FOCUS 2026: Income that moves with markets

Glen Davidson: [00:00:00] Hey, Adam, welcome to Scottsdale. Nice to have you up here.

Adam Kramer: [00:00:02] Nice to be back here.

Glen Davidson: [00:00:04] Welcome back, everybody. Now, Adam, I think many people here are thinking, you know that Adam guy, he probably came in the other day from Boston and went and climbed Camelback or went golfing but you didn't. You had some other things up your sleeve.

Adam Kramer: [00:00:20] I planned out to be here in the morning so I could be here for game seven of the Boston Bruins. That didn't work out so I had a little extra time on my hands. I ended up going to visit a corporate store of one of the holdings in our portfolio, tried out the products. It's been in the portfolio for a while and that was a good use of time.

Glen Davidson: [00:00:35] Doing some analysis all the time even on...

Adam Kramer: [00:00:37] A little analysis, yeah, a little original research.

Glen Davidson: [00:00:39] Very good. Now, let me jump off of that point. In an environment like this, and even today we're seeing a lot more volatility, do you and the team with Tactical High Income and the other mandates that you run, do you meet more frequently? Does it ramp up with volatility?

Adam Kramer: [00:00:57] You know, Glen, we have this very consistent and repeatable and duplicable process. We have our meetings on the calendar. We're continuously speaking to everybody, all the experts at Fidelity, the analysts, the macro people, my co-managers who are great. Nothing really changes. It's a duplicable and repeatable process. The thing about our strategy is that it really is designed to take advantage of these dislocations in the markets. If you look at all the major income-oriented asset classes from Treasury bonds on one end to dividend paying stocks on the other and everything in the middle, the plus sectors, they all take turns as the best and worst performing asset class in any given year. The difference in performance of these asset classes could be thousands of basis points. It's these periods of volatility that can really create a lot of opportunities. Our process in place just allows us to find them and wait for them, being patient as well.

Glen Davidson: [00:01:51] What's nice is you're not restricted to a couple of asset classes. You're going across the capital spectrum of so many companies, a good diversity for the portfolio. We're going to touch on that today. We'll go through each of the buckets, see what you've been doing. Each time we meet there's a lot of activity going on behind the scenes. You've got all of those resources coming to you, including David Bridges, who now is, I guess, a contract. Some of you may go way back with Fidelity and remember we had somebody in Boston by the name of David Bridges. He used to be with the CIA. That's all I can tell you. He was a consultant within the firm, and still is, for geopolitical risk as well. You still have access to him.

Adam Kramer: [00:02:31] Yeah, we still have access to him. I used to love speaking with David. Whenever I had a question about geopolitics I'd reach out to him. We have a contract with him where we could speak to him and ask him about what's happening in the world. That's pretty important because at the end of the day the market has a tendency to rightly or wrongly price in risks and rewards in the asset classes only to get adjusted the following year when the actual events occur. We wait for those episodic opportunities, to your point. Based on the process that we have in place we can assess whether or not there's too much good or bad news priced in. That's one of the tools that we could use to help us determine.

Glen Davidson: [00:03:08] A lot of the people that are watching at their office or that are here have seen you before but we should remind them about Tactical High Income Fund. As I was saying, I think it's always very interesting talking to you, talking to you with Scott Mensi about what's going on, the dynamic changes within the solution. Could you give everybody a reminder of the structure of Tactical High Income?

Adam Kramer: [00:03:42] Tactical High Income, we've been around since 2014 so we have a pretty long record and a lot of cycles, ups and downs in the market, so you could see how we've done in up and down markets. Really, this is a dynamic income solution. It's designed to wiggle around the traditional 50/50 balanced fund but not be forced to invest in just investment grade bonds and stocks. We have the flexibility to invest in high income, high yield bonds, floating rate debt, convertible bonds, preferred shares, emerging market debt, emerging market equities, real estate income. It's probably 20, 25 different asset classes. It goes back to what I was saying, the whole philosophy of the fund is that the market misprices these asset classes year in, year out. That is actually the fuel for the idea generation.

