Summary

00:00 – Introduction to the podcast and guest Brett Lewthwaite.

03:09 – 2026 Market Volatility: Geopolitics, US-Iran actions, and the supply-chain
inflation spike.

04:47 – The Three Strategic Themes: De-globalization, Fiscal Crisis Risks, and the AI
Revolution.

05:58 – From Globalization to National Interest: The end of free trade and the rise of
"Liberation Day".

10:00 – National Resilience: The urgent focus on energy security, military strength, and
semiconductor sovereignty.

13:41 – Global Shocks: Assessing the impact of the US-Iran conflict and rare earth
vulnerabilities.

18:21 – Debt Dynamics: Why computer models say the current trajectory is
unsustainable and how "the rules" might change.

23:17 – Fixed Income Strategy: Using bond market volatility as an opportunity to
lengthen duration.

27:44 – The AI Deep Dive: Why AI is "eating software" and creating deflationary
pressure despite the boom.

33:45 – Active vs. Passive: The flaws of lending to everyone and the case for active
management in 2026.

40:00 – Conclusion: Breaking the "old world" habits of low interest rates and low volatility

Paul O'Connor:

Hello again to all listeners and welcome to the Netwealth Portfolio Construction Podcast series. I'm Paul O'Connor and my role is Head of Investments for Netwealth. On today's podcast, we have Brett Lewthwaite joining us again from Macquarie Asset Management. Brett's the chief investment officer and global head of fixed income, and is based in Sydney. Thanks for making the time to join us again, Brett.

Brett Lewthwaite:

Always, Paul. It's a great pleasure.

Paul O'Connor:

Brett oversees Macquarie Asset Management's fixed income broad range of investment capabilities globally. He has also been the lead portfolio manager of the highly regarded Macquarie Income Opportunities strategy since 2004. Brett is the chief investment officer and head of fixed income, serves on the Macquarie Asset Management Credit Executive Committee, and is a member of the management forum. Brett has more than 30 years of experience in financial services, and prior to joining the firm, he worked as a portfolio manager at BT Funds Management for nine years. Brett holds a graduate degree in applied finance and investment from the Securities Institute of Australia, as well as a Bachelor of Agricultural Economics from the University of Sydney.

Macquarie is a large Australian headquartered investment manager with fixed interest personnel in Sydney, London, and the US, and is one of the operating divisions of the ASX listed Macquarie Group. Macquarie is a multi-disciplined asset manager, managing assets across fixed income, equities, and real assets. As of 31 December 2025, Macquarie managed 736 billion in funds under management, of which 238 billion was in fixed income and credit. Macquarie has been navigating fixed income and cash assets since 1980. The Netwealth Super and IDPS investment menus include seven Macquarie funds and 19 Macquarie Professional Series funds across Australian and international equities, fixed interests, global macro, currency, hedge funds, and property. The menu includes four fixed interest funds that Brett works on, including the highly successful Income Opportunities Fund.

So 2026 has certainly provided us with increased volatility across markets, mainly based on geopolitical issues. So it'll be great to understand Brett's macro views and how the impact of the US actions on Iran have played out on the global economy and bond markets. Just when we thought we were nearing the end of the inflation spike from earlier this decade, inflation appears to be rising again, but more as a result of the impact on supply chains rather than being demand driven. So moving to the questions, Brett, you've spent your career navigating many market cycles and environments. Can you remind our listeners what you and your team at Macquarie Asset Management do for investors?

Brett Lewthwaite:

Sure, Paul, and thank you so much for that fairly extensive introduction. It's always humbling to sit and listen to all that, and it captures a lot of the things, but I think how does that work out in practice? We as an investment team for many, many years now, we've been very focused on trying to be the most credible manager we can be to our clients and all the relationships we have. And essentially what that means is trying to do as much work, consider things through investment processes, yet really focusing on what clients are seeking. And through the years, we found particularly consistent returns are the things that attract clients and keep clients. And what I mean by that is year after year of good excess returns above benchmark. And obviously it requires a certain approach, which is more focused on doing all the little things really well and having a really good handle on some of the big changes that are happening out in markets.
And one of the key cornerstones of that is the amount of detail our team goes into in what we call our strategic forum. So we hold these a couple of times a year, and we really do a series of deep dives, and that sets us up well with lots of information around the prevailing themes. The track record suggests that ultimately it helps us in terms of positioning cloud portfolios. And of late, those deep dive themes have been very, very interesting.

