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Investing Specialists

Mary Ellen Stanek: Hitting for Singles and Doubles in the Bond Market

An accomplished fixed-income investor on managing through the coronavirus, the economic outlook, and the state of muni credit.

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Our guest this week is Mary Ellen Stanek. Mary Ellen is managing director and chief investment officer of Baird Advisors, which is the manager of the Baird family of mutual funds. Mary Ellen's career in the investment business began more than four decades ago. In her current role she oversees fixed-income strategy and portfolio management among other duties. In addition, Mary Ellen serves on the board of Baird Financial Group as president of the Baird Funds and as chair of the Baird Diversity Steering Committee. She obtained her undergraduate degree from Marquette University, her MBA from the University of Wisconsin Milwaukee, and she's a CFA charterholder. Mary Ellen was recently named one of the 100 Most Influential Women in U.S. Finance by Barron's, and Morningstar named her a finalist for Outstanding Portfolio Manager for the 2020 Morningstar Awards for Investing Excellence.

Bio

Mary Ellen Stanek and team bios 

Pesce, N.L. 2020. “The 100 Most Influential Women in U.S. Finance” by Nicole Lyn Pesce; Barron’s; April 10, 2020

Heine, G. 2020. “Morningstar Awards for Investing Excellence—Outstanding Portfolio Manager Nominees” Morningstar.com; June 15, 2020.

Baird Bond Funds

Baird Aggregate Bond Fund 

Baird Core Intermediate Municipal Bond Fund

Baird Core Plus Bond Fund 

Baird Intermediate Bond Fund 

Baird Municipal Bond Fund 

Baird Quality Intermediate Municipal Bond Fund

Baird Short-Term Bond Fund 

Baird Short-Term Municipal Bond Fund

Baird Strategic Municipal Bond Fund

Baird Ultra Short Bond Fund

Market Commentary

Baird Advisors Fixed Income Market Commentary; May 2020

Baird Advisors Municipal Fixed Income Market Commentary; May 2020

Transcript

Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance for Morningstar, Inc.

Jeff Ptak: And I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Benz: Our guest today is Mary Ellen Stanek. Mary Ellen is managing director and chief investment officer of Baird Advisors, which is the manager of the Baird family of mutual funds. Mary Ellen's career in the investment business began more than four decades ago. In her current role she oversees fixed-income strategy and portfolio management among other duties. In addition, Mary Ellen serves on the board of Baird Financial Group as president of the Baird Funds and as chair of the Baird Diversity Steering Committee. She obtained her undergraduate degree from Marquette University, her MBA from the University of Wisconsin Milwaukee, and she's a CFA charterholder. Mary Ellen was recently named one of the 100 Most Influential Women in U.S. Finance by Barron's, and Morningstar named her a finalist for Outstanding Portfolio Manager for the 2020 Morningstar Awards for Investing Excellence.

Mary Ellen, welcome to The Long View.

Mary Ellen Stanek: Thank you, Christine. Great to be together.

Benz: Thank you so much. So, one question we've been asking all of our guests since the pandemic began was how they've been working through this period. How are you and your team working? Where are you working at this point?

Stanek: Well, it's an interesting question that we never would have contemplated. We have very robust business-continuity plans, but never envisioned that we would have to take them and very quickly pivot them in a very different direction. So, what we did on March 16, is we split up the key investment players, effectively put them--it was almost like Noah's Ark--and then had one group go one location, one group go the other. We have several people also working from home, and then we enhanced all of our capabilities at home. So, all of the key talent has robust at-home capabilities.

That said, we put in substantial safety measures to try to keep a core group of the team able to continue for as long as we could, working in our offices with our systems, and we believed into the market chaos that we would be better able to meet our investors' needs because they needed information and wanted information. But we also wanted to be able to manage the portfolios and take advantage, as it turns out, with opportunities that were being created.

Looking back, it has gone extremely well. I would say that several of the things we've had to do--we're known for being a highly collaborative team that works very hard to have cross relative risk and cross relative-value conversations all day every day and we believe that's part of our secret sauce. And so, being very intentional and purposeful about how we create that virtually as we had to distance ourselves from each other. It's been a challenge, but it's actually gone quite well.

Ptak: What was it like to run bond money in early to mid-March when cash and bond markets weren't functioning? How did your team respond? And with a benefit of hindsight what do you think you got right and wrong?

