Talk Your Book: Animal Spirits Live with F/m Investments

21:13And when you need to make a choice, you get kind of wooed into one that seems a little funky and you assume it's fine. Like, we look at some of the ETFs coming out for, you know, are the Eagles going to win this? Are they going to make it the postseason? Those are things that are great to put on Polymarket and CalShe. But once you make them brokerage account level easy, you start to get into some trouble. And so I worry a little bit that, and as someone who's done a lot of innovative things from a firm that's happy to embrace that. Look, we came up with a, we own a single treasury in an ETF. I mean, we were laughed at a lot of rooms.

21:44When we say, you know, it might be a little too far, kind of look at that as there's some things that might be a little too far.

21:49Ben Carlson:So getting back to the tax stuff, remind us how, what you do in the Compounder series. Because a lot of these, a lot of places are now, there's a ton of ETFs using options. Like, how are you trying to defer this tax situation and not pay out as much income? Sure. So options, we try to do the same thing, right? We're always trading in kind. So we'll buy security, say AGG, and before it declares its dividend, we'll sell it and we'll buy something that's pretty similar to it. And, or two or three things that on average look a lot like AGG. We'll hold onto that through AGG's dividend period. And then before any of those other funds declare a dividend, we sell back out and rotate back into AGG, which just basically has the benefit of capturing the dividend every day.

22:30So if you watch the NAV of AGG, you'll watch it go up because all the coupons get collected and ingested into the NAV. We just get out of the way before that NAV is decreased and the dividend provided. By doing that, we never collect the dividend. And therefore, you're just getting a total return experience.

22:46Ben Carlson:I mean, I imagine there's not a ton of activity. No, it's 20 trades a year in that sense. I mean, it seems like a lot of turnover because we're constantly in and out. We can't own half of it. We'd still get half the dividend, but you're getting a pretty clean exposure. And our goal is to give you a GG, whatever it is. And then we do a high yield version. You'll see us branch out into cash for folks who don't like the options-based world to get cash. We actually want to own a treasury. We'll do it in that space. We'll go to BDCs. We'll go to REITs. We'll go to things where you have a lot of cash income that you'd like to defer or not collect the dividend on.

23:16All right. BDCs, a lot of smoke. So to be fair, BDCs has been around for a long time and many of them done a really good job. Some of them recently have garnered a lot of negative interest, perhaps deservedly so. So I've been, I think, pretty fair on what's happened in the space. And I think the most legitimate criticism is that I think everybody understands how we got here. 2022 sucked for everybody. And the bonds were supposed to be your ballast. They were supposed to protect you. And they pushed you overboard. So your bonds fell and then the stocks fell with it. And because there was a relatively benign economic environment, the credit held up.

24:00And the floating rate was amazing for these private loans. And everybody was really happy and then all the money came in and et cetera, et cetera. The money came in so fast. They couldn't spend it. And so there just can't be - It's a problem, by the way, I'd like to have. There can't be that many good borrowers. And so how do you think about that? How should investors think about the rise of this asset class? Which, by the way, I don't think that in three years, we're going to look back and say, like, holy shit, can you believe how crazy that was? I think it's going to be way bigger. I think it'll be much bigger.

24:31And are there that many good borrowers? Maybe. The banks have stopped doing a lot of that activity. So someone had to step in. Some of it's private credit. Some of it's in the BDC market, flavors in between the two, or private credit raising raising BDCs. But why don't you explain the difference? So private credit firms, generally speaking, think of like a hedge fund, a lot of different ways they can lend money to you. And it's a one-to-one relationship. And they can have a lot of covenants, just like your mortgage. And you can customize some of those features. BDC is a very technical 40-act wrapper, which is a way for someone like a private credit issuer to do underwriting, to raise capital from all of us, and then find a way for it to get into our brokerage account.