Paul O'Connor:

Can you walk us through what these key themes are and how you think they'll be shaping markets over the year ahead?
Brett Lewthwaite:

It's interesting because quite often when you start doing the deep dives, and the ones from the most recent one had a component around this, because the materials and much of what's playing out now, we were talking about through our strategic forums in the past year or even longer than that. But the three primary ones that we've been focused on recently, the first one is really what we would call either deglobalization, to put it in one word, or the shift away from globalization and a distinct shift toward what we call national interests or national priorities. A second theme that we've really looked into is the ongoing concerns around government debt levels and the risk of a fiscal crisis, as that's topical and continues to come up in many conversations. So we really focused on that. And a recent one too, and the rate of change in this one has just been incredible, was a deep dive into AI.

And what we were asking ourselves in our deep dive is, is this a transformational boom? Is it a bubble or perhaps is it both? And so we really went deep on that theme as well. And so perhaps we can gradually work our way through. I think they're interconnected and obviously the one or probably the two at the moment, the most pressing are around this shift to national interest or what I call NI, and the other one is AI, which is this technological revolution, but hopefully we can cover off all of them.

Paul O'Connor:

Well, it's a fair challenge you've set yourself there, Brett, but let's give it a go there, mate.

Brett Lewthwaite:

Sure.

Paul O'Connor:

Deglobalization has been a growing theme in the developed world in recent years, but can you talk us through what you mean by deglobalization and the shift towards national priorities?

Brett Lewthwaite:

There's so much you could really talk about this, but I think the way I've tried to encapsulate it as best I can is the world spent a good 20, almost 30 years embracing a concept like free trade, the idea of outsourcing. And to some degree, it manifests itself in a situation where, to put it very broadly and as succinctly as possible, we essentially were encouraging companies to utilize the world's resources, low cost locations, et cetera, to create high quality goods with the primary aim of maximizing profits for themselves and their shareholders. And that really worked well on many levels for a very long time. But leaving that, I guess, somewhat unchecked as time has gone by and as awareness has grown, that approach didn't give much, if any, consideration to what that meant for individual nations or components of populations. In effect, it was the idea of outsourcing manufacturing to China and benefiting from those types of things.

But as time has gone by, I think people started to realize that the outcome of that less conscious approach was ultimately that China was developing at an incredible amount of pace and direction. And if it was left unchecked, perhaps the global order would change. Obviously, many Western nations started to notice, I mean, most notably the US and increasingly became a bit uncomfortable with what that outcome might look like if indeed it was left unchecked. And then I think there was a series of shocks. One was probably around when Trump was first elected and started to call this out and there was a bit of a trade war then, but it cascaded through things, in particular like COVID, where I think all of a sudden the realization that relying on one particular area of the world to produce so many important inputs to so many things, and at that time it was medical, really did show some vulnerabilities. It accelerated a little bit more there.

And I think it got increasingly so at the time where, as we've sort of turned towards 2026 or it was really 2025, and the concept that became known as Liberation Day was really becoming this sense that China was not just perhaps becoming the world's producer or manufacturer, but to some degree they were replicating a lot of the technology that people like Apple or Tesla had been giving to them, and they'd been utilizing to create their own companies and those companies were producing arguably the same, if not better products at cheaper prices. And at some point that had to stop. And Liberation Day was really around trying to rebalance perhaps disadvantaged trade arrangements. And as we know since then, it's been an accelerating ride of geopolitical tension. I could probably talk a little bit more there because I think the Liberation Day thing is very important, but perhaps I'll pause in case there's a question from that point already.

Paul O'Connor:

Well, look, I guess as you're talking there, Brett, free trade and globalization certainly makes sense. And it plays to the heart of the, I guess, economic theory of comparative advantage. But I guess the other thing, the realization from Liberation Day and probably prior to that was that deglobalization's not an even playing field. And I think that is where we've seen some of these responses from the US there as a result to try and fight back and I guess wrestle some of the gains that the Chinese economy has made as a result of it. So it's certainly rational your comments there of what you've been saying, Brett.