Stanek: Well, so interesting. And that is where you have the benefit. And our team has a wide range of experience, but a number of us have worked for decades together. And that experience matters, particularly as you go into these very uncertain times. Certainly, none of us had ever experienced a pandemic in our lives. None of us had ever seen the economic self-destruction that we went through as the economy virtually was shut down in the interest of public health. So, as we tried to manage through that and understand that we always say in tough times, good times, investing is like putting a puzzle together. And you look for those missing puzzle pieces. Do things make sense?

I grew up with a father who always would say to my mother, Katherine, these kids, all brains and no common sense. And so, trying to think about how are we going to be able to navigate through this for our investors? Again, remember--and we always remind ourselves--that the position we occupy for investors, we typically are their core. One investor said to us many years ago, you're my sleep insurance, and thought we were going to be offended. And I said, actually, that's a badge of honor. That's exactly the position that we occupy for investors across the duration spectrum, taxable or tax-exempt.

So, into this, you know, we checked off all of those key boxes that are so fundamental to how we invest, make sure we have available liquidity for our investors should they need it. And in hindsight, they did need it in particularly the month of March. Quality and integrity of the portfolio, so that what our investors believe they have in terms of the portfolio, and our style and approach that we truly show up and behave like that into all market environments. We really strive for an all-weather approach and a balanced approach.

As we sorted through these things we've never seen before, we went back to the things we do know, and we do know how to do and that's layer liquidity into the portfolios. And certainly, those decisions in that structure had to be in place long before the chaos started. But confirming that we had those layers of liquidity ready and available in the portfolio, the quality and the structure or the integrity of the portfolio structure, was it intact and could it withstand some very significant stress--both financial market stress, liquidity stress, as well as economic stress--and continuing to do the fundamental analysis that we believe we do and have always done. All of the risk mitigation that we have on the portfolio, again, things that you have to have in place long before any of the onset of the volatility.

One of the best risk-management tools we have is diversification and diversifying our exposures very, very carefully. Portfolio structure, some people will refer to it as how we load the dishwasher. Other people have used that analogy. I think it's a great analogy to use in terms of how we structure the portfolios across the sectors to both deliver portfolios that will deliver on the objective, but over time will provide our investors competitive after-expense ratio or fee value. So, into the chaos where there was, for moments and days, liquidity was quite challenged. And so, how were we able to do that? In hindsight, the liquidity layers held up very, very well for us. Certainly, cash is your first layer of liquidity, but then your Treasury positions, agency mortgage-backed positions, some of your shorter, very high-quality asset-backed securities. So, those layers held up very, very well for us.

While we continue to try to put that puzzle together and understand what was happening, and one of the key pieces that was an important piece of information to watch carefully was where the selling pressure was coming from. At the time, in real time, we believed in the industry and we could watch your data and others' data on redemptions and net outflow activity and the force selling that happens with portfolios when managers have to meet those redemptions. We also through our industry contacts realized very quickly that leveraged investors were being forced to sell and take down leverage. And that was causing certainly some additional dislocation. We confirmed at the time that when you get into those chaotic environments, and investors are being forced to sell, other investors are being forced to sell, they sell what they can sell. And typically, that's high-quality, shorter duration assets. And so, it puts some, as we said at the time, quality on sale and created some unusual opportunities.

Looking back, I said to some of our younger credit analysts the other day, the last three months are like dog years careerwise, but it will help shape them in terms of how they think about risk, how they manage liquidity, how they manage and make recommendations on portfolio names and portfolio structures. It's a great living laboratory for young talent.

Benz: We'll talk more specifically about your investment approach and some of the things that you've been doing with the portfolios recently. But big picture, can you talk about what's your outlook for the U.S. economy and how does that broadly inform the way you're executing the strategies you manage?

Stanek: Sure. So, it's again--there is not a lot of precedent for this. So, you have to look at current data and try to make some assumptions. So, a pandemic of this magnitude with all of the uncertainty and particularly that the available remedies seem to be to shut down the economy to force social distancing, to force sheltering in place, while we tried, we society tried to buy time to flatten the curve. Again, no precedent for any of that.