[00:04:32] That's why we always like to say that this is the type of fund or solution that you can own at any given point in the cycle. It could be early cycle, mid cycle, late cycle, or recession. We're always going to be able to find those areas that have too much bad news priced in. We're all always cognizant of where we are in the business cycle and that's sort of the conversation that you were asking about. I'm always cognizant of where we are, what's happening. We're just trying to find those areas that are mispriced. That's where we can find those ideas. We're not trying to make predictions, we're trying to let the ideas come our way. That's how we've created value and preserved capital over time.

Glen Davidson: [00:05:14] What you're focused on is yield as well. I want to get to that in a minute. Last week I was reading about something in the US and it was an autocallable fund, not at Fidelity, and it's about high yield but at the risk of the stock market, very concentrated and very complicated. That's not what Tactical High Income is all about. I thought of you when I read that because of the diversity of asset classes and the focus that you have on yield but on risk minimization. Can you talk about yield maintenance with the portfolio?

Adam Kramer: [00:05:43] Before getting into that, the other thing that's very different with our fund is that we're not a sleeved approach. It's I as the lead manager on the fund who's determining what securities come into the fund. It's really a security selection focus with a top-down overlay. With regards to yield, around half of our return over the full life of this fund has come from income. Yield is a very, very strong component to the total return of the fund. We try to say that we're always looking for a very big premium relative to what you'd get in a traditional balanced fund. Sometimes we've been double what you can get in a balanced fund but on occasions we're 100, 150 basis points on average, a premium yield. We try to say as well a minimum yield is maybe what you'd get in a triple-B investment grade bond market. That's sort of the goalpost that we have in place.

Glen Davidson: [00:06:46] Makes a lot of sense. Now, how do you also plan for different outcomes? You and the team don't get together and say let's put all our money over here. You really are looking at quite a scatterplot of ideas that could come.

Adam Kramer: [00:06:58] That's a key part of our process. I'm trying not to make the predictions. I am trying to let the ideas come our way. With these asset classes they tend to, like I said, price in so much bad or good news. When I look at an asset class or an idea at the security level, whether it be a stock or a bond or a preferred share or convertible, I try to take into account all the scenarios. What is the upside, downside risk-reward in the event of the underlying stock, or if it was a bond, were to go up or down 10% for the stock or up or down 100 basis points for the bond or the preferred, what would my total return be? I'm looking for that equity-like return with limited volatility. I think if you look at the return, how did we do it over time? We've only been overweight equities one year and that was in 2021.

Glen Davidson: [00:08:06] The fund was launched in 14.

Adam Kramer: [00:08:07] Right. We've been overweight equities one year. That's duplicable and repeatable is that we are looking at these asset classes on a regular and consistent basis. We're not sending money out to different fund managers. I'm doing that in other strategies. We're finding the best ideas within each asset class. That's what makes us really pinpointed, specific, brick by brick, putting together a portfolio of top ideas that actually has a very good upside, downside risk-reward profile.

Glen Davidson: [00:09:00] The market today, let's just do another macro question before we get into the buckets, there seems to be a real gamification of the marketplace. It seems that way. It's almost like a betting market. The results that you've achieved with Tactical High Income have been more ... not risk-off but risk reduced from what a lot of people are doing within the market. Fair statement?

Adam Kramer: [00:09:21] For now, you mean.

Glen Davidson: [00:09:22] In Tactical High Income.

Adam Kramer: [00:09:23] Yeah, yeah. One of the interesting things that's happened with everything that's going on in the market, and we've heard a lot of different speakers, I haven't really seen the real material worry in the market priced into many different asset classes. Like I said, we try not to make the predictions but when things are rich and the risk-reward is not that great we'll de-risk and we'll wait for the opportunities to come away, or we'll find other areas in other places. We have definitely been de-risking the portfolio although the stock part of the portfolio remains consistent. It's really on the credit side that we've reduced and we could talk about that.

Glen Davidson: [00:10:05] As a long time investor does that concern you? I'm sure it surprises you, the level of risk that investors are still willing to take given the geopolitical risk and other aspects of the market that we've seen.