Brett Lewthwaite:

Yeah. And look, I think it goes a bit further than that too. And this is where it shifts more to the concept of focusing on national interests as much of that outsourcing had taken place and you think about some of the trends and every region's got their own areas in this, is that what's become increasingly apparent and even as we sit here in 2026 and I'm sure we'll talk about Iran, but all of a sudden the most important things to individual nations are things like security or military strength. Can we defend ourselves? The most important one at the moment is, do we have access to energy? Are we energy secure? Equally, are there certain inputs, whether it be food or medical, all the way out to the very topical rare earths that we need as essential imports, potentially the semiconductors and chips and things like that, all the way through to medical.
Indeed, are we vulnerable if those things can be cut off? Can we produce those ourselves? And I think this is all tied up in ensuring that you stay at the cutting edge of technology and AI. And ultimately it requires incredible infrastructure, whether it's power grids, data centers, but it goes all the way through ports, roads, logistics, supply alliance. And realistically, many countries have underinvested in these things for a very long time and they've got quite a bit of work to do to get back to a point where they can tick all those boxes. And I think the US has seen that and it's pulled back. And by them pulling back and focusing on these things, it's forcing just about every other country to consider these as well and likewise do the same. And so we've sort of transferred away from global cooperation to global competition and with that comes quite a bit of abrasion.
I think there's good news and bad news in that. I think the good news is what that really means is that governments are very focused on their own economies and they will be required to sponsor projects that are in the interests of national strength or national resilience. That should be good for real economies and good for jobs and all those sorts of things. But equally, and as we're seeing event after event is that when nations turn inwards and do those sorts of things, ultimately we're competing for resources and relationships in the world, and that becomes quite abrasive. The downside is that it's more volatile and there's always a risk here that one of these events flares up into something much greater.

Paul O'Connor:

Yeah. Well, it's interesting though, that move towards deglobalization, but I guess at the same time at the moment, the world's grappling with the conflict between the US and Iran, which was a little surprising that the US have, I guess, done what they've done there. But how are you and your team approaching this from an investor's perspective?

Brett Lewthwaite:

Yeah. Well, I think in terms of doing the deep dive as we talked about and really looking at all the facets of the shift to national interests or NI, a couple of things that we noticed, because at the moment it's Iran, but it's probably been a series of things, right? And if we go back to Liberation Day, if you really looked closely there, because it was obviously fairly abrasive and very noisy, a lot of the emphasis seemed to be really around penalizing or trying to even up the playing field versus China. But curiously, China really didn't respond and the tariffs went from whether it was 35 or 40% all the way up to 146, and still China didn't really respond. And there was a series of postponements, "Let's meet in 90 days and try and talk about this situation, see if we can come to an agreement."

And it was really only late last year that I think they got to a point where the US was getting a bit frustrated and equally China was as well. And that's where this topic around rare earths came up. Broadly, you would say that I think China reminded the US that it created 98% of those critical imports, particularly into things like aircraft and weapons, likely reminded the US that it was somewhat involved in wars in Europe with Ukraine and also the Middle East around Gaza and Palestine, and that weapon depletion was going to be difficult to restore without access to some of these things. And I think it's moments like those which really took maybe a trend away from globalization to national interest to be something that became far more urgent. In other words, the vulnerabilities were quite acute. And at first you think, "Okay, well, that probably means deescalation," and to some degree it did, but realistically in the background, it really just said, "Okay, we need to close off these vulnerabilities as quickly as possible."

And I think broadly, and I say the word "broadly" because you can't be prescriptive or specific in these things, but you can see the trends, I think what you've seen then, whether it's around overtures around Greenland, for example, which has got a lot of rare earths, the action in Venezuela and now Iran all seem to be caught in this same situation, I guess a symptom or a byproduct of that shift towards national resilience or national interests. And so we're seeing things through that lens. And obviously each one of these events has its own particular curiosities. And at the moment as you and I speak, which is mid-April, at this point whilst there's discussion around ceasefires and while there's markets have embraced that, the Strait of Hormuz do remain closed, and the risks with the current situation is that it does look as if it has created another at least energy, if not global supply chain shock. In other words, significant shortages that are gradually drying up through global supply chains.