25:07And just about anyone can buy it. Whereas most private credit funds, you have to be fairly wealthy to get involved. BDCs, because of their 40-act nature, much more ecumenical, but they have some limitations in what they can do and how much money they can pay out and how they're formed. The upside is you get liquidity. You can sell it to anyone on the street at any time. And the downside is you get liquidity. You get liquidity. And if you get a mark to market every day, intraday, you get it every couple of times a second. So if you're in a fund where your manager says, hey, we really think this should be marked at par, at 100, but the market says, I don't know, I think it's 80.

25:41You're getting 80. whether you like it or not. Blue Owl got in trouble when they tried to merge a private fund into a public one, and everyone in the private fund said, we don't want to take that haircut for liquidity. And there was another Blue Rock where the investor said, oh, you're getting 65. Yeah, and the marks on those are hard. Look, WeWork proved this in the equity market. When you have 14 people who decide the value of something, there's a whole market out there who doesn't have to agree with them. Those 14 folks can get groupthink pretty fast. You open it up to analysts on the street, individual retail investors who have their own ideas.

26:11they'll come up with their own number. So actually, I'm glad you said that. So there are a lot of publicly traded BDCs. ARIES is the biggest, I believe. ARC has like$14 billion or something like that. And they trade like a stock. And I would imagine that most individual investors have no idea what they're trading, right? Like how to mark the loans. Who is actually in there on an intraday basis? Are these hedge funds? Like who is setting the price that we see on the screen? So market makers. who are generally trading ETFs, trading stocks, trading other bonds, they're the ones who are ultimately offering that liquidity, right?

26:48There's got to be some shock absorber. Although I could put a market order in and you could be exactly on the other side and we're just going to meet in the middle and off we go. But it's mostly professional market makers that have a pretty good idea. At the end of the day, there's a combination of third-party providers. So your trust companies, your accountants, your third-party valuation agents who are going to come up with that mark that they'll determine the NAV on. That will sort of start us off the next day. But that isn't to say the managers don't get some say in it. If a manager looks at a number and says, that's just wrong, here's why, the boards and independent boards that control this may side with the manager.

27:22So you will get some noise. Oh, may they? They may. It used to be the manager's job and the board would just say, yes. Now, because of all this news, there's a lot more contention in that space. And the boards aren't, you know, particularly interested in saying, we know more about this credit than you. They don't. But at the same token, they appreciate big moves or big deviations from a third-party valuation source, expose them to some liability.

27:46Ben Carlson:I'm curious for your thoughts on the illiquidity side of things, because bonds themselves are not as liquid as stocks, obviously. They don't trade as much. Maybe you'll disagree with me there. But some of these ETFs have had problems in the past. Remember during COVID, some of the corporate bond ETFs. Remember, there was a huge divergence and even some really high-quality ETFs. Not having the background or the ability to see through private credit and do credit analysis on these individual loans, the mismatch of assets and liabilities is the thing that I think obviously got a lot of them in trouble.

28:13Ben Carlson:And even the Blue Owl CEO admitted, like maybe us and the advisors didn't explain this whole illiquidity thing. And it is tough to me to think of having these illiquid loans in a more liquid structure. That's obviously a big part of the problem. It doesn't matter what the loans are worth if people are trying to sell all at once. So I'm curious just your thoughts on the whole nature of putting in illiquid security in a a little more of a liquid wrapper. That mismatch has always been problematic, right? And we found ways to work through it. Market making helps. You know, having a longer term view helps.

28:45But ultimately, some bonds are way more liquid than stocks. The on-the-run 90-day, the most liquid security on the planet, right? So certain bonds are more liquid than your average large cap stock. Some are less liquid. There are some you need bonds that may never trade. They're issued and they just sit in portfolios until they mature 20 years from now, 30 years from now. So it depends where you are. Some of the BDC loans are somewhat illiquid, but there's a market of folks who want to move them. And a really interesting example is bank loans, BKLN, right? Bank loans are super liquid. They're just really, really hard to settle.