Now, as we have this restart of sorts, what does that restart look like in terms of we had unprecedented levels of unemployment claims, unemployment, underemployment, lot of potential noise and all of that data. But now as we start to bounce back, if you will, what does that look like longer term? We would be in the camp that we're more cautious about what it looks like. Certainly, the bounceback feels significant as you're bouncing off extremely low levels. You also had unprecedented fiscal and monetary stimulus, not just in size, but in urgency, and that certainly has come to the rescue very, very quickly. How much does that potentially have a distortion effect, whether it be very generous employment benefits that once those wind down and wind off, what will that mean? What does it mean in terms of the PPP loans and having to put people temporarily back in place to be able to have those forgiven and turned into grants and longer term what does employment look like?

We watched some things very, very closely, sentiment indicators being one of them. How are businesses feeling about their future? And you typically can see that in terms of what kind of plans they have in terms of hiring plans, in terms of capital expenditures, in terms of any kind of M&A activity, and just the general sentiment surveys that come out. Consumer--consumer is two thirds of GDP. So watching consumer sentiment, and all of these consumer indicators--both the survey indicators, but also some of the real-time data, gives you a sense for how cautious the consumer is or isn't going to be going forward.

We've had a fair amount of distortion in the short run, as we put this literally unprecedented amount of stimulus in place. And as that all winds its way through, we have longer term some concerns about what certain sectors and what the economy overall is going to look like. That said, it probably means inflation stays lower longer than people expect. And probably interest rates staying lower longer than people expect. So, how does it impact our investment decision-making? Certainly, from the credit side in particular, being able to analyze sectors and companies--one of the things that in talking with our credit team, they're always struck by how dynamic companies are in terms of adapting to change. And we tend to invest in large companies with good managements who focus on generating cash. And so, they tend to be able to navigate the storms a little bit better and why we tend to continue to see value there.

There is significant uncertainty in terms of the macro environment, no doubt. And so, as you do and approach the fundamental analysis and go back with a clean sheet of paper, certainly your economic, macroeconomic forecast, your earnings forecast, all of that has to be relooked and remodeled. But as we look at our work on the credit side and our underwriting, if you will, we look for resilient business models and responsible management teams. We look at how do these companies, how have these management teams in particular and the companies performed in prior periods of stress. And as we look at how they have responded in here, many have done a number of, in our opinion, very responsible things. They've lowered or canceled capex plans, they've stopped share-repurchase programs, they've looked at dividends, or in many cases cut or trim dividends or eliminate them, and they've looked at continuing to sharpen their pencil in terms of their expense structures and other reductions. Maybe not music for the equity, the shareholders, in terms of EPS growth, but from a bondholder vantage point, certainly music to our ears, and probably makes the fundamentals even stronger to support ultimately paying our bonds back.

We continue to come at it in a very fresh way is probably the best way to put it and reconfirm the reasons for investing in a sector or company and then overlay updated assumptions in terms of the macro forces and then, some micro forces--they may be impacting certain sectors disproportionately in here.

Ptak: Can you give an example or two of differences that one would notice in the portfolios that you manage pre- and postpandemic? I think you've mentioned sectors a number of times. I know that's an important part of your process is looking at particular industries and verticals. And so, you mentioned that under these circumstances you have to revise your assumptions. So, maybe an example of a sector or an industry where you've had to markedly revise your assumptions and maybe it's resulted in a change in the way you manage the portfolios?

Stanek: Some of the things we've done--so, if you looked at the portfolios prepandemic and post, as we went through 2019, we really over the last several years, really, we've tended to evolve the portfolios and take down the overweights to credit and went into 2020 with a slight overweight, but continue to be cautious, and it wasn't because we had a crystal ball and saw any of this coming because we didn't. I don't know that anybody did. But it always comes back to us--the fundamentals matter. But it also is critically important for us to always remember the fundamentals matter. And then, for unit of risk, what are we being paid to take that risk? And so, the spread, the option-adjusted spread, or the additional yield you get to own that bond. And so, that's the part that changed and changed very dramatically, obviously, in late March, early April.

And so, if you looked at our portfolios as you saw that we actually did increase credit pretty substantially, in hindsight--for us, pretty substantially. In hindsight, do we wish we did more? Absolutely. But at the time, we were balancing all those other key objectives of maintaining liquidity, maintaining integrity, portfolio structure, quality--again, because there was so much uncertainty in the environment. And first and foremost, we always got to remember, what are we there for? For our investors, and it's that core of the core positioning in investors' total portfolio landscape.

