VISION 2026: Income in action: Turning yield into opportunity - Adam Kramer, Scott Mensi

Glen Davidson: [00:00:01] Hi, everyone. Adam, Scott, great to be up here with you again. 

Adam Kramer: [00:00:04] Great to be here again.

Scott Mensi: [00:00:06] Same.

Glen Davidson: [00:00:06] I think last we did this was May. What's amazing about Tactical High Income fund is we could do this every day because you're changing the portfolio with an extreme active eye because of the vast number of asset classes that you have and the markets that we're faced with. We're going to get into that today. I think it's important that everybody's reminded this is a 5-star fund, it has been one of the best-selling balanced funds over the last several years and it's run with a keen eye on risk protection which I think is very important for everybody to hear about. Adam, why don't we start with you? If you could give a quick background on Tactical High Income and then we'll get into all the changes within the asset classes.

Adam Kramer: [00:00:42] Glen, glad to be back here. Nice to see everybody again. This fund is an income solution. It's a flexible mandate to invest across the full spectrum of income-oriented asset classes from stocks on one end, dividend-paying stocks anywhere in the world, to investment grade bonds and everything in the middle. It's that everything in middle that really matters the most because most of the time, if you go back decades, it's something other than stocks and investment grade bonds that's the best-performing asset class in any given year, whether it be convertible bonds, high yield bonds, preferred stock, emerging market debt. We're looking for those opportunities. We want to be an alternative to a traditional 50/50 balanced fund, an alternative to a 60/40 fund, 40/60 fund, but it's a set it and forget it total return compounder, tax efficient, less reversion to the mean of total return, where income is actually half of the return if you go back over the life of the funds.

Glen Davidson: [00:01:31] What we'll illustrate today is the vast number of people that are inputs for you in the development and the structure and the running of this portfolio as well. Scott, hold tight. Adam, I'd love to ask you about investment grade. Why don't we start there? I know you've had a keen eye on the 30-year in the past, is that still factoring into the portfolio today?

Adam Kramer: [00:01:48] We want to wiggle around the traditional 50% S&P 500 profile, 50% US investment grade bond profile. In the US that would be around three-year duration investment grade. Our rule of thumb with my co-manager, Ford O'Neil, we use a lot of his rules of thumb with fixed income, whenever spreads are very tight in investment grade, which they are right now. I think they're in the top decile. You really just want to out that 50%, three-year duration with as little capital as possible. We're doing so with the 25-year Treasury which you see in the top 10 holdings. We've had it there for quite some time. It does a good job of tracking 50% of the investment-grade bond index but, really, it's there for downside protection. In a worst-case scenario where there really is a true liquidity-driven sell-off we feel that the 30-year Treasury, 25-year Treasury, the long end of the curve will get the asset class and act as a downside dampener. That's basically what we have. We really don't own any investment grade bonds anymore. We're waiting and watching but with spreads where they are right now relative to the amount of duration risk you're taking on you're really just taking on interest rate risk and the risk of the economy getting weaker so we're finding opportunities elsewhere.

Glen Davidson: [00:03:00] And elsewhere may have been high-yield bonds, Scott, in the past but that's been reduced, I believe, in the portfolio.

Scott Mensi: [00:03:06] Definitely. We've talked a lot, Glen, over the last 12, 18, 24 months and there was a period of time back in April where we had a quick chance to buy some high yield bonds. We had spreads widen out a little bit but credit spreads have been pretty tight, basically, throughout all of 2025. When we look around we have reduced exposure because spreads tighten in. We always try to find that good balance of income relative to the amount of duration and credit risk we're taking on. We have brought it down but even when we aggregate it up we're still ... one of the great things about this portfolio is that we're not allocating to different managers, we're buying the individual securities. We can still find a basket of high yield bonds that we can get 8% yields, two, three-year duration. That's a pretty good matching. We're still able to find some things there but we're also exploring other areas of the market that I think a lot of other shops out there just don't have the resources to do. That's been an interesting area for us.

Glen Davidson: [00:04:07] I'll stick with you, Scott, collateralized loan obligations. Tough to say but that's a smaller portion of the portfolio but still an active area for your fund.

Scott Mensi: [00:04:16] Oh, definitely. When we look at high yield people think of sub- investment grade debt, corporate debt, they think of high yield bonds, but there's leveraged loans, we have an allocation there as well. Leveraged loans are floating rate debt issued by a lot of the same companies as high yield bonds. They're senior in the capital structure. With the way the interest rates are and the way the markets have been moving they actually offer a higher yield. They've been an interesting investment opportunity for us. There's another part of the leveraged loan market,  70%, roughly, of all leveraged loans are owned by collateralized loan obligations. This is, basically, when a manager buys up a pool of loans and then turns it into a structured product. That means they take that pool of loan and they sell different tranches of rated debt against it. Those ratings can be triple-A all the way down to single-B. There's an equity tranche involved in there. We've got the expertise in our team, we actually issue CLOs out of our group and then we also are investing in third party CLOs. We have an analyst that's dedicated to just looking at the CLO market and what we find is that when we look at CLOs that have actually higher credit ratings than some of the underlying loans we're getting 100 basis points more in yield. This is an opportunity for us to [add?] a small piece of the portfolio but find a security, higher credit rating, better yield, makes a lot of sense for what we're trying to do in the fund.

Glen Davidson: [00:05:40] Thank you. Adam, Tactical High Income has been, if I recall correctly, light as far as preferred shares in the past. That's not necessarily the case today.

Adam Kramer: [00:05:49] Yeah, so just to give a little background, I manage with a co-manager, Rick Gandhi, the preferred share portfolios of Fidelity. We're looking at all the preferreds out there.

Glen Davidson: [00:05:58] In the United States.

Adam Kramer: [00:05:59] In the Unites States. We look at Canada as well, we've had Canadian preferreds as well. In the United states it's mostly US banks, investment grade banks, utilities and REITs but there's a high duration. Right now you're getting a decent yield but if, let's call it, a mid-single digit yield versus seven-year duration it's not the best matching. Spreads are tight but they are attractive relative to investment grade. One of the things we're looking at right now is where can we get something that's 10%. In our case there's a preferred share in the top 10 that you could look at. It's a company called Strategy. Basically, you're getting paid 10% pre-tax, return on a capital dividends, tax deferred, there's a very wide spread. If it was an investment grade bond that had back in collateral it would trade at a tighter spread. It's backed by Bitcoin maybe five or six times so there's a lot of bad news priced in. That's a way to beat the preferred market in our opinion. That's where we're sort of focusing on security selection.

Glen Davidson: [00:06:59] Right now you have the preferred issues from Strategy, which used to be MicroStrategy. Scott, I thought that used to be the convertibles that you had with Strategy. Did that change, that converted, I suppose.

Scott Mensi: [00:07:10] Well, it definitely changed. One of the great things about where we sit in Boston, I've been a part of the High Income and Alternatives Group at Fidelity coming on 15 years. In a couple of weeks I've have been in that team for 15 years. One of the great things of our group is we've got a dedicated group of analysts that look at the full capital structure of a company. Companies can issue bonds, loans, convertibles, preferreds, and common equity