#119 - David Eichhorn: Client‑Focused Solutions at Scale

23:06So that's kind of the too much of the return structurally is going to managers as opposed to asset owners. We've been trying to point that out for a while now in this space.

23:16David Eichhorn:I know one area you focus on is liability-driven investing. We have some listeners who may be less familiar with that. How do you explain what LDI is, what it means to hedge, and why an institution would want to hedge rather than simply maximize returns? Sure. I mean, I think the short of it is, you know, and this really lives predominantly in the corporate defined benefit space. And it really we had talked about managing risk versus liability forever. Inception of the firm. Camidly, not many people listened. But there were a variety of regulatory changes in the mid aughts right before the financial crisis that made liabilities much more mark to market.

23:53So what it really did is bring into sharp contrast for plan sponsors and the fiduciaries of those plans that the liability itself has a lot of interest rate risk, right? When you're running a pension, you've promised to pay money way out in the future to your pensioners. Well, that feels like a bond. It's a promissory note to your pensioners. So that bond has an interest rate profile, very long duration interest rate profile, candidly. And so if I'm marking that to market like we do in the corporate space, that's going to have a lot of volatility. If rates drop, the liability is going to go up a lot and your funded status will fall and vice versa if you're not hedged.

24:30And so that's really the nature of liability driven investing and kind of how it started. And we were very early into that market and are one of the largest managers in that space. You know, that's an area where as clients begin to understand the risk, we started making the key point that you need to address that risk. It started with simple things like owning longer bonds, longer treasuries, longer zero coupon treasuries to match the interest rate risk of your liability or better match the interest rate risk. And then over time, that really was a key element of what grew our derivative businesses.

25:01A large, to this day, a large portion of our derivative business, around half, are interest rate derivatives to further hedge that liability risk. So those clients, as they look at their LDI strategy, they say, I don't want to be at the whim of interest rates, and I want to hedge some, if not all, of that interest rate risk. And kind of the funny thing that we've said maybe coming from a bond manager is we've always made the point, interest rate risk is not a well-compensated risk. We've said that for 30 years. It may not be compensated at all, but it's certainly not compensated like the equity risk premium.

25:33Again, funny for the kind of a bond manager to say it that way. So we said hedge most or all of your interest rate risk and use your risk budget on equities to the extent you can tolerate equity risk. Some can tolerate a little, some a lot. But that's, if you think of LDI comprehensively, it's better managing interest rate risk so you can deploy whatever risk budget you have into markets where you think to be compensated more handsomely.

26:00David Eichhorn:There's also a significant mindset shift from managing assets in isolation to managing assets relative to liabilities. Why do you think that shift may be hard for investors to make? And why is it so important? And how does that framing change portfolio decisions? I think it just because, you know, liabilities don't get talked about every day in press and a whole host of reasons. And when we talk about every variation of assets, but I think for clients who step back and look at it, it's not as hard. Now, what it means for different investors can be different, but it doesn't have to be as hard as it sounds.

26:33We're recording this a day after the national championship game. I think Michigan scored, going from every 69, I think 69 points in the game. And given they'd been scoring 90 something throughout the tournament, if you only told me that, I'd say it probably didn't work out well for Michigan last night. But you need to know UConn scored, I think, was 63 last night, if I recall. all. That's asset liability and asset liability awareness. I'm not even getting LDI as a specific genre of that, but asset liability awareness is that is just stepping back is the reason assets exist, contrary to popular belief, is not so that folks like NISA can manage them.

27:12Assets exist so that they can absolutely store value to pay some consumption in the future from most of our clients. That's a pension liability or an endowment payment, something like that. And so when you frame it that way and you step back away from it, you said, well, what is my it could be a capital L liability, very marked market like corporate liabilities, or could be more lower case liability like an endowment. It's not exactly as clearly structured, but there's still payments out there you want to you want to make to the university or the mission or whatever it is. when you frame it that way, I think it really helps clients think about it appropriately and think about risks the right way, including in some cases, that means a comfort of taking more risk.

27:52It's not always, I think sometimes people are about asset liability matching is always a de-risking discussion. That's been a lot of what's been going on in corporate DB space. In other spaces, we think looking at asset liability in the right framework could actually give you more risk tolerance or capacity than you appreciated.