The kinds of things that we were able to do we call that quality on sale. And I actually went and pulled the issue dates. You saw the primary corporate bond market open up and open up pretty substantially. The first names that were able to start issuing were some of the highest-quality names in the universe. So, for example, Exxon Mobil issued multitranche deal on March 17, Aa1, AA companies, so very high quality. In February, those bonds, five-year bond, was about 40 basis points off Treasuries. Now, that we felt was too tight and not something we'd want to own at that level. The new issue spread was something like 225 basis points off a comparable Treasury in March. By the end of May, that spread had narrowed to 64 basis points. And Exxon is just one example--or Pepsi was also a March 17 name that we did a seven-year deal, 180 off a seven-year Treasury. The spread in February would have been around 40 basis points, high single A, 1 A+. You saw Berkshire Hathaway Energy. That was a March 20 purchase. That came 355 off in March. It was 55 basis points spread back in February and had narrowed to 90 by the end of May.

So, I mentioned these--I could go on and on. But you saw many high-quality names and champion names common start issuing and issuing and continuing to issue. And that really, when we look back on it, helped provide liquidity and confidence in the corporate bond market, but the market overall. Now, we look in hindsight, March, April and May were the top three biggest issuance months ever for the investment-grade credit market. So, when we look back on it, one of our top credit people was saying, boy, I wish those spreads had lasted longer and that we had taken more advantage of that. On March 23, 24, into some of those widest points, when U.S. investment-grade overall. March 23, I think was the high-water mark this cycle, 373 basis points option-adjusted spread. At the end of May, that had narrowed to 174.

I realize I'm throwing a lot of numbers at you. But those were the kinds of things that we were trying to do to take advantage of what we believed was compelling value and good fundamental value from an analytic vantage point. We saw similar things on the very short end, particularly on the structured side. So, AAA rated credit card deals and auto deals, we saw those spreads widened out precrisis. An American Express credit card deal, 2.4-year average life, would have been about 25 basis points off. We bought it at 141 basis points off. A Hyundai Auto, again, would have been around 30 basis points off. That's a 1.7-year average life. We bought it at 228 basis points off.

We tried to take advantage as much as we could, in hindsight. One of your questions for me was, what did we get? I wouldn't say we got it wrong. But I would amend that to say what would we wish we had done differently, and certainly bought even more of the quality on sale that we saw. Unfortunately, and that's our big lament, it didn't last very long.

Benz: Speaking of that period of market pandemonium back in March, some of the strategies that you manage like Aggregate Bond and Core Plus Bond saw drawdowns in the neighborhood of 7%, 8%. So, do you feel that that revealed weakness in your risk-management process? And if so, what steps have you taken to fortify your approach?

Stanek: You always go through periods of dislocation and try to learn. No matter how many decades you have and experience you have, we've got to constantly get better and think about what is different and what did we learn from that. So, just to provide the facts, in the month of March on our funds, the taxable--actually, the entire, all the bond funds--we had about $2 billion net outflows. We saw a fair amount... It was an interesting month because there was a lot of purchase activity, too. So, we saw a lot of two-way flow. But, for example, the core plus bond fund had net outflows of 3.28% in the month of March, the aggregate bond fund minus 1.12%. Overall, total, minus 3%, just a little more than 3%.

Now, year to date, through the end of May, we've actually picked up just under $4 billion in assets total in the fund complex, and net flows are about 6.22% with the Core Plus up 4.34% and the Aggregate 6.79%. So, January, February, April, May, and so far in June, have all been decisively positive. But into the March chaos and the scramble, we saw investors... One of the other senior portfolio managers went back and was looking at the investor activity. And as you know, we try to stay very close to our investors because we want to make sure we're providing them information to either reconfirm the decision to continue to hold the product, but insightful information that might be helpful. And as we discern and go through and look at the actual movement on the part of the investor base, what we saw was investors, some of our bigger channel partners, were rebalancing asset allocations. And so, as equities plummeted, they were rebalancing and selling bonds to buy equities, which is something that again, from an asset-allocation vantage point, you should do. Many of them--and we saw this particularly with our healthcare clients, but not exclusively our healthcare clients--others were confirming liquidity and shoring up liquidity and making sure that they had in place their layers of liquidity to withstand whatever was ahead.