And so I guess we have to be fairly cautious about how we think about how that's going to affect global economies, both on the growth and particularly inflation side, and how that might mean for financial markets. So there's a bit of structural thinking, that deep dive looking at the general trend here, and obviously a bit more tactical thinking around, okay, here is an abrasive situation [inaudible 00:16:16] that we're talking about, how is it particularly playing out and what are the consequences that we can see coming forward there?

Paul O'Connor:
So what do you think a more fragmented nationally focused global economy then will actually mean for markets and economies in the coming years?

Brett Lewthwaite:

Yeah, it's interesting, isn't it? Because I mentioned earlier and I think there's this fair bit of merit in this, is that when governments think about sponsoring national programs, let's call it in the name of resilience, it does require government sponsorship. And so another way to think about this is that governments are going to have to do a lot more fiscal policy, in other words, sponsor some of these projects. And so that's generally very good for global economies. And so I can see a situation where economic growth is actually quite good because as country by country, they consider about further investment in defense, further investment in energy. Energy could be everything from renewable energy, green energy, all the way through to nuclear. It could be obviously investments and opening of refineries, like here in Australia will probably be considered now given the shortages that we may be facing.
All these sorts of things, AI, is a lot more investment in economies. So that's probably strong growth. I've mentioned that it likely comes with a level of abrasion and volatility, but I guess to some degree too, there is this sense of, well, okay, how do you fund that then? Because we've lived in a monetary policy world for quite some time. The byproduct of that has been a incredible buildup in debt in many levels, but particularly at the sovereign or government debt level. And this links to that second theme that we talked about, which is this concern around government debt levels and whether at some point perhaps we're heading towards some level of fiscal crisis.

Paul O'Connor:
Australia, with many developed countries, have structural budget deficits, but you've mentioned the need for an increase in fiscal expenditure that would require more debt. So the obvious question is, how does this play out along the unsustainable debt dynamics of many developed market countries?

Brett Lewthwaite:

It's one of those things too, and as with the take-up and being a little bit cheeky here, we obviously utilize things like Claude and we thought we'd ask Claude a little bit, let's ask the computer and see what the computer says about the current trajectory and whether a fiscal crisis is coming. It probably doesn't surprise anyone, but a computer said, "Yes, this doesn't look sustainable." But it is interesting, right? Because the things that we've been talking about is that this focus on national interests or NI or resilience, it's a need, it's not a want. To not do these things could lead to dramatic outcomes for certain countries. I mean, I've probably put that a bit strongly, but what I really mean is that these are very critical and so they have to happen. They're not really a choice. And so where that generally leads people to think is, well, how are we going to fund it?
Surely that means that if governments borrow, there's going to be higher bond yields, all these sorts of things. But what we would notice and really highlight to people is that this has gradually been happening for some time, but it's happening at an increasing rate. And what I'm talking about here is that the policies that we're all used to now ultimately are things that we think are rock solid, but realistically, they're just policies and the rules can be changed. And even Liberation Day is an example of changing the rules. But what we've noticed in the trend and some of the events is that ultimately policymakers, and I use the word policymakers because it's from the government side, but it's also from central bankers, it's around people who are trying to put each and every economy on the best. But I guess what I'm trying to say is that the rules can be changed and I think the rules will be changed in the interest of national resilience.

And the little phrase that we have is that policymakers can mandate, legislate, confiscate, and ultimately they can and will.