Adam Kramer: [00:10:16] Not really because everything is sort of trading in the normal ranges. I mean, the economy is strong and with good reason. There's a lot of good things that are priced into the economy. What I like to look for is the market overreacting and pricing in a risk that hasn't occurred yet. Unlike last year at this time after the tariff tantrum, during COVID, during 2018, the market just had a tendency to rightly or wrongly price in risk before it actually occurs. We just didn't have that happen this time. We've been seeing it in select areas, and we'll talk about that. It's all normal to me. Everything's trading in a range. Some asset classes are quite expensive now and the risk-reward for me is not there yet.

Glen Davidson: [00:11:04] But you're seeing lots of opportunity as well. Why don't we start there? Let's start with high yield, that bucket.

Adam Kramer: [00:11:10] High yield bonds, I consider myself a high yield bond analyst. I started out 26 years ago as an analyst in the High Income Alternatives Group which is based in Boston. We look at high yield bonds. High yield bonds are basically these bonds that are sub-investment grade. Right now they are trading rich, if you wanna call it that, relative to its history. It's probably in the top 5% of richness relative to its spread over Treasury. It doesn't mean that that's a warning sign, it just means that it's a good economy and the risk-rewards aren't there. We have actually reduced the high yield bond exposure in this fund to the lowest it's ever been. That was as of April 30th, March 30th rather. Why is that? Well, when I look at just generically speaking, if there was a 6 1/2% bond and there was a 3-year duration, and that bond was trading at the record tight spreads that they're at right now, one is really only taking on interest rate risk and credit spread risk at this point. Of course, if interest rates were to go down 100 basis points one could make close to 10%.

[00:12:26] But if interest rates go up 100 basis points, or credit spreads widen 100 basis points, you're only really making 3 1/2% on that bond, 3 1/2% versus what you can get in the T-bills today in the United States. With the extra liquidity that you get in the T-bills where you can wait for something to happen, to me is a better alternative. We have actually bumped up our T-Bill exposure in the fund as you see in our disclosed holdings and a lot of that is as high as 20, 20+% after episodic sell-offs in high yield. The credit spread on high yield is a T plus 280 now. T plus 450 is sort of where it hit last year during the tariff tantrum and it couldn't go higher than that if there was a true recession but the economy is strong.

Glen Davidson: [00:13:10] Let's go to preferred shares, that's actually a very concentrated focus for you right now.

Adam Kramer: [00:13:16] One of the things I do also with my co-manager on this fund and my co manager in Boston, Rick Gandhi, we're co-managers on the Preferred Stock fund, Preferred Stock ETF in Boston. I've been looking at preferreds and managing preferred stocks since 2010. For anybody who's not familiar with what a preferred stock is, it's basically senior to common stock. It has no sensitivity to the equity. It pays a dividend sort of like a bond but it's a preferred dividend, taxed differently. In the United States the preferred market is mostly US banks, utilities, the biggest banks and utilities. Relative to their investment grade brethren, because there's a lot of investment grade bonds in those same companies, it's actually inexpensive.

[00:14:02] On the absolute I find it to be not so attractive because you're taking on, give or take, you're getting a mid single digit yield but you're taking on a 7-year duration. It's not the best matching. I don't own any pure play preferred stock of any banks or utilities Where we do see opportunity that we've spoken about together in the past is preferred stock of digital Treasury companies. These are trading quite attractive relative to investment grade bonds, high yield bonds, preferred stock. Basically, what these are are preferred stock of companies that hold Bitcoin on their balance sheet. Generically speaking, for every $1 of preferred outstanding there might be either $4 or $6 of Bitcoin on the balance sheet, a good ratio, but they're trading very wide to every other credit asset class.

[00:14:58] You're also getting a very attractive double [indecipherable] yield after tax because these are tax deferred. In order to get a pre tax yield you'd have to go look for something that's 18, 19, 20% and you'd have to go into the stressed area where you might not even be able to find that. It's a very mispriced part of the market right now and that's a big part of our fund as well for preferreds.

Glen Davidson: [00:15:25] A company like you're talking about that's got a preferred issue, that's owning a lot of Bitcoin ... Jurrien talked Bitcoin is very tradable these days and is certainly moving with risk. Is a downtick in something like Bitcoin erasing the value in this company that you have through the preferred issuance?

Adam Kramer: [00:15:47] The way way it's structured is that for every $1 of preferred there's around $4 to $6 of Bitcoin. If you were to look at that, that's called loan to value, that's a very low loan to value, in other words over collateralized.