We stayed very close to try to understand what was behind the activity. As we roll forward, we have seen investors continue to come across the product line and show a net inflow activity. And we've specifically seen our healthcare-client segment, which is a pretty significant investor base for us, now seeing significant inflows as some of the stimulus money is coming through. It's been very, very interesting in terms of while our activity in terms of net outflows was small and meager by comparison to many in the industry, and I think that's a credit really to the investor base. Again, we try to make sure that they understand what we're trying to do, why we try to do it with our approach, and then the expectations for how the portfolios and the products are going to behave, and try to ensure that's exactly what we deliver.

Now, to the question of performance--we had a pretty good year started in terms of 2020. We had a very good relative year in 2019. And as we started earlier this year, we actually had a very good year underway and you roll through early part of March, we were doing actually quite well. And then the last couple weeks of March when basically nothing could keep up with Treasuries is really the headline, although credit, any kind of spread products exposure tended to underperform. And our overweight to credit, in particular overweight to BBBs certainly hurt us. As we look specifically at the performance, while we never want to underperform our benchmarks, when we look at March in isolation on a net basis, the aggregate portfolio was down 1.53% relative to its benchmark and core plus was down 1.35% relative to its benchmark. Now, when you look at the comeback, and at the time--and we did many, many, many calls with our investors into late March, early April, and continue to do many--we expected and indicated to them that patience would be rewarded.

Frankly, we were pleasantly surprised. The laments of the wide spreads didn't last for very long. The flip side of that is spreads continued to come in and contract. We had a very strong April. Core plus was up over 100 basis points relative to its benchmark net and the aggregate portfolio is up 91 basis points net. May was strong at 40 and 43 basis points net. And so far, June has actually been quite strong. Core plus is up 48 basis points, not an Agg 17. So, we've continued. We've been surprised at how quickly the snapback has come.

And so, what are the lessons learned? I would say we're not disappointed in our process or the integrity of the portfolios. The lesson learned or reminded was when you get these periods of substantial dislocation and we talk a lot amongst ourselves and with our investor base of exogenous risks, right? How do you forecast a pandemic? How do you forecast that we would self-impose an economic shutdown? If you had advanced that theory to us as a scenario, we would have put almost a zero percent probability on that--not completely out of the realm, but certainly not a realistic scenario. So, when you look at all of that, and you see how the portfolios stood up and behaved, how we were able to meet any kind of liquidity needs while we have been so net-inflow positive for a long time--we have seen periods of withdrawals and net redemptions--but the portfolios easily met those redemptions, and while we were able to continue to take advantage of the opportunities that were being created.

So, final point I would make is one that we remind ourselves of often is that the benchmark is a representation of the universe that the investor has chosen to meet their investment objectives. So, if it's a retirement plan, and they're investing in our aggregate portfolio, our aggregate fund is just to deliver is tracking the Bloomberg Barclays Aggregate Bond Index, which is a very broad representation of the investment-grade bond market. So, to the extent we have overweights or underweights against the benchmark, to the extent we own exposures that are not included in the benchmark, we add an element of risk or tracking risks relative to the benchmark. And while we say to ourselves every day we come to win for our investors, the reality is, we don't win every day for our investors.

The key to investing in the bond market in our opinion, and particularly with the spot that we tend to occupy, is to make sure--it's a game of inches to make sure that we tilt the portfolios so that we have a high, high, high preference to track the benchmark with a high degree of consistency, and then compound that consistency. We often cite the Morningstar data in terms of how the portfolios behave not just against benchmarks, but against peers in their relative peer categories. And so, that's what we're trying to make sure that we do and keep intact.

And to the question about, was there anything in all of this that we were disappointed with, certainly the underperformance temporarily, you're never happy to see that happen. But the integrity of the portfolio structure and making sure that we continue to deliver and meet those primary objectives for investors. If anything, this kind of environment confirmed so many of our fundamental tenants in terms of how we show up every day to try to win for our investors.

Ptak: I wanted to shift to strategy, and one of the things that's striking about the way you run money is you don't make interest-rate bets, you run a duration-neutral style, studiously matching the duration, the interest-rate sensitivity of your portfolios to that of their benchmarks. My question is, at the time you started in the business, interest rates were significantly higher, inflation wasn't nearly as subdued as it has been over the past few decades, really, at this point. Do you think about the risk/reward of making an interest-rate bet, a duration bet any differently today than perhaps you would have when you started out in the industry, and basically settled on your duration-neutral approach?