29:19Settlement is T plus seven or T plus 70 or T plus 700, and you don't really know what it's going to be today. So BKLN comes out as this really great ETF, like a derivative now that's just making that liquidity move around because it's just going to sit around and wait for those settlement chains to happen. BDCs work in a sort of similar way. There is a supply and demand imbalance. You can't go and turn the BDC in and say, give me the loans, right? Like you are buying like a closed-end fund version of this. So you're going to see the price move. And the good news is the price can move. So if you really want out today and you're willing to take a lower price, there's probably someone who's willing to take it.

29:52Now we go back to March 8th, you know, sort of 2020, COVID hits. We see this massive dislocation in ETFs. Something weird, I think, actually happened. It was the opposite of what most think. The bonds had no real price, right? there wasn't a lot of liquidity. The ETFs were actually pricing the bonds. But because bonds don't trade every day, we get what we call an evaluated price. Someone is sitting there and says, OK, based on all the math and all the history, we think the value of this bond at 4 p.m. today should be this. They're often not looking what the bond actually traded at. They're just looking at the math saying this is what it should be based on its cash flow, its credit rating, and all these other factors.

30:26So you saw this dislocation because the evaluated prices just weren't right. And over time, you kind of need those. You look inside of MUB, half those bonds don't trade every day. They still need a price so we can price the security. MUB is super liquid, even though you can't transact all of it every day. So we've developed a market structure that is relatively accommodating and pretty good at solving those problems. But there are individual issuances where you do bust. And there are problems when too many people get on one side of the trade where some really silly things can happen. And that's where you got to do your homework.

31:01So getting back to the after-tax stuff that clients and advisors love, I don't want to get you in trouble. I know we're not tax attorneys here. But how should investors think about the potential risk of is this getting too cute? Are we running afoul of the intended rules and regulations? Yeah. So, I mean, it's probably for folks who are listening to this, it's tax day. So most American of holidays. We're here in Washington, D.C. So thank you guys for coming. You can drop your tax bills at Indiana Avenue at the IRS HQ. They're happy to have you. But I think when you, there's a good rule. If they have to explain to you how it works and it takes more than a few sentences, you really need to leave it to someone else to do, right?

31:42Don't try to do that on your own. Make sure an accountant or an attorney has blessed it. And if you have to, they have to hand you a piece of paper that says, hey, hey, we had someone read this thing. And we've got a new view of how the law should be read. Probably a good sign to turn around. Like what we do in the compounder series, it's just a normal ETF trade. There's nothing special about it. It's no different than the trades we do every day in all of our funds that every ETF manager is doing in all of their funds. It's when you start seeing things that are really new and you look at it and say, that seems too good to be true.

32:12If you can't back it up in a sentence or two, probably is. Is there an example of things that you're seeing come to market or ideas that you're hearing that investors need to be careful of? Because to your point, there is so much choice. There are so many things that it really becomes paralyzing at a certain point. Yes, I mean, a lot of the derivative income strategies that advertise themselves as income that is natively tax-free and never ever will be subject to tax does have some concern to me. There are some ways that that may work. There's a lot of ways it won't. I do have some risk and some worry about some of the 351s that we see advertised.

32:45I think that's a great way if you have a strategy and you want to convert. if you have a bunch of wayward assets with high appreciation and you just stick them into this mysterious rediversification engine that's going to promise you gains and riches and no taxes, eventually the IRS, I think, is going to have to look at that pretty hard and say, is this really the intent of when we wrote this thing 40, 50 years ago? Is that what we really meant? Probably not. A lot of the platforms out there have taken that view. I suspect there will be some headlines in that space. I think you'll see some action there.