Glen Davidson: [00:16:06] There's a big cushion there.

Adam Kramer: [00:16:06] It's a very big cushion. It's not going to move with Bitcoin. Really, this is going to pay your dividend and it's going to be what happens to the credit spread, which our starting point is actually quite wide is what I'm trying to say. There's no sensitivity to the equity or Bitcoin. It's really just a preferred dividend stream that will move up or down with the credit spread. Bitcoin actually has done well when there are periods of negative real yields and when the Federal Reserve is either holding rates constant or lowering rates. It's very possible that we will have a potential negative real yield environment going forward if inflation does move higher. It is possible that the new Federal Reserve is holding rates constant or not raising as well. The setup for Bitcoin from that respect is very good. I'm actually feeling okay about the equity sensitivity of these digital asset Treasury companies. We have a few of those in the fund as well where we'll have a little bit of that exposure to the stocks as well. I think that's a good area to be in relative to software, for example.

Glen Davidson: [00:17:17] Interesting. A long time ago in your career you took an interest in oil tankers. You were probably the only person in Boston at Fidelity that did, and people wondered why. Now everybody's lined up to talk to you about oil tankers. Can you tell us your thesis on that?

Adam Kramer: [00:17:34] Oil tankers was the first industry that they gave me back in 2000 when I was an analyst. Back then the industry was very boom-bust. For anybody who's not familiar an oil tanker or product tanker carries oil or refined product from point A to point B. They collect the rates, they have their costs and that's your profits, very simplistic.

Glen Davidson: [00:17:56] If they can get to point A to point B.

Adam Kramer: [00:17:58] Exactly. This was a very boom-bust industry. I know all these management teams and for many years they were always doing the wrong thing at the wrong time, buying ships at the peak, taking on debt, et cetera, et cetera. Over the last five, six years these management teams have found religion with regards to capital allocation and they've actually paid down their debt to below scrap value, to the point where their free cash flow breakevens are below cycle trough. For a deep cyclical industry like this that's a huge benefit. Also what they did is they changed their dividend policy where they said that either 80 to 100% of their net income will get paid out in dividends. There's that potential to get a nice income stream that actually fits quite well into this fund. During periods of dislocation, geopolitical unrest, you were asking about that in the past, oil tankers have to move in different directions. They travel slower, they travel longer, it takes the [indecipherable] the system. These stocks usually act as a good downside protector.

[00:18:59] What got me really excited about the industry over the last couple of years, especially going into this year, was number one, around 13% of the world fleet is operating in the shadow fleets. These are the ships that we hear about on the news today that are operated by Iran, Russia and used to be Venezuela as well, that are very old in environmental liabilities. If there was peace in the world they wouldn't be able to get insurance and operate, they'd get scrapped. That's 13% potential supply that can get out of the system over time. Over the last nine months or so there's this big private company  in South Korea that's been buying ships in the market. They control maybe 20 to 25% of the ship days. That's very different from the fragmented nature of the market that we've had over the past decades. You have this real big tailwind.

[00:19:50] For me the ultimate bull case would be if there was peace in the world. If there's peace in world then that supply comes out and that's a boon for these rates. Ultimately, I think that the oil tankers, which are a big part of our fund, can work when there is demand destruction or when demand remains in place with regards to where the economy is. In other words, the inventory levels have really been dropping and they're going to have to be rebuilt. Countries who have had lower inventories are going to want to build those over many years, maybe even above where they were previously to have that extra buffer. That is going to be a secular tailwind as well. Many, many different things that can work in their favour and again, there's not that much good news priced into them.

Glen Davidson: [00:20:40] At some point oil is going to come back online. There's going to be flow again. Will that actually bring many tankers that have been kind of sidelined in as well? Because they've got to get the flow, they've got to get equilibrium back around the world. Will that actually bring more tankers online, if you will?

Adam Kramer: [00:20:58] If you place an order for a tanker today you don't get it for a number of years. There's good visibility on that front. I think the key thing is the amount of tankers that can leave the industry as well so it's a good offset. Countries are looking for oil and refined product. I've been looking at the trade rags at some of these routes, very, very long routes to build up inventory for refiners. There's a lot of interesting long routes taking place. It's going to take some time for this to play out.