And it probably means that to some degree, central banks will be involved as needs be if in turn there's periods of volatility in the bond markets where perhaps yields need to be suppressed or a level of financial oppression in the name of national interest. Now that might sound like a bit of a stretch actually, but it's all sorts of things. It's everything from creating sovereign wealth funds. You may have noticed some of the negotiations around Liberation Day that the US has had with places like Japan, encouraging Japan to build factories in the US, which helps the US re-industrialize, then that's a different form of funding. Taking an equity stake in Intel, which the US sees as a critically important company to the future, perhaps rather than taking a significant tax off that company, trying to apply additional tariffs and things to things like chip sales to China.
But ultimately it could come all the way back to even looking at where national savings are. There's many countries with pension funds. And if you look inside those pension funds, they've been operating in a globalized world and they've been seeking opportunities all around the world and that's generally worked quite well. But if indeed there's a funding need at home now, I think you can see policymakers lean on pension funds and say, why is it that you're owning treasuries or why is it that you're investing in global, passive vehicles all around the world without any due diligence when there's projects and priorities at home that need attention and investing? And if they can't encourage, and I'm sure you can encourage them to do this because it's in national interest and it's national savings. And if you can't encourage them, you can always change the rules and mandate them to do that.

And so I guess what I'm saying is that there's many ways this could be funded. And I think the default mindset at the moment that everybody is in, one that ultimately governments will just borrow more money and they can't borrow too much, it will end up in a fiscal crisis. Whilst, of course, I think that will be something that is to some degree utilized, slipping into a fiscal crisis, timing that or thinking that ultimately everything else won't be tried first, I think it's a case of that more so than slipping into that fiscal crisis.

Paul O'Connor:

I guess going back to Reinhart and Rogoff's 2010 study when they propose that public debt to GDP ratios, if they exceed 90% can result in significant lower long-term medium growth. But so you're not so sure we're facing a fiscal crisis and then would be at the beck and call of the bond vigilantes. I guess you're inferring that obviously sovereign funds and there are some other options and levers that governments can play obviously to fund the deficits.

Brett Lewthwaite:

Yeah, absolutely. And ultimately, I think if indeed, let's think about a very indebted world, there is a certain cost of capital or bond yield or interest rate, whichever way you want to think about it, where I guess the fragility in the system, that level of yield gets too high. And if that doesn't self-reinforce through lower growth and abrasion in financial markets, let's all be honest with ourselves. I mean, we came out of the financial crisis, central banks utilized quantitative easing, and they did it all the way through to the middle of COVID, which is an incredible amount of time and a incredible amount of money printing, for one of another word. Ultimately, that tool can be used again. And so I guess the way we think about this is that, yes, it's right to be concerned about this. Yes, it will create volatility. I think bond yields will jump around, but I do think to some degree there are ways that can and will be utilized that may limit just how far those yields can go.
And I think we've even seen that over the past few weeks where perhaps financial markets have played some level of role in thinking about, at what point to press harder in Iran or perhaps now seek a ceasefire given level of oil prices and rising bond yields and things like that. And since then, you've seen things cap and go back to normal. So ultimately we would see the volatility that you're seeing in bond markets is opportunities to actually lengthen durational buy bonds, knowing that ultimately policymakers will be incentivized to try everything to fund this shift towards national interest. And having a very high interest rate does not help that at all. And so they'll be doing everything they can to get the cheapest interest rate they possibly can.

Paul O'Connor:

Yeah. You've touched on there that potentially longer duration bonds could become attractive in the shorter term. So what are the other implications for portfolios, if indeed the portfolio makers do choose to mandate, legislate and confiscate, as you so articulately put earlier, Brett?

Brett Lewthwaite:
I generally think that the situation we have is because the shift towards national interest or resilience is so important, policymakers are incentivized to ensure economies remain strong. You don't want to have a recession here. It's not a time to slow down and fall behind. And so I think policy levers will be utilized to try and keep economic growth going. I think that applies to financial markets as well. I think they can be volatile. I try to think about it as a core or a central view is that ultimately policymakers will try to ensure that growth and markets continue to go well, and it's best to position for that. But knowing equally that we are in abrasive time and there will be some volatility that goes with it. And so I guess the way that we think about it is to some degree have a fairly conservative portfolio and utilize the volatility of ways to add risk.
And as your markets perform quite well, try and get back more to that conservative position and try to think about, we almost call it a slightly contained environment. There's limits to how much pain or how high yields can go before policymakers will respond. It's even a phrase that we use is, "This is happening. What will they do?" And trying to anticipate when that happens. So I think there'd be quite a lot of opportunities, but obviously the tail risk is to some degree that one of these missteps perhaps is larger and may require a bigger drawdown and we have to be cautious about that. And perhaps even just thinking about where we are in the Iranian situation at the moment where the Strait of Hormuz is closed and it's been closed for longer than anyone thought.

