc., also known as Axiom Liquidity Partners. Let's jump right in. Risk and return usually means high interest rates or coupons imply a higher risk. Is this why the US has higher coupons or interest rates in Europe? Or is this just because the US is desperate for money and needs to compensate the investors for that?

Athan Tolis: 00:45 Well, the easy answer to your question is to observe that the central bank in Europe has lower administered rates, negative rates, and that is a guide for the rest of the curve. But there's obviously more to it than that. You can sit and observe how equities markets have done the last couple of decades and European equities markets, depending on which one you choose to look at, peaked 20 years ago, 10 years ago. Germany is a little bit better than that, but it's the exception. The U.S. stock market is within 3% of its all-time high that happened two months ago.

So it isn't entirely out of order that people who buy European securities should have lower expectations on return than people who buy American securities. The other thing to keep in mind when we're discussing bonds, and more so risk-free government bonds than other bonds, is that People aren't necessarily trying to optimize the return. The people who buy them may be squeezed into buying them. They might be squeezed into a corner solution if you want.

So what do people buy Govis from? What drives the need to buy them? Sovereign wealth funds might own them, or they might be owned by foreign central banks for their reserves. Or the need to own them might be driven by the fact that you need to stick collateral in some derivatives exchange. Or you could be a pension fund with stipulated requirements for duration. So between all of that, it isn't unthinkable that the demand for government paper is higher than the supply, and that has the effects that you see on returns.

Stefan Wagner: 03:05 And at the current point, once I look, correct me if I'm wrong, but when I looked at it, you can buy basically US treasury bonds and asset swap them into sterling and still get a better return than your UK government bonds.

Athan Tolis: 03:21 Absolutely. That's actually an observation we made the other day, and it's the fact that the higher administered rate in the US may actually be sucking investment into the US from the rest of the planet. and all those people who are actively asking for the Fed to cut rates may discover that money is no longer moving into the U.S. as fast. I wouldn't want to be the guy who's trying to sell CP for General Electric should the American rates come down. We could observe quantitative tightening from the private sector. I'm not saying that's going to happen. I'm saying it's something to keep in mind.

Stefan Wagner: 04:20 Fair enough. I come from the equity or equity-rich side of the business. And while you come clearly from the interest rate side or bond swap side, what do you think the fundamental difference are in the way you see the world versus, what's it called, the equity, equity-rich side, besides that you think at basis points are an annual reoccurring thing and people think it's a one-time upfront?

Athan Tolis: 04:42 Yes, that's something we discuss very often. More seriously, The fundamental difference from a trading perspective is the fact that bonds largely move together. You can hedge bonds extremely well with other bonds. As a bond trader, if you're looking to precisely get out of what you get given by your clients, you're making a big mistake. Part of the job description, say you're a bond market maker, is to run a portfolio. Long story short, the nearest thing to a bond trader on the equities trading floor is actually the equity options trader.

He does not go hedging every strike and every expiry. What he does is he gets out of the underlying as quickly as he can, and then he runs a book. So a vanilla bond dealer is closest to an equity derivatives dealer more than anything else. Except in bonds you have much, much better liquidity and that's the difference. And, you know, the other difference is the guy who trades equity derivatives has a degree in finance, the guy who trades the bonds probably was a quarterback or something. It's the other fundamental difference.

Stefan Wagner: 06:12 Possible. Now, you know, there's a lot of people out there who think they know what's going to happen next or opine also what just happened and called economists and Warren Buffett himself says, you know, we shouldn't listen to it. Or I think he strongly said, show me a rich economist. I don't think they ever got it right. But is there, should somebody listen to economists? You know, how do you cut through the noise that's out there? How do you go about it in a sense? How do you determine what you listen to and what not to?

Athan Tolis: 06:43 When you say economist, I presume you mean sell-side economists, not go through the works of famous economists in the past, right? Yes. I actually think it's a good investment to follow them, but it's an investment. you cannot read them here and there because like you and me they have strong fundamental beliefs that they like to cling to so you know we know each other for a very long time and you know me to be a bear you know when you and I have a chat From the beginning, I'm going to tell you something bearish.

So you're listening more for the tone of my voice than anything else. Exactly the same way, if you're following a sell-side economist, your duty is to follow this economist often and try to figure out which way they're leaning relative to the past. But yeah, there was, for example, a golden age when Stephen Roach was editing the economics for Morgan Stanley. It was El Gabbach and Antisai. I followed that. That was my Bible at the time. I loved it. But you have to keep in mind that, you know, in the words of Rosenberg, it's Very difficult to be a bear when you have the bull on your business card So context is important and you need to follow these people closely.

Stefan Wagner: 08:15 Otherwise, you really don't get anything. You need to listen when they change their tune basically. Yeah, that's key. Yeah, okay. Jumping to the next one on the news is central bankers. They always seem to get it wrong. Can they ever actually get it right? Nobody ever said this or that one got it really right. They always get it in the neck in a sense. Is that part of the job or can they ever get it right?

Athan Tolis: 08:46 See, I actually happen to believe that central bankers have delivered enormously, but they have delivered to the people who matter to them. And the people who matter to the central bankers are the class of asset holders, people who own assets.

Stefan Wagner: 09:11 So in this country, the United Kingdom,

Athan Tolis: 09:24 80% of bank assets are property related. And if you look at where people live, 60% live in a home they own, 20% rent and 20% rent from the government. That's grosso modo, it's varied through time. And two thirds of the 60% who own have a mortgage. So 40% of society, the upper middle class if you want to call it, have a mortgage. And when things got bad, the central bank took things away from the market and set the base rate administratively. No one gets a look in, a number that made it affordable for everyone to be able to carry on living in their house. That hasn't been discussed much, but it's precisely what they did.