Glen Davidson: [00:21:35] Makes sense. Let's talk about equities, let's talk about the allocation within the portfolio and how you work with Ramona Persaud as well, who we're going to hear from tomorrow.

Adam Kramer: [00:21:42] Ramona is great. She's a co-manager on this fund, and Ford O'Neill as well, and Rick Gandhi, of course, who I mentioned. The way I use my co- managers, we're always discussing where we're seeing value and income in our respective asset classes, but what are your best ideas as well? A lot of Ramona's best ideas are in this portfolio. Ford, Ramona, myself, and Rick, we all work together on other asset allocation strategies so we're meeting on this regular and consistent basis. What's great about Ramona is that she is such a great investor, looking where the dispersion opportunities are, very good downside protection and looking for other opportunities for upside. A lot of those top ideas coming to the fund.

[00:22:31] In terms of equities, we mentioned the oil tankers. I have a lot of the pharmaceutical companies that Ramona likes as well, some banks, too. We've always been historically underweight the largest names in the S&P 500 but one of the things I've done since March has been narrowing that underweight. It was good timing as well. There was a lot a bad news priced into the largest themes in the S&P 500. That's basically where we stand right now. We have a few small-caps. I like to sprinkle the portfolio with some small-caps that can really move.

Glen Davidson: [00:23:10] Can you talk about your focus on software companies?

Adam Kramer: [00:23:14] One of the great things about this fund is that we have the flexibility to go elsewhere. We've avoided a lot of the software companies both in the equity and in the credit markets. I'm lucky to have Rick Gandhi as a co-manager on this fund, who's really a software expert. He was our analyst in software, created a lot of value for us on the convertible bond side in years past. At this point we really think it's still a little too early still. We're looking  with kid gloves to look for those areas that might have too much bad news priced in but there's still lot of uncertainty [indecipherable] terminal value relative to artificial intelligence.

Glen Davidson: [00:23:55] I'd be remiss if I didn't ask about what you're the king of, convertible bonds, that's something that is cornerstone to this portfolio.

Adam Kramer: [00:24:06] My first convertible bond that I looked at and put a rating on it, buy or sell, internally for Fidelity for our group was the tanker industry. That goes back 24 years as well. I started to manage the convertible bond portfolio in the United States in 2016 and previously some other strategies in 2008 so I've been really involved in that market for 15 years. A convertible bond for anybody who doesn't know is a bond that pays an interest. You're promised to get paid back 100 cents on the dollar at the end. What's different is that you can actually participate with the stock. It's the only fixed income asset class where you can double, triple, quintuple, or as was the case with some Hall of Fame convertibles in the past, 10, 13, 14 times your money. This is our secret sauce. I've always used the convertible bonds as an offset to that underweight in equities. We've been overweight equity sensitivity but underweight equities through the convertible bonds.

[00:25:09] Convertible bonds are a great way to invest in growth companies that have some really good characteristics. We find our ideas from new issues. The convertible bond market today is the only fixed income asset class that's really still trading above mid-cycle. The last time I met with you it was trading below mid-cycle, now it's above mid-cycle. We can really find some interesting opportunities and they're always in different industries that we wouldn't have expected to come to market. There's space, in years past there were data centres, Bitcoin miners converting their model to business cycles, right now there's a lot of artificial intelligence in there and I'm just trying to find the best ideas in this portfolio and that's an area that we still like a lot.

Glen Davidson: [00:25:52] We've just talked about a number of buckets and we've talked about some tactical moves, why don't we sort of do an overview? I think we have a slide that will touch on tactical moves that you've made within the fund.

Adam Kramer: [00:26:04] This is our asset allocation. It's more of an output to what I've spoken about. You'll notice the bottom is the equity. We've sort of averaged in the 40s. What we toggle are all the asset classes in the middle, the convertibles, the preferreds, the high income, the emerging market, debt, loans, et cetera. Now, if you look at summer of '18, June of '18, and then you scroll all the way down to the far right where we are today, I would say the portfolio looks very similar to where we were in the summer of '18. In the summer of '18 we brought down all those credit asset classes, emerging market debt, bank loans, high yield bonds, and we increased our Treasury position, maintained our equity positions in the 40s. It's not that we thought something bad was gonna happen but we felt as if there wasn't enough recognition.