28:09David Eichhorn:Well, because you're going back to the purpose of the assets, which is to cover future liabilities. And some of those can be more easily ascertained because if you have your corporate pension plan and you can roughly figure out what your liabilities will be. But I would think most investors have some liabilities, even if you're an individual and you have a portfolio, it's to cover your future expenses. So there could be some matching almost at every level. Really well said. And that's, you know, even how, again, we've described at times in the D.C. spaces, it's your pension liability to yourself.

28:45Right now, again, it's not as contractual, but at the end of the day, you'd like to retire very comfortably. Right. So you have some stream of cash flows you want to be able to pull out of your assets. So I think that's a great way to describe it, Alex.

28:57David Eichhorn:So let's live through the last, let's say the last decade. So take us back to the period before 2022, when interest rates were near zero. What were the hardest conversations you were having with clients during that environment? That is a weird environment. I hope I hope we don't go back to it for a lot of reasons, frankly, not just as this is an asset manager. So, you know, clearly conversations, whether, you know, long bond at two percent, two and a half, you know, wherever we were at different points in time. Naturally, there'd be a conversation. Should I own bombs at two percent or on the front end of the curve, effectively zero and on some parts of the globe negative.

29:33Right. You know, we, of course, always came back to every risk premium should be thought of as on top of the risk free rate. You know, for practitioners speak, a treasury is a risk. I hope it's a risk free asset. I think it still is. So one, in that very low rate environment, there's going to be a different total return on all your assets. And it's always comparing a bond yield versus what you think you can get in a comparable instrument. But clearly that created conversations with clients. Should I own bonds at these levels, etc.? There's a paradox in that, right, because somebody has to own every bond.

30:07And the one thing I do know about assets is they're all owned. The Fed didn't own every bond in that environment. And so what made interest rates as low as they were was, well, someone had to own them. And you get in this paradox of, well, if you're not owning it, who does own it? And I think what came through loud and clear in that environment was certainly individuals who have very specific hedging requirements were very natural owners of those. And so, you know, our LDI clients in corporate space, they maybe added less to hedges over that environment because I think there's more upside than downside in rates.

30:41But they were really, really on balance, kind of true to their hedging objectives and at times difficult conversations to your question, but still nonetheless held with it and held with the hedging strategy that from a managing risk overtime and deploying risk budgets where they're best deployed, i .e. equities, it still, I think, serve clients well. Of course, crystal ball, if everyone knew exactly what was going to happen in 22, they should have unwound all their hedges and what have you. But, you know, mapper timing is really, really hard. That's why I don't really try to do it in any real size.

31:10And so most of our clients stuck with their hedges throughout that environment.

31:14David Eichhorn:And we know with perfect hindsight, interest rates were near zero for over a decade. Then, as you mentioned, came 2022 when long duration bonds experienced one of the worst years on record. How did client conversations change during and immediately after that drawdown? That was an uncomfortable environment. I mean, markets make you uncomfortable and they humble you every day. That's kind of what makes it fun. But I think that was an environment where the conversations, we certainly, I think we, but maybe more important than this, our clients reap the dividend of all the hard work of preparing boards and committees for what they were doing with their fixed income.

31:52So yes, clearly bonds sold off a lot. If you were hedging and you own bonds, that part of your portfolio was losing money and potentially a lot of money in the case of it was a long bond portfolio and a long bond portfolio plus an interest rate derivative. But at that point, still a majority of our clients that were using bonds in that context were not fully hedged. So the dividend that I'm referring to is, you know, we always describe to clients, to our clients, their committees, their boards, that when you're not fully hedged, as weird as it is to say, you want to lose on the asset you own, right?

32:27I mean, of course, perfect foresight is you wouldn't own the asset, right? But you have to balance your risks. But if you're 60 % hedge, you still want all those equal interest rates to go up. Because if they go up, you're picking up around on your liability. And so we actually saw one, I think over that period, effectively, no one, again, there can always be one counterexample that I'm not remembering, but I can't think of really a circumstance where a client unwound a hedge because they didn't know what they were in, right? They stuck with them. And quite to the contrary, as rates were going up, it's like, finally, there is an opportunity to hedge it higher.

32:58I've been waiting for higher interest rates. We're finally getting it. And we really saw our hedge ratios across clients go up quite meaningfully throughout 22 and beyond, particularly when 22 obviously wasn't a great equity market. But as we came out of that and equities really started to get their run and rates stayed at high levels. Now you had like a great double whammy in a good way. You had great appreciation and funded status thanks to interest rates having gone up and now equities climbing as well. Now, that's why corporate pension funds right now for the first time really in decades are more than fully funded.

