Meet the Active Manager: Skyler Weinand Approaches Mortgage-Backed Securities & Fixed Income Risk

Transcript:

I’m Skyler Weinand. I started Regan Capital 15 years ago now. Regan Capital is based in Dallas, Texas.

I’ve been in bonds, fixed income, particularly mortgage-backed securities for the last 25 years now. We’re about a 25-person firm, bootstrapping, slowly growing, but we’re up to almost $4 billion in assets.

U.S. real estate is one of the largest markets in the world. It’s almost a $50 trillion market. A lot of folks in the United States have a mortgage on their home. Mortgages are about $13.5 trillion.

So we’re invested particularly in mortgage-backed securities, and more specifically in government-guaranteed mortgage bonds. You’re able to go out and invest in a government product that’s guaranteed by the U.S. government, backed by home loans, which is a very, very safe asset these days since home prices are up 40-plus percent since COVID. In a liquid format, in an ETF.

So our goal really is to deliver return of capital in a very, very safe return on capital. Low interest rate risk, very low credit risk. To deliver that inside of a portfolio where investors want an extra 1-2 percent versus just sitting in cash.

Our market is still really inefficient. The government created these enterprises over 50 years ago. Ginnie Mae, Freddie Mac, Fannie Mae.

These are all government-owned entities. They guarantee principal and interest. But as an individual investor, you can’t actually access these instruments.

You need to be an institutional investor to invest in and trade in mortgage-backed securities, mortgage bonds. So that’s where we come in. I’ve been in this business 25 years.

We have deep institutional relationships. And we’re creating vehicles for investors to be able to access certain sectors of the market, particularly safe, low-duration, government-guaranteed instruments, where they can pick up yield above and beyond sitting in a money market fund or U.S. Treasuries.

The Fed has dropped interest rates 1.75 percent in the last two years. Folks were used to getting over 5 percent yield on cash and on money market funds. Now that that cash is only yielding 3.5 percent, we’re seeing a deep desire for folks to come back into certain sectors of fixed income that are safe, like ours, to earn significantly higher yield than what they can get in cash.

So that, along with, you have tremendous rate volatility over the last five years. The Fed lowered rates to zero post-COVID. Rates got over 5 percent. In 2022, fixed income investors lost over 10 percent on average.

So you also have this fear of losing money again in bonds. And so that’s where it comes back to delivering on a return of capital, but also return on capital in a very safe manner.

First and foremost, I want to get paid yield commensurate with the risk I’m taking on.

And only in the last five years has anyone really, in the last 40, had to think about interest rate risk and losing money if interest rates go up. So you should be getting paid a yield higher than that risk you’re taking on.

That’s square number one.

So sitting in the front end of the curve and floating rate instruments that are also government-guaranteed allows us to take on almost no credit risk, very little interest rate risk, and get paid a pretty nice yield relative to where we’re positioned.

When you’re investing in fixed income, there’s three distinct risks.

First of all, credit risk. Am I going to get my money back?

Second of all is spread risk. So if there is market volatility, investors require an extra, let’s say, 2% of income or premium above and beyond U.S. Treasuries or safe assets.

What does that mean? How much am I going to lose? Am I going to lose 4% or 8%?

Now the third most distinct risk is interest rate risk.

So duration equals interest rate risk. What do I mean?

Duration of, let’s say, three years. Let’s break it down really easily.

It means I’m going to get my money back in three years. And if I don’t get my money back for three years from now and rates move up overnight by 2%, you take that 2% and you multiply it times that three-year duration, my investment is now immediately worth 6% less.

Why?

Because I might have lent money to a government or to a corporation yesterday at 4%, but now that corporation is selling bonds at 6%.

So my 4% coupon on my investment or my 4% yield is worth less today than it was yesterday when I lent them the money because now a new investor can go out and lend that corporation money at 6%.

So because I’m getting my money back in three years, that’s roughly three years times 2%, that’s a 6% loss in price overnight.

Everyone’s experienced a tremendous amount of volatility really in the last six years now since COVID.

Credit sensitivities. You have interest rates moving in a greater and higher fashion than any of us have really ever experienced in our lifetime.

Now we also have worries about AI disruption and how that’s going to affect corporate balance sheets and especially the large movers that are up 100% in the last five years.

Whether or not their credit, their bonds might default and whether they might fall 15% to 20%.

By sticking still in government-guaranteed assets and staying safe in short duration and waiting for those things to play out, that deserves an allocation in folks’ thinking, whether that be cash, cash plus, or thinking about where they’re generating yield.

Let’s play it safe until these things play out.