Stanek: So, it's a great question and it's one I've probably been asked for many times over the many decades. So, just to step back and how did we choose this strategy--in the very early 1980s, we started doing asset liability-matched portfolios using duration for our pension clients to fund pension-liability streams and take advantage of the then interest rates that existed but also to be able to raise actuarial assumptions for those pension plans in terms of how the assets were going to perform. We found that for the nearly five years we were doing that we were one of the pioneers at using duration in the practical management of bond portfolios in a customized way initially. We found that we could track and beat those custom benchmarks with a high degree of consistency that we decided at the end of 1985 that why don't we just do this for our entire product line and effectively go duration neutral to the bond market itself or segments thereof.

Today, we have a product line that spans the duration spectrum, an ultra-short-term bond strategy, a true intermediate one- to 10-year benchmark strategy, our aggregate--which is our core product--the one to 30-year against the Bloomberg Barclays benchmark and our Core Plus is against the Bloomberg Barclays universe. So, we, in our separate account management do some long-duration LDI work for some of our pension clients, but again, all in the duration-neutral stance.

The reason we took the entire product line in 1985 there and have confirmed many times over the years is the market and trying to time interest rates is a very, very tough, tough decision. But it's not just one decision to get right. It's a series of calls that you have to make and get right. And we have just found that most managers, including ourselves--even though we think we've got a decent track record of forecasting interest rates, most managers get it wrong--where they make one really good call and they don't get back the other way. And they find--if you look at their return patterns--they tend to be very unpredictable.

Our strategy is really--I like to describe it as a hybrid between a passive and active strategy. We're passive like an index fund in terms of the interest-rate sensitivity that we assume, but we're very active in terms of how we position the portfolios. And we often joke about the benchmark is enemy number one because the benchmark is what our investors are selecting--whether it's a sophisticated investor doing a sophisticated asset-allocation framework or an individual. They're choosing that expected risk and expected return implied by that benchmark. So, we make our decisions then and we spend our time, attention, and resources where we believe we have a demonstrated track record of adding value. And that's in yield-curve positioning, sector allocation, individual security selection--which is by far the most significant--while we also are very mindful of managing liquidity and minimizing transaction costs or those enemies of our investors' wealth.

And so, all of those things together, it's... We're hopeful that we will play baseball again because the baseball analogies are good ones. We don't try to hit home runs and make a big duration or a big interest-rate call. Because we think the chances of hitting that Grand Slam or that home run are, even for the best of hitters, their percentages, their batting averages tend not to be all that high. And the risk of striking out is actually quite high. And for us that is not commensurate with why people own bonds in the first place. They own them for predictability, for cash flow properties, to lower overall volatility in their portfolios, the liquidity--for any number of reasons, again, along the duration curve, and taxable or tax-exempt. So, what we want to do is provide as smooth a ride as we can pay for ourselves and offset those expense ratios and then compound consistency. Again, we don't get it right 100% of the time, but to be a lot more right than wrong and take a lot of little bets, if you will, hit a lot of singles. We always say we'd try to get on base, you know a lot of singles, we will take a walk, we will get hit by a pitch--whatever gets us on base, because we want to be able to have very high batting averages and use the resources and the talent that we believe we have assembled.

Benz: Jeff and I recently talked to a well-regarded investment advisor and he concluded through the period of market weakness, equity-market weakness in particular. I think he had said he had taken his client portfolios from being 50% of fixed income and Treasuries to 100% Treasuries, and he had concluded that he just wants the best ballast for his clients' equity holdings and he has determined that that's how he will position them for the foreseeable future. What's your counter argument to that approach? Assuming you don't agree with that approach, why would you say that investors should approach it differently?

Stanek: Well, there's many ways to invest, right? And I don't want to be judgmental for that individual in terms of how he's thinking. He's got a better insight in terms of the full risk profile and the risk tolerance of his investors. And so, that said, I would--I don't know that I would argue--but I would offer up, is probably a better way to put it, that it's a missed opportunity. That if you can provide a yield advantage, and if you can provide a relatively smooth ride--when you look over time, whether it's trailing three, trailing five, trailing 10 years since inception, you are paid to take the risk. And again, that's where making sure that you maintain the integrity of the portfolio, the underlying quality and structure of the portfolio, you can get paid to take that risk. But every investor can decide is that risk worth taking.