33:32And that's been kind of that one-two punch of, I'll call it, 22 interest rates and subsequent to 22 equity markets.

33:39David Eichhorn:And I suppose when you're fully funded, you should, all else being equal, want to hedge even more, right? Yes, absolutely. With an asterisk that if you would have asked me that a couple years ago or a few, I would have not put the asterisk on it. Honestly, Alex, I think what's changed in the corporate space has been interesting is a combination of relaxed funding rules, how quickly you have to fund any deficit. There's been material changes for some of the rules I alluded to in the early aughts. And additionally, some other legislative changes on the use of surplus. So forever, we talk about, particularly if you're a closed plan, de-risk, maybe get to a little overfunded, but just try to really de-risk your plan.

34:19And now we've had some interesting conversations with clients where maybe you want to keep a little bit more risk in perpetuity because you have a use for surplus. We've seen some pensions actually reopen for the first time in ever, basically, you know, right? A few very notable pension plans. And so I wouldn't call that watershed at this moment that it's happening everywhere. So, yes, still the risk to your point, still meaningfully de-risked versus the old classic 60-40 or 70-30. Still very interest rate hedge. But maybe there's a role for a little bit more risk assets going off into the future because of some of the legislative and regulatory changes.

34:55David Eichhorn:You work with public pension plans, corporate plans, and also multi-employer funds, and each has a different liability structure. How do these client types differ in how they think about funding status, risk, and interest rate sensitivity? I'll order them this way, you know, going from kind of the most market to market to the least, right? You have the corporate pension community, the multi-employers a little bit in the middle, and then public funds are, I'll say, the least. So they look at their liabilities certainly differently. And I think the main difference there is interest rate risk hedging central to what you need to do to manage risk.

35:34And certainly for those first two sets of clients, it absolutely is. the nature of the role bonds play in their portfolios tend to be a risk management tool vis-a-vis the liability. Whereas in public fund space, bonds play a very important role. But in what's really nice with, as you alluded to, with rates higher now, bonds actually are delivering some amount of return at this point because they have a reasonable yield for the first time in decades recently. So our public fund clients think of them as the diversifier generally. And again, I'm painting very broad brushes, but generally as the diversifier to their equities, the safe asset class, the asset class they can draw on when there's the inevitable equity drawdown, et cetera.

36:18In some cases, they use some longer bonds because, and again, until the inflation scare recently, typically interest rates have fallen recently when equities fall out of bed. That correlation has been thrown into question a bit recently. But the bonds play a role of not directly as a liability hedge, more as how do they help offset some of the risks and balance the risk vis-a-vis their equity and other risk asset classes.

36:41David Eichhorn:Earlier, you talked about beta disguising itself as alpha in institutional portfolios. But how do you think about it when it comes to fees? And how does NISA help clients address that? You can trigger me on that. So I have to be a little curious. So I think the main thing we've contributed to this area is, and I'm going from memory, seven, eight, nine years ago is publishing a lot. And others have done this as well as looking at particularly in bond markets and bond markets where the index has a material amount in treasuries like the Bloomberg Aggregate Index. If you regress managers' excess performance on betas, that could be the high yield market or credit spreads, depending on the exact horizon, but often over half of their excess return is attributable to betas, correlates, and therefore there's a coefficient to a beta asset class.

37:30Over half of their excess return often comes from a beta as opposed to alpha. And we argue alpha is where skill is, and you should be paid more for skill. I'm not necessarily picking that you shouldn't be paid for solid beta construction. I just think in a world where you can get beta effectively for free, go buy a corporate bond ETF at very low fees or high yield ETF, the active management fees should be thought of in the context of, well, how much is that skill delivering, genuine alpha, versus how much is the beta delivering? And the fee discussion should reflect that. And it should reflect.

38:05And to be clear, this is not the only manager. There are some managers who you look at what they deliver, a preponderance of what they're delivering is genuine alpha. It's just the majority, the median manager is very healthy, has a very healthy dose of beta. And as a result, we question, should they be receiving an active fee level that's commensurate with a true alpha type of approach?

38:25David Eichhorn:I guess the other way to say it, perhaps more simply, is in some ways it's a benchmark problem. So you have managers that are managing against the Bloomberg aggregate index, and that has a certain makeup. And they're tilting one way or the other all the time, effectively. And if there was a better index that had that same tilt all the time, and you could access it cheaply, that's how they should be measuring their alpha and measuring how much fees they charge for that alpha generated. You actually said it perfectly. And it's again, I alluded to all the customization we do. If we were talking to a prospective client and they said, great, we really like your alpha against the ag, et cetera, but we would like you to deliver some of that excess return by overinvesting in credit, et cetera.