33:17And I think it's less going to be what actually happened and more the marketing of it. Most of the tax rules that have teeth to them have less to do with what you're doing. So things that are clearly illegal are clearly illegal. It's the things that are probably legal, but can be marketed in an inappropriate way that become problematic. Look, if you've ever filed a complex 1040, your accountant kind of takes out a bottle of whiskey and looks at it and you could give three or four accountants the same thing, you get different answers. It's a bit wild, but it's amazing. And this is the one thing that I never quite understood.

33:51I always feel like paying your taxes is a bit like a bidding process with the government. Like they have a number in mind. They just, it's like buying a car. They don't want to be the first to offer a number. So then they make you follow these forms. They offer a number and then they say, sorry, we graded your test. We think you're wrong. Pay us penalties and interest. It's like, well, just tell me the number. I'll click the box and say yes and move on with my life.

34:08Ben Carlson:So he started out asking you about the bond market being the smart money. A lot of people, What's the, who was it, the Glanville guy said he, if he dies, he wants to come back as the bond market someday because it's so powerful. I think a lot of people have been scratching their heads in recent years about, well, if the government debt is so high and we added all these trillions in debt, like where are the bond vigilantes? Why is it not happening? Why aren't bonds streaming higher? Because every time they go up, people go, all right, here we go. This is it. We hit 5 % and people go, this is it.

34:33Ben Carlson:We're finally punishing the government for spending so much money. Well, we've warned people. The bond market has made some warning signs of like, hey, we've got issues. The problem is there's, what,$28 trillion of cash sitting on the sidelines? So there's a lot of cash that comes sloshing in to help. And a seemingly insatiable demand for U.S. government securities. Like, eventually an auction will have a terrible failure. So I was going to ask you, like, what would actually make you worry? Like, what would be the—because people keep saying, like, just wait, it's going to happen. And people have been saying that for 50 years.

35:02Ben Carlson:Government debt's too high. Like, what would cause you to say, okay, this is a moment in time when, like, it's worth worrying about something here? We could have a legitimate failed auction. So the government auctions off securities, a 10-year, once a quarter, and they reopen it occasionally, you know, up to every week for the 90-day. And we bid. Any of us can bid. You can go and get a treasurydirect.com, and it turns out, as an individual taxpayer, you're allowed preference over all the major institutions. You get your bids filled first. Eventually, they will not, the government will say, we want$30 billion for this auction, and there just will not be$30 billion of demand, and they will not be able to fill it, no matter what price they say.

35:38Now, practically speaking, there'll probably be a price there. Like, we're not going to have debt more expensive than Argentina. But at some point, what we expect to happen, like, so if we think a number will come out at 4 % and it comes out at 4.2%, we say that thing trailed by, tailed by 20 basis points. When that number gets big, right, like tens of basis points, things, weird things will start to happen.

36:00Ben Carlson:At that point, don't we just do what Japan did and we buy our own debt, essentially? We could. We've, obviously, the balance sheet of the Fed has grown and done that before. Yield curve control, though, has some real drawbacks to it. I mean, Japan started doing that and lost a whole decade in change in its equity market over that sort of behavior. And JGBs start repricing. They de-link from the 10-year, and they start to go a bit bananas. And the yen goes nuts on the back end of it. So when you have that level of control, you got to really commit to it, and you got to accept some pretty negative outcomes are likely.

36:31All right. So take us inside the ETF factory. How does it work in terms of you think you have a good idea? You want to bring it to market. And then what ideas are you most excited about? Not to give anything away that you're cooking up, but like maybe something that currently exists. How does the whole thing work? Sure. So first thing is you got to talk to your colleagues about it. And if anyone looks at us and just says, that's really interesting, we get rid of it right away. There's a scrap heap of ETF history of just interesting ideas. It has to solve a problem. Like, don't tell me it's interesting.

37:04Tell me what problem it's solving. And we hold each other very much accountable to that. Then we call you guys. We talk to users and say, hey, we have this idea. We want to solve this problem. We think we can do it this way. And if folks actually understand the problem we're solving, agree that is a real problem that needs to be solved, and they want it solved, then we can carry on down the road. That gets rid of 90 % to 95 % of the really interesting ideas. Because there's some really complex things we could do. It'd be a lot of fun. But they're not actually going to help someone make better investment choice decisions.