I look at, for example, our Aggregate Bond Fund since inception, and it's now 19.5. The end of September of this year, it will celebrate its 20th anniversary, net of the institutional expense ratio of 30 basis points, we've delivered 46 basis points per annum. So, you can compound that 46 basis points and that can be meaningful value for that underlying investor. In the case of our Core Plus, it's been net 68 basis points on the institutional class. I also have the investor class, which is 42 basis points net. So, hey, this is America. It's all about choices, right? And so, I would provide collegially what this choice has been able to deliver if our past is any indication of our future.

And again, going back to where we started, those benchmarks are representative of the capital market. And so, if somebody wants to invest in investment-grade, fixed-income dollar-denominated capital market, we are going to structure a portfolio with our tilts and our overlays that we believe will track it with a high degree of probability and outperform it, all while staying dollar denominated, all cash market, no derivatives, no leverage. One of our comanagers always jokes about--it's a portfolio of bonds, pick it up and take a look at it. I always say, if my mother, who is an investor, wanted to pick up our portfolio and look at it, it's a portfolio of bonds. It's pretty straightforward what we own. So, that's what we're trying to do. At the beginning and the end of the day, we want to show up and behave and deliver what our investors expect. But we do not want to amplify risks that investors have elsewhere in their portfolio. And to the comment about the 100% Treasuries, that investor wants a complete offset against equity-like risk. And that's a worthy objective. It's just what is the price of that insurance--or the opportunity cost is probably a better way to put it--to being that high quality in your posture. So, we think there is a way to have your cake and eat it too, but you do have to accept a bit more volatility.

Ptak: Your team runs muni money, too. The pandemic has been, it seems decidedly credit negative for municipalities. And so, maybe you can talk a little bit about how your team's approach to assessing credit has evolved within the municipal space?

Stanek: Yes, thanks for asking about the muni team. We are biased, but we think we've got the strongest leadership and an incredible muni team sitting side by side. Right now, we've got them divided and socially distanced--one in one location and one in the other in terms of our co-leads, Duane McAllister and Lyle Fitterer, but joined by the other two comanagers and it has been a really interesting environment. Having that capability and being able to think about cross-relative risk and cross-relative opportunity, the muni market--we tease them--should be one of the quietest, sleepiest parts of the bond market, and it was anything but. It absolutely got rocked and was really at the epicenter of some of the greatest volatility we saw.

In that, while it's been challenging, the time-tested experience that our team brings to the table and the active management capabilities, certainly the liquidity event in March evolved pretty quickly into a credit event. And now with time we're sorting through the strengths and the weaknesses of each sector and each individual credit. But again, having that talent in place to be able to do that, while we're playing defense to prepare for any uncertainties that exist, it's also been an opportunity to play offence and to add to areas that got overpenalized, if you will, during the downdraft. So, we were well positioned across the fund lineup going into all of this and have marginally increased credit exposure to help enhance returns going forward.

I might also say, one of the things that has also been interesting to us into the dislocation in the muni market was our ability to add taxable muni names and credits as well as tax-exempt munis into some of our taxable funds, particularly our ultra-short and our short-bond products. So, while the municipal lineup has performed very well in here, and we have a lot of confidence about portfolio structure, team, experience, all of that, they manage liquidity very, very well in here. But we found they also provided real time to the opportunity set for us in terms of as we saw marginal flows coming in over the last several months and wanted to put some money to work.

Benz: What would you say is the biggest point of disagreement on your team at the moment? And how have you resolved it?

Stanek: It's a great question because, while we have a lot of experience together, and some of us have worked together for a long time, we are very different people and have different perspectives. Now, with all of our shared experience together, you could argue that's potentially an inbred myopia that can develop. So, one of the things we try to do, and it's also a great way for us to develop young talent and talent across the entire team, is we run day in and day out a very flat structure. If you happen to wander into our offices unannounced, other than where our primary workstations were located, or our relative age is, you wouldn't necessarily know who's who in the zoo by the way we work. And that's by design, because we want that fresh perspective. We want people challenging us; we want people asking us, you know, long-standing views or a tendency or a bias. One of our senior comanagers always fondly referred to our biases. Let's challenge those and let's figure those out.

I would say, certainly the level of risk in the portfolios is always first and foremost a big topic that we challenge ourselves on and did throughout. That was one of the reasons why making sure through all of this uncertainty and volatility over the last several months, trying to make sure we kept the lines of communication open and active and purposeful and tried to simulate what happens here or did happen here day in and day out when we were all working together side by side. It's not unusual to see the senior portfolio managers out on the trading desks. We tend to office our analysts--the younger talent--out on the desk because we want them in the middle of all the activity. And then, the more senior people have glass-enclosed offices on the outer rim, but we're constantly interacting back and forth.