[00:27:00] At that time in 2018 we were just about to start the tariff war and the Federal Reserve was about to start to tighten. We didn't think those risks were priced into the market. We all know what happened in Q4 of '18, the market basically crashed. As you can see in 2018 up until '19 we started to add back all those asset class that we had sold off in the episodic opportunity. That's the thing. We are very good at coming in to mop the floor with our best ideas list. We like to be liquidity providers. That's the time to really buy credit. You can see we bumped up all those asset classes.

[00:27:40] Now, today, we're sort of in a similar position, probably around a quarter of the fund in T-bills. Our credit is the lowest it's been, even lower than it was in 2018. There are two differences. Number one, we own many more convertible bonds than we did in Q4 '18, because I'm seeing a lot of value there. We own some really interesting convertible bond ideas that could do well in different environments. We also own, you can see the little green area there, a lot more preferred stock which are the Bitcoin-backed preferreds. Those didn't even exist a year ago. That is the key difference. Our yield is still premium, we still have the underweight to equity but we have a lot more defensiveness in the portfolio and dry powder to wait for some opportunities to come our way.

Glen Davidson: [00:28:31] This slide is really illustrating active management. It also looks like stress on a page. Your calm demeanour is because you have such an amazing team that provides you with inputs that help make these decisions.

Adam Kramer: [00:28:43] We have a tremendous group called the Fidelity High Income and Alternatives Group. Almost two and a half dozen analysts in our group that are looking at the full spectrum of income oriented asset classes. They're looking for the sweet spot in the capital structure because many different parts of the capital structure get mispriced. They are coming to me and saying, these are my best ideas. I love it when an analyst comes and says, I think this is really mispriced, you have to put it into the portfolio, or I think you should hold on to this, it's undergoing a little bit of stress but you have to hold on it. It's the analysts that come up with some great ideas. My co-managers, Rick, Ford, Ramona, come up great ideas.

[00:29:24] I'm also an asset allocator in these other funds I was telling you about where there's 18 different asset sub-managers within Fidelity that I'm speaking to all the time. I can get our best ideas in emerging market debt, in REITs, in infrastructure stocks, in commodity equities, from these people that are on our team, that are part of this big synergistic process. That's sort of how we put together this portfolio brick by brick with white gloves.

Glen Davidson: [00:29:49] We just have a couple of minutes left but one of the areas I read that you were very interested in is tungsten. We should touch on that before we conclude. Tungsten, I know from light bulbs a long time ago but what's the idea around it?

Adam Kramer: [00:30:01] Tungsten, for anybody who doesn't know it's a W on the periodic table. It actually is the metal with the highest melting point. When it's mixed in with some other materials it actually has the hardness as strong as diamond. Tungsten is used in everything. It's in drill bits, it's in semiconductor fabrication equipment, it's in everything that you see, defence it's everywhere. What's interesting is that we were trying to find an alternative to gold and silver nine, ten months ago. I was doing some reading and I said, oh, wow, there's something that happened in January, I guess it was January 2025, there were export restrictions from China because 88% of the world's production comes from China, North Korea and Russia. That 12% that's in the Western world is only enough to meet the demand of the US. That means the rest of the world is in deficit.

[00:31:04] If you look it up, tungsten, what China has done is export restrictions that don't seem to be, at least for the time being, coming off. Is there an opportunity for a Western company to open a mine, many of which have been dormant, like you said, they used to be for light bulbs, and we are invested in a company that could help supply the Western world that took over a dormant mine that's in operations now. That's a good example of how we can pinpoint, find an idea, an original idea, get to know the company, the management team make it a good portion of the fund.

Glen Davidson: [00:31:42] Really interesting. You've taken us through a number of asset classes, not all of the asset classes, we'd need more time for that, but you've also shown through talking about something like tungsten that there's a lot of opportunities out there and you haven't exhausted the opportunities for Tactical High Income, and you do it with very low risk. Thank you, Adam Kramer. Very interesting as always.

Adam Kramer: [00:32:02] Thank you, Glen, appreciate it.