37:33So we go down that road. Once you start getting into this, though, I still got to convince a professional market maker to take us on. So if I can't explain it to them, that's a good tell. And if they come back and tell us, hey, interesting idea, it's going to trade a dollar wide, probably not investable by the average person, another exit spot for us. But at the end of the day, it's really simple. If we can't articulate the problem we're solving and you can't articulate how it solves your problem, we're not going to do it. And it's the marriage of those two that makes products work, we think. We're working on a lot more in the rotational fund, sort of tax-aware space.

38:06We'll do some more in inflation, right? Inflation is a generational problem, and it's not solved yet, so we'll see more action there. And the bond world is really big. There's a lot of other products that we think folks want to see and reimaginations of things we're doing or recombinations of them to make it easier to invest that we'll start working on in the future. But if we talk about one thing that's sort of off-target for us, maybe just a small reason of why you should pay your taxes, Your taxes do go to some pretty cool stuff. Last week, we sent people around the moon. I mean, when you think about, like, I'm trying to save the marginal few dollars on this, just remember that we need tax dollars to sponsor that sort of stuff.

38:44And every now and again, you feel kind of proud when you watch those guys, you know, men and women come down, you know, from 35 ,000 miles an hour to zero in the Pacific Ocean. And by the way, NASA, to its credit, stuck the landing within, like, 200 meters of where they thought in 20 seconds of it. So like there's some good that comes from maybe not trying to squeeze every dollar out of that tax stuff because we do want those stories. All right. It's not all bad. I agree. I agree. All right. Anything else? What else? I mean, that's it. Markets have been strange recently. All-time highs today? All-time highs.

39:17Ben, what was the sad you told me before we started recording?

39:21Ben Carlson:5 % of stocks hit all-time highs the day the market did, which is third lowest ever or something. Wow. Individual stocks haven't come along yet. just overconcentration of a few stocks driving a lot of action. Yeah. Still, for all of the political unrest in the world, I wouldn't have thought we'd be seeing all-time highs in, what, nine, ten days of up markets in the NASDAQ? You know what? I think this time the stock market was a smart money. It got it right. It did. I mean, I do worry that it's trading the rumor. Like, we haven't actually resolved these issues. That's over. Yeah. I hope you're right.

39:55Ben Carlson:More right than wrong this decade. But so 2022 is a bear market with, you know, that was an inflationary thing. But we haven't had a credit cycle in, I mean, there's been some flare ups and scares. But really, since the great financial crisis, has there been one credit cycle that you can point to? Maybe energy a couple of those years? 2015 energy. 2015 energy. There's been pockets of it. There hasn't been a market wide credit cycle. So what's going to cause that? I don't know. Maybe you should ask why has there not been one, right, first, which is we added a lot of regulation. Some of it that actually kind of worked.

40:24Ben Carlson:So the GFC regulation, you think, maybe is part of the reason for that? Some of it. Yeah. And then I think lenders got smarter, right? And the combination of good regulation, smarter lending, smarter borrowing to some extent, and then a really healthy stock market that was able to just sort of peanut butter over all the cracks and all the other - The stock market created so much wealth. So much wealth. And the housing market. And the housing. There's so much wealth and money and liquidity out there that you see these distressed funds popping up before there's even distressed. And yeah, I mean, at some point you would think, you know, at some point they will stop, but who knows?

40:57I think the thing that does it is probably not the credit in. It's actually just the underlying demographics of what we have. We've got, you know, we don't have enough people for jobs we need. We're hoping that AI will come and increase productivity that will kind of keep this train rolling along. But we do have a, just like China has faced, just like Japan has faced, we do face a sort of crisis of labor coming in the future. And that's probably the thing that, you know, sets it off. We need AI. We do. We might need it. It's certainly going to be the new Fed view of we need AI to increase productivity, to allow all of the other metrics to keep humming along.