It's a great way for us... A friend of mine once said, how do you put those microphones out in the bleachers, to hear that point of view that might be different than yours, or someone who might have a different perspective or some new information. And we're constantly trying to simulate that and do that. Certainly, in this virtual environment where we've had to disperse the team into many different locations in the interest of public health and our own health, we've had to be a lot more purposeful about it. I would say we're doing pretty well with that. But communication is critically important so that you can have those robust discussions.

And I would say what we try to do in terms of resolution is we regularly say, the senior team doesn't have a lock on all the great ideas or all the wisdom; in fact, just the opposite. We want to validate our point of view with the bottom-up and that's where the sector analysts--anybody on the team who wants to share a perspective--can offer some insight and some wisdom. One of the things that was really helpful to us during some of the toughest moments in March, early April, was some of our investor-servicing people providing us real-time information of what was happening in terms of net redemptions going out in terms of some of the bigger products in certain of the bond-market sectors. I remember looking at some data in terms of some big muni funds that we're seeing just again, unprecedented--I feel like we use unprecedented in every other sentence--but just huge redemptions. Well, it explained quite a bit in terms of what kind of selling pressure there was to meet those redemptions. So, long-winded way of saying, we want to have that perspective and we want to constantly challenge ourselves.

At the end of the day, we think we get a better product. And one of the things that we're convinced of, we're able to better develop the entire team, much like successful sports teams. The best teams are people, individual players, who can see the whole field and know where their teammates are going to be, where the ball is going. And so, we try to do that in terms of how we think, how each individual player on the team thinks. They might be a credit analyst and migrate successfully through that path for the rest of their career or they may take on a broader role at some point. Our job--my job as chief investment officer and the other senior leadership on the investment team--our job is to develop that talent to see the whole field so they are prepared to continue to take on responsibility and ultimately provide sustainability of this process in this approach, and this team, most of all for our investors.

Ptak: One last question, if I may. What doesn't work in bond-portfolio management that worked 10 years ago? And conversely, what works today that won't work in a decade?

Stanek: Well, we've built this business... I've always found joy in life in managing both the investment side and the business side. And in our case, we surround ourselves with great business talent, but ultimately, the investment leadership drives the business decisions, and we keep it elegantly simple. We align everything we're doing in the interest of our investors. When we launched the funds, we wanted to be as low as we possibly could be in terms of our expense structure. So, 20 years ago, when we were planning the launch the Baird funds, we wanted the institutional class to be on parity with the front end of our separately managed fee schedule, and we launched at 30 basis points; 25 basis point investment advisory fee rate in there.

And at the time, I remember having lots of discussions about, wow, why are you so low? We said, we want to build the business that is investor-centric in terms of how we think and how we resource it; how we provide incentives for how it all works for everybody, so we're all paid based on how we do for our investors. So, we keep that really tight alignment. Baird is privately held and employee-owned. So, we have an owner mentality in terms of how we think about our investors' interests. So, all of those things--you know, I was going to give you a quick, smart-alecky answer--but low fees were important 10 years ago, 20 years ago, and they will be in the future. Being really competitive and minimizing those enemies of our investors' wealth and trying to continue to control what you can control, but deliver net results for investors that are very competitive.

What kinds of things, though, are today and will be, as you see so many wonderful things evolve. Communication has always been such an important part of what we do as we communicate with each other across relative risk, across relative value and debate portfolio structure. The tools and the technology--and this is where the younger talent, it's amazing what they bring to the table in terms of the tools and the insight and the ideas; in terms of how we'll continue to evolve those tools internally. What I think experience brings is that judgment, right? And the art of what we do. The tools are great, but the art and the judgment and the experience. And so, I'm excited. Our future is so bright. We've got 25 CFA charterholders on the team. Our young talent is so capable. And our job is just to continue to give them opportunities to develop. So, our investors--myself included, and our family--will continue to win for years and years to come, invested in these bond funds.

Benz: Well, Mary Ellen, this has been a really illuminating conversation. We really appreciate you taking the time to share your thoughts with us today.

Stanek: Thanks very much.

Ptak: Thanks again.

Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts. You can follow us on Twitter @Christine_Benz.

Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)

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