And it may well be creating a situation where we're in the midst of a bit of a global energy supply shock, it would be prudent to be fairly defensive at the moment and perhaps use the current rally as an opportunity to just say, "Well, hang on a sec. Things are quite good here. Let's get a bit more defensive because ultimately there may be a bit more inflation ahead that obviously has all sorts of second, third, and forth thought of consequences. Perhaps it might be an idea to be a bit more cautious for the coming months also."

Paul O'Connor:
Moving to your third theme from the strategic forum, AI. Everyone's talking about AI. You can't open a newspaper without

seeing stories everywhere, but there appears to be a lot of long-term positives such as material productivity gains, but it also appears there's going to be shorter term disruption to business models and changing employment needs that could see unemployment rise. So how are you thinking about it? And does it impose an investment opportunity or is it a threat or I guess a combination of both?

Brett Lewthwaite:

It's a real interesting one. And I think the pace of change is just incredible. If I reflect on my own journey, we did a really deep dive towards the end of last year asking that question, is it a boom? Is it transformational technology? Is it a bubble? Is it both? And I think even at the time we could see the technology was helpful. We had question marks around perhaps how you monetize the benefits of it, but ultimately where we came to it, and as I guess this somewhat progressed, a number of us did some AI training courses. We were actually strongly encouraged, if I should use the right words. Reluctantly so to be honest, but I was incredibly blown away by just how capable it was. And that was before Claude. Then we got Claude, and then we started using Sonnet and then Opus, and we know there's a new one called Mythos coming out soon, and the rapid improvement has just been considerable.

So I think in the space of just a handful of months, we've seen just how beneficial and the best way to think about it is just having this incredible research assistant on so many levels. And equally at the same time as doing the deep dive, what we heard from one of our analysts in the US who focuses on the tech sector, he said something interesting. He said that he wasn't particularly worried about the Magnificent 7 or the AI 8, they were big companies, they would respond to what was going on, but he did make a comment, and this was in November, that he'd never been so uncertain about the outlook of the other companies in the Nasdaq. We were a bit like, "Sorry, say that again." And he was like, "Yeah, I think their business models have got huge question marks around what that might mean." And sure enough, so we took a lot of software exposure out of our portfolios and we've got very limited, and that was quite insightful at that time. And it wasn't till February where that really started to play out.

And so it is interesting at the moment, there's this famous comment from, I think it's Marc Andreesen from 2011 where he was talking about how software was eating the world, and that was, I think, in 2011, and here we are in 2026. And I think the saying has caught fire now that AI is eating software or perhaps even AI is eating the world. And it's interesting, right? Because to some degree, the early disrupted components, particularly with things like Claude Code, are many of the technology companies themselves. And so it's incredibly disruptive technology. More broadly, I guess we see it as a very powerful tool. It's most likely going to bring the cost of many things down. Unlike national interests or NI, which is enough to get our heads around, AI seems to be going the other way, which is probably bringing significant amounts of disruption and deflationary pressure.

There are big question marks around how much displacement might take place. I think there's still significant questions around how has all this investment come back in a return to investors? In other words, what I'm saying is the valuations associated with much of what we're seeing, the required investment in terms of the build-outs, the data centers, the power, the cooling, all these sorts of things. There's huge questions around that. And to some degree, whilst that's happening, you've got this powerful tool sort of reshaping the way everyone works. It's a very, very complex thing. And then we have to link it back to what we're seeing in the world too in geopolitics because at the same time, as this rapid change, this rapid investment, the need for more energy, for more chips is occurring, it does look like global supply lines are choking up a bit.