39:12We would say to your point, Alex, well, let's change the benchmark. We can, you know, there are full credit benchmarks or intermediate where 100 % of the benchmark is that beta or high yield benchmark, depending on how aggressive you want to be. So we're very comfortable setting up. In fact, we spend a lot of, and I'm so glad you mentioned that we spend a lot of time with clients. Let's make the benchmark representative of the beta exposure you want, because at that point, you can't always get that passively depending on the exact benchmark design. but for artistic license, probably can get a close enough version of it passively.

39:44Then hold us accountable to have we delivered alpha over that new harder benchmark? I think that's one of the particularly the aggregate with with the amount of treasuries our government keeps issuing. It's become a larger and larger portion of the benchmark. And it's just an enormous attractive nuisance of an overweight for spread product. We would argue to your point, change the benchmark and hold us accountable to that.

40:06David Eichhorn:I know NISA also focuses on replicating hedge fund-like returns using derivatives. What problem is that trying to solve for clients? Yeah, and that goes, but you alluded to kind of how we develop products and I said not being a visionary, just partnering with clients. That really came out of a very direct one-on-one conversation with a client where I'll say a problem, the challenge that they were seeing is fees going up wildly. you know, the hedge fund winners that really, and there are some great hedge funds, fees going up wildly and lockups going up considerably. And maybe they're the best managers, or frankly, maybe they're just in the distribution, the ones who've done well lately, right?

40:46And I think this asset owner was somewhere between frustrated to indignant on, they're managing liquid assets and they're locking me up for three years and fees are high, et cetera. So they presented the challenge to me of, we know you run very adjacent strategies with some of your derivative programs you want run, sometimes referred as QIS strategies, et cetera. Will you build a portfolio for me that seeks to deliver that type of return? Different way to say it is maybe some elements of hedge fund returns are actually kind of beta. They're messy dynamic beta, but trend is an example, a classic CTA type strategy where there are a lot of trend managers get a lot of high fees managing against trend.

41:27We think there's this very basic strategies that are more index-like that can deliver a hedge fund-like outcome, and you should be charged something not low index fees because it's a dynamic beta, but much lower than hedge fund fees. And that was really the problem slash challenge that was thrown our way. And it's really been a really interesting strategy to run and kind of, I'll say, co-develop and begin managing to help address that issue of fees, lockups, and a liquid alternative that can be dialed up or down depending on the posture in the market at any point in time.

41:59David Eichhorn:And what's interesting about that approach is even if the gross returns aren't as good, you have a lot of cushion because you're wiping out a large percentage of the fees. Exactly right. And it's a heck of a head start. I know we have a client who's done similar things where we don't manage private credit, but a client who's invested themselves and co-invest. And it's exactly to get that head start on back. My earlier comments of avoiding grabbing that illiquidity premium, grabbing whatever the asset class is trying to deliver, but try to avoid fees. And again, I'm a manager where everything we do is based on asset management fees.

42:35So certainly we like fees, but they should be apportioned in some reasonable amount relative to the the absolute excess return you're going to get get in in that asset class. And importantly, they should be a portion relative to is it beta or alpha? And again, I think some of those asset classes, hedge funds, private credit, there's actually more beta bouncing around in there than I think people appreciate often. And the fee structure should reflect that in our opinion.

43:01David Eichhorn:And this focus that we just talked about that you have is also some evidence as to your client-centric approach, whereas many managers don't have those similar types of conversations. And in some ways, their business tends to do better the more fees they charge, as opposed to looking for ways to reduce the cost for investors. You're absolutely right. And I want to be clear, you know, because I wouldn't want people to see this in like, you know, Nissa and Dave are pure altruism. You know, clearly we need to earn a reasonable fee so that we can deliver this very non-scalable in a lot of ways business.

43:35this. So of course, we're not above fees, far from it. But you're right, we certainly, the nature, and I think this is why we have very high retention rates with clients, et cetera. We only offer products we believe in. So we offer very few products, candidly. And it's a high bar for us to have a product that we believe in, that we believe we're delivering genuine alpha, or for that matter, if we were delivering it, just a beta in a passive way, but one that we can deliver at the right fee. And I think that's important because I think that's what, again, if you want a long-term partnership, it's important that you work with clients to understand, well, what value are you getting out of it?