41:30And in that sense, if it works, it's going to have a lot of great promise. Well, Alex, thank you very much for inviting us down here. It's been incredible to see the rise of FM. I think that you are, next time we speak, you will graduate out of the boutique world. I don't know where the line is, but you don't feel boutique anymore. No, no, we don't feel that way anymore either. I think it's$25 billion, so we hope so. I appreciate you guys for being supporters of this and letting folks know about what we've been doing for really since the get-go. Well, thank you. Okay.

41:55Ben Carlson:Thank you to Alex and the whole team at FM Investments for hosting us. It really was a fun show. They brought us out to a wonderful dinner afterwards too. You and I were blown away. I love, I always love a good dinner like that. fminvest.com to learn more and then email us animalspirits at the compound news.com. Investors should consider the investment objectives, risks, charges, and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the fund, please call 1-800-617-0004. Read the prospectus or summary prospectus carefully before investing.

42:35TBIL Fund Risks. The U.S. Treasury 3-Month Bill Fund may be susceptible to an increased risk of loss, including losses due to adverse events that affect the UST three-month bill funds investments more than the market as a whole, to the extent that the UST three-month bill funds investments are concentrated in a particular issue, issuer or issuers, country, market segment, or asset class. While US Treasury obligations are backed by the quote, full faith and credit, end quote, of the U.S. government, such securities are nonetheless subject to credit risk, i.e. the risk that the U.S. government may be or be perceived to be unable or unwilling to honor its financial obligations, such as making payments.

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45:43Fixed income risks include interest rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the value of debt securities. Credit risk refers to the possibility that the debt issuer will not be able to make principal and interest payments. There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the alternative minimum tax, parentheses AMT, capital gains distributions, if any, are taxable.

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53:06The prices of certain securities provided by pricing services may be subject to frequent and significant change and will vary depending on the information that is available. Holdings and additional information can be found at colon HTTPS colon forward slash forward slash www.fminvest.com forward slash ETFs forward slash CPHY dash FM dash compounder dash high dash yield dash ETF. FM US Treasury 10-Year Note ETF

53:48The UST 10-year note fund may be susceptible to an increased risk of loss, including losses due to adverse events that affect the UST 10-year note fund's investments more than the market as a whole, to the extent that the UST 10-year note fund's investments are concentrated in a particular issue, issuer or issuers, country, market segment, or asset class. While U.S. Treasury obligations are backed by the, quote, full faith and credit, end quote, of the U.S. government, such securities are nonetheless subject to credit risk, parenthesis, i.e., the risk that the U.S. government may be, or be perceived to be, unable or unwilling to honor its financial obligations, such as making payments.

54:31Holdings and additional information can be found at colon HTTPS colon forward slash forward slash www.fminvest.com forward slash ETFs forward slash U-T-E-N dash FM dash U-S dash Treasury dash 10 dash year dash note dash ETF. FM U.S. Treasury two-year note ETF. Parenthesis UTWO and parentheses, colon. The UST two-year note fund may be susceptible to an increased risk of loss, including losses due to adverse events that affect the UST two-year note fund's investments more than the market as a whole. To the extent that the UST two-year note fund's investments are concentrated in a particular issue, issuer, or issuers, country, market segment, or asset class.

55:31While U.S. Treasury obligations are backed by the, quote, full faith in credit, end quote, of the U.S. government, such securities are nonetheless subject to credit risk, i.e., the risk that the U.S. government may be or be perceived to be unable or unwilling to honor its financial obligations, such as making payments. Holdings and additional information can be found at, colon HTTPS colon forward slash forward slash www.fminvest.com slash ETFS slash UTWO dash FM dash US dash treasury dash two dash year dash note dash ETF.