And it may well collide at some point.
And I guess what I'm saying here is some of the important elements that go into creating chips are blocked largely in the Strait of Hormuz. Taiwan gets a lot of its energy, for example, from the Middle East, and ultimately Taiwan produces the semiconductors. Not to mention that the price of energy's gone up a lot. And so in terms of how this build-out collides with an energy shock, there's quite a lot to think about in there. And so I guess what we're doing here is acknowledging this, embracing into it, leaning into it, playing, utilizing the tools. And I guess we have a view that it is disruptive and deflationary. Perhaps that sort of helps offset some of the inflationary pressure we might see out of the geopolitical tension. It's real and it's coming and it's reshaping things. And what we've seen in software so far may be instructive to what we might see happening in other sectors. And so we're somewhat cautious on that.

Paul O'Connor:

Given everything you've described there and those key themes from the strategic forum there, Brett, deglobalization, debt pressure, AI disruption, what does a well-constructed fixed income portfolio actually look like today? And has the traditional role of bonds in a portfolio changed?

Brett Lewthwaite:

Yeah, an interesting question. I'll go through the portfolio construction piece and please remind me to go back to the has it changed question if I get lost in trying to answer that. I think everything we've been talking about now is to some degree have been around the themes and understanding some of those drivers. And we haven't necessarily then focused on, well, what is the price in markets? And I think that's always very important. And if you look at fixed income portfolios at the moment, what you can see is generally bond yields are at much more attractive levels than have been for quite some time. And ultimately you can see credit spreads are relatively tight and there has been some recent headwinds on the credit side of things, namely through, I guess, concerns around the private credit channel. I guess to some degree, thinking about pricing is that bond yields are most likely reflecting the outlook in a way that sort of is encouraging the investment in bonds because it's attractive.
Albeit, we do have to be conscious that an inflation shock might put a bit more upward pressure on bond yields. And so at the moment, we would sort of encourage being patient in terms of how much duration to have in portfolios, but seeking to add on those opportunities. That's not always easy to do as an individual investor. So ultimately that's kind of the sorts of things that we do, but ultimately we're seeing where yields are and the likely volatility that's coming through there as an opportunity to have more duration in our portfolios. On the other side of the equation, which is, well, how much credit should we have? O

bviously credit gives you a bit more yield. As I said, credit spreads are fairly tight, which means they're expensive. The world has got quite a lot of uncertainty, a lot of abrasiveness at the moment.

I mentioned briefly some of the concerns coming out of software in the AI disruption and how that's affected components of the private credit markets. And so it's possible the credit cycle may be turning a bit. What that means is ultimately better opportunities may be laying ahead. So we're playing a very defensive hand on the credit side at the moment. We are hopeful that if indeed there's more volatility and a bit more correction in what you call risk assets or EMEC equities fall, there'd be an opportunity to add more credit. If we think back to the conversation I had, given that policymakers are very focused on trying to create conditions to pursue these national interests, and that includes strong economies, stable financial markets, ultimately it does mean that things like credit spread or credit opportunities should be limited. So we do want to run a decent level of credit, but we don't want to be caught running the riskier components at the moment.
Has fixed income changed its role in a portfolio? I guess there's a question I think I was ever asked in the first 25 years of my career in fixed income. It was always a given. And I think where it really came from was the significant move from very low yields in the end of, I guess, the earlier eight days of the COVID outbreak. But obviously then the huge inflation shock and the fiscal policy response to that. And through that period, you had the situation where most things sold off bonds and equities at the same time. I guess there's always a chance that that situation could occur again in that we're experiencing an energy shock via the situation in Iran. But ultimately, as we've already talked about, there's probably a limit to that. And also keep in mind that yields are already at much higher levels than they were back in 2000 and 2021 when they were down near a half percent.

And so to some degree, the outcome from that wouldn't be as high. But those situations where they don't really act are probably rare. And so I'd say most times it'll continue to play the role it's always played in people's portfolios.

Paul O'Connor:

So you're an active manager of fixed income, but obviously we've seen a huge rise in allocation to passive strategies. So in your thoughts, what's the case for rethinking that now? And I guess I also think to myself, if we do see inflation, we do see yields increase. I mean, a large portion of, like the Global Agg Index is now duration again. So it does, in my mind, lean towards moving more back towards active, but what are your thoughts on that?