44:10What value are we getting out of it as a manager? And we should both, you know, I view fees, neither of us should be perfectly happy, right? Because, you know, we need to run a business and clients should be getting appropriate amounts of excess performance given at the end of the day, it's their balance sheet at risk, not NISA's, right? If there's defaults in private credit, right? That's on their balance sheet, not the manager's balance sheet. we spend a lot of time and I think I think we're thoughtful about the right apportioning of fees. And it's a it's a key element, I think, of just treating clients the appropriate way.

44:42David Eichhorn:And it goes back to an unreasonable business setup is one where you earn reasonable fees for the actual value that you're creating. Succinctly said, I should I should I don't do enough podcasts. I could have said it that way. Been done. Sorry. Sorry. That was long winded. No problem. So for my last question, I'm going to ask you for a moment to try to be a visionary. What do you see as the next growth phase for Nyssa? The quick answer is I'll say more of the same in the sense of those strategic constants and being a genuine solution provider. And that's really the platform that I think if I've probably been feigning a lot of humility, where we've been good, I think, over time is in spotting based on that solution provision, spotting a jumping off point of like, wow, this is probably really something that's going to interest clients.

45:30I think we can do well. I think it's a really great outcome for MISA as well. So it starts with that always. And so I think you alluded to a number of them. We've been doing some really interesting things and I'll say hedge fund alternatives. I've kind of referred to myself as the accidental hedge fund manager. It's not exactly what we were trying to design it. It came out of client conversations. And I found this whole conversation, I can't believe, and I failed probably to weave in, we have recently started, we brought on a team to manage equity strategies, particularly dynamic extension and equity market neutral, that actually on the surface may sound different for NISA, but it's actually the same wild breadth of active positioning and seeking high information ratios.

46:11That we brought on, and I do view, I think this is probably its biggest single core competency is serendipity. The opportunity presented itself for the team, and it seems to be the right moment for dynamic equity extension strategies, equity market neutral. And we've been really excited with the conversations we're having with clients, existing clients and prospective clients on that strategy. I'm excited that is a key pillar of our near and intermediate term growth.

46:40David Eichhorn:That sounds great. David, I appreciate you joining us and sharing all your insights. Thank you. This was great. I really enjoyed it. Thanks for having me, Alex.

47:10David Eichhorn:sure you don't miss future episodes. And don't forget to forward today's conversation to others you think would enjoy listening. Important information. This podcast is provided for informational purposes only and should not be considered legal, tax, investment, or business advice. It is not a solicitation, recommendation, or endorsement. All opinions expressed by participants are their own and do not necessarily reflect the views of the Evoque Advisors Division of MAI Capital Management, LLC, or Evoque, its affiliates, or any companies mentioned. Information shared has not been independently verified by MAI or its affiliates.

47:44David Eichhorn:MAI Capital Management, LLC, or MAI, is registered with the U.S. Securities and Exchange Commission, SEC, which does not imply any particular level of skill or training. Certain information contained herein has been obtained from third-party sources, and such information has not been independently verified. No representation, warranty, or undertaking expressed or implied is given to the accuracy or completeness of such information by any person. While such resources are believed to be reliable, Evoke does not assume any responsibility for the accuracy or completeness of such information. Evoke does not undertake any obligation to update the information contained herein as of any feature date.

48:21David Eichhorn:The content is intended for a general audience and does not constitute a recommendation to buy or sell securities or adopt any investment strategy. Any examples or scenarios discussed are illustrative only, involve risks and uncertainties, and do not guarantee future results. Non-traditional assets carry significant risks and may not be suitable for all investors. Decisions should be based on individual objectives, risk tolerance, and circumstances. Statements herein are general and may not reflect an individual's or entity's specific circumstances or applicable laws, which vary by jurisdiction.

48:54David Eichhorn:Further, speakers' views are personal and may differ from evoke and MAI recommendations and are not specific investment advice, and do not consider client objectives, risk tolerance, and diversification. Guests may have current or past relationships with Evoke and MAI, its affiliates, or the host, including as clients, service providers, or business partners. Participation does not constitute an endorsement or testimonial. No compensation has been paid or received for guest participation unless disclosed. MAI and its affiliates may have business relationships with entities mentioned in this podcast, which could create potential conflicts of interest.

49:28David Eichhorn:These relationships may include advisory services, investment management, or other arrangements. MAI seeks to manage such conflicts consistent with its fiduciary obligations and policies.