And they delivered. Equally, Alan Greenspan was the maestro because he delivered the Greenspan put. Ownership of stocks was very wide at the time. 1987 was probably one of the periods in time when Stock ownership was the widest, especially not passive stock ownership through your pension, but people managing their own stocks. And he saved them. He saved the middle class.

The Greenspan put, the Bernanke put, all of that stuff was immensely popular. People like to say that it's the wrong thing to have done, but these people delivered precisely what the public wanted. And they exercised their freedom and their independence to do precisely that. So they've been extremely successful. What the future holds, nobody knows. But for the time being, they've done what the people wanted of them. And people who complain that they are unelected, they wouldn't have done anything different if had they been elected.

Stefan Wagner: 11:56 So would you have any advice for the new ECB, Christine Lagarde?

Athan Tolis: 12:02 Oh, of none. Christine Lagarde knows everything, knows everybody. She has an amazing political mind. She has experience from running a large organization at this point. And what she needs to do now is deliver on European Banking Union. Her goals are largely political. I will be very surprised if she doesn't turn out to be a very successful central banker on the parameters on which her success is going to be judged. Fair enough.

Stefan Wagner: 12:46 Now for a very long time, we now have been in a very low or negative even interest rate environment. And, you know, investing in reasonable bonds with a reasonable credit has been, you know, pretty much a low income affair. Any hope this might change and why and when or what do I need to do? Do I need to go down further the credit and where I can find value?

Athan Tolis: 13:11 That's the easiest question you've asked me so far. There's no hope for change. Not in the absence of a crash at any rate. Should that happen, then sure. And that answers the second part of your question, the one about going further down the credit curve. But the answer is simple arithmetic. In fixed income, you know precisely what you're going to get. There's no such thing as capital appreciation. The clue's in the name. You know up front what you're going to get if you hold the bond to maturity. I mean, way back in the day when the coupon strip was non-trivial, we could have had the discussion about its reinvestment rate, but that's not a long discussion when the coupon is as low as it is today. So the answer is no.

Stefan Wagner: 14:03 Okay. And I mean, right now, the majority of US corporate debt is pretty much triple B right at the border of going high yield. If this goes down one notch, there's no illiquidity. I think when GE was threatened to go one notch down, there would have not been enough liquidity. I mean, what's going to happen here in this case?

Athan Tolis: 14:24 You're taking me away from my area of expertise. Well, I don't know about credit. You could write on the back of a stamp. But all my friends in credit have been saying for a while that liquidity is dreadful. I don't know that things will change much from here. One thing I will tell you. is that all these initiatives whereby you give your access to somebody and he tries to find the other side, they're not going to make a big difference, other than maybe to eliminate some bond trading jobs. When I used to run Book to Eat back in the early days of the internet, people would come up to me and say, now with your system, am I going to be able to get into the IV? And I'd be like, if no one lets you in like that, access the computer is not going to make things any better for you.

And similarly, all these initiatives whereby we're going to use technology to defeat the illiquidity and credit, I don't see that happening. I don't see why someone who really needs to do something is going to let the world know. He's going to work it by himself.

Stefan Wagner: 15:53 Yeah. And one of the last questions, I mean, a little bit also coming back to the use of technology or how you approach managing portfolio, how much can one in such a low environment and which pretty much all trading around the same thing, how much can you add in actively managing a bond portfolio versus just passively index tracking?

Athan Tolis: 16:16 So actually that's something that is a very important part of what we study and what we do. So thanks for asking that question. Depending on the index you're trying to beat and before the increased costs in dealing, You can get anywhere between an extra 15 basis points or up to 100 basis points non-leveraged. And if you're running both longs and shorts, you can double that. So that's the one sentence answer. Obviously, the caveat about dealing costs is an enormous one. You take that out. kind of like negates the whole issue. We've done an obscene amount of simulation.

And the main thrust of our work is in the field of identifying what those trading costs are to be and what they turn out to be. We've concluded that for markets where there are, I don't know, a couple hundred bonds to pick from, like US treasuries, you can get away with monthly rebalancing, and you're going to outperform by amounts that are significant and add up over time. You try to do that in South African bonds, where there's two issues, there's not much you can do. You will bleed money. Whatever you make up from picking bonds in, say, Spain, even, you're going to give back in Bedok. I'd add here, and it's probably a controversial point to make, I think the most natural players to run bond portfolios are dealers.

And the reason is they get paid to deal. The issue, of course, is you would need to trust them, you know, not to be naughty. And that's where I think technology has a lot to add. If they can prove to you that you've been dealt with algorithmically in a fair fashion, then you might be comfortable with them simultaneously running some type of index. And that's a technology that we're developing actually.

Stefan Wagner: 18:42 Fantastic. Last question. I always ask everybody is that you have any up to three favorite finance movies, you know, like Wall Street or any other one or Wall Street.

Athan Tolis: 18:58 I like now that I've grown up but when I watched it I didn't like it at all because I was in awe of Daryl Hannah and she's made to look old and used and I didn't like that at all. My favorite would have to be Trading Places because that's just a funny movie. It's a tremendous movie. And, you know, if you want the Wall Street type of selling your soul to the devil, you should just go to Source and watch Klaus Maria Brandauer and Mephisto and be done. That's my view. So trading places. That's my favorite. Fantastic. Thank you very much, Arthur.

Stefan Wagner: 19:41 Thank you for having me.