Brett Lewthwaite:

Yeah, it's interesting, isn't it? I think if you go back to the first thoughts around the benefits of passive, I think it was really around diversification and for a lower fee, and that makes a lot of sense. But that was at the beginning. Where we find ourselves now, whereas there's been a widespread proliferation of passive. I'd almost call it passive is massive, which is quite interesting. So much money in markets is not really making investment decisions. It's just buying and selling because it's in an index, is a strange place to find ourselves. You can see it mostly in particularly US equities where you got this huge concentration in a small handful of stocks being the Mag 7 / AI 8. And so many passive investors probably are unconscious that they have got such a significant exposure to just a handful of stocks. And who knows, AI could upend that.

And it goes the same with fixed income. I mean, with fixed income or credit, the best way to think of it is credit is credit. It's lending money to people and you get an interest rate for doing that and you get your money back at the end. Generally when you do that, you want to think about who you're lending to and embracing passive is essentially lending to everyone. And quite often it's the most indebted that you're lending to because they're the biggest components of indices. So there's always been quite a lot of flaws, but I think in my mind, particularly in fixed income, it always comes back to, let's look at the return outcomes and let's also consider the fees. At the start, I said that passive was cheaper. These days, the difference between fees in passive and active are marginal, and that's really being a bit too expressive. It's tiny.
But the reality is performance, particularly in the active side, has materially outperformed passive year after year for decades, really, 20 years or so. And so it doesn't make a lot of sense on the fixed income side at all. You can't even make the argument it's much cheaper. I think it could be simpler, but I'm not even sure how that applies. So I would just be encouraging people to think about, does it still give you diversification? Is it to the right things? I think we're in a period of time where you really want to understand what you're invested in and being broad and bland and not really sort of being, I guess, discerning in terms of who you're lending to doesn't seem to match the environment we're in.

Paul O'Connor:

Well, I guess I've noticed that too with portfolios that we administer for clients and they're either typically all active or all passive. So there doesn't seem to be a lot of thought across even the underlying asset class exposures and how passive is used there or the risks associated. But we better bring the podcast to a conclusion there, Brett. But if you've got one thing for our listeners to leave them with, one shift in mindset or portfolio behavior, what would it be?

Brett Lewthwaite:

Yeah. I think the more I thought about this question is that we were in a very low-yielding world post the GFC for a very long time. That was a fairly good time to be in financial markets, the financialization of everything. Markets, everything performed well from 2009 all the way through to COVID and then got a bit more volatile, but you could argue many markets continue to perform. And there was a lot of habits that we got into because interest rates were so low and because volatility was so low, we embraced things like passive and passive became massive. There was a proliferation of private markets because you needed the yield. You chased the yield. And I think about those habits and how long they've built up for. And I say, "Okay, well, I understand that." And then I compare those conditions that encourage that behavior or those outcomes and I compare them to what we're now experiencing today.

And we spoke about NI and national interest and national priorities and thinking about how much is invested at home versus being in things like passive. We talked about AI and its ability to disrupt and we're seeing it in software companies. And I think right here, right now, there's probably plenty of people saying, "Am I happy to invest in that small company or lend to that small company? Do I understand whether it will be disrupted? Do I understand its business model?" And those sorts of things are very, very different. And so I would just say, the one thing I would leave investors is that, are you stuck in the habits of the old world? Because we're in a brand new world now.

Paul O'Connor:

Yeah. And I guess that's very pertinent that comment there that you just need to continually think about your portfolios, the portfolio construction, your asset allocation, the type of managers and allocations that you are using in those portfolios. And to my earlier comment, I do see quite siloed portfolios, many portfolios that investors are using, particularly passive there. But Brett, thank you very much for joining us on the Portfolio Construction Podcast today. It's been a really fascinating discussion. It has been very educating for myself, and I am sure the listeners too have also enjoyed your comments and your insights that have certainly been very thought-provoking on deglobalization, debt dynamics, and AI. So thank you for your time and your insights, Brett.

Brett Lewthwaite:

Excellent. Thank you, Paul. Always a pleasure and hope to be back sometime soon.

Paul O'Connor:

Absolutely. To the listeners, thanks for joining us again on the Portfolio Construction Podcast series, and I'll look forward to you in joining us on the next installment.