This was an opportunity to speak with an amazingly accomplished portfolio manager and entrepreneur. Right now, the specter of interest rate volatility, market volatility and inflation risk have investors’ full attention. Nancy Davis’s fund, IVOL, was built on her experience dealing with these issues and has received a lot of positive recent notice. Nancy began her career at Goldman Sachs where she became the Head of Credit, Derivatives and OTC Trading. She went on to be a portfolio manager at HighBridge and taking on management responsibilities at Alliance Bernstein before taking the leap and founding her firm, QUADRATIC CAPITAL LLC in 2013. It is there that she has built a unique business around her expertise. In this episode, we talk about her background, what problems her strategies try to solve and how she does it, and the decision to structure her fund as an ETF.
Describe your background and what led to the founding of Quadratic-
The experience at Goldman Sachs, HighBridge, Alliance Bernstein
Getting back to being a Portfolio Manager and forming your own firm
What Investment Issues does IVOL try to address?
Interest Rate Volatility
Investment expectations and market volatility;
Where would IVOL normally fit in an asset allocation?
Dealing with Interest Rate Volatility
Generationally low interest rates vs the Federal Reserve with its foot on the interest rates
Interest rate jumps that are big on a percentage basis but not that big in terms of actual BPS
Financial industrial complex where expertise in dealing with rising interest rates is retired or dead
What is the difference between interest rate volatility and equity volatility- how do you exploit this? Recent examples
What is the difference between CPI and “actual inflation”?
How does your strategy try to address that?
The fund is made up substantially with TIPS, but also with other securities and options- Why are TIPS not fully adequate? How does being invested in OTC rates improve upon other methods?
How does the IVOL implement its investment strategy (TIPS + other options/FI)- Why is this preferable?
Enhancing other allocations
Traditional Fixed Income – IVOL holds TIPs and is long-volatility, which can act as a potential diversifier to a fixed income portfolio centered on the Barclays Agg.
Real Estate- IVOL may help hedge the risk of falling real estate prices brought on by rising long term interest rates.
Equities- IVOL owns fixed income volatility and may act as a market hedge since volatility has historically increased during large equity sell-offs. IVOL is potentially defensive for an equity portfolio given its use of US Treasuries. Further, its options potentially benefit from a steepening of the yield curve, which historically has often occurred during equity market declines.
TIPS- IVOL owns TIPS, but they are enhanced using TIPS with options. These options function as options on inflation expectations, because the yield curve is largely a result of inflation expectations.
Floating Rate Notes- IVOL has the potential to appreciate when the interest rate curve steepens and long dated inflation expectations move higher, giving investors a similar benefit to the one they are expecting from their FRN without the credit risk.
Short Duration Bonds- IVOL may help hedge during bond market sell-offs should the yield curve steepen and volatility increase while providing potentially enhanced distributions.
Factors that impact IVOL
TIPS Bond Price- Rising prices are usually good for the fund
Volatility- Rising volatility is usually good for the fund
Expectations for rate cuts- Increased Expectations are usually good for the fund
Long Dated Yields – Rising yields are usually good for the fund
What are the couple of pieces of news that you are following intently that many investors aren’t focused on?
The decision to go ETF vs a traditional hedge fund partnership-
What went into that choice? Were there drawbacks?
The benefits of transparency, tax efficiency, lower costs for investors
Finally, how best do we follow IVOL and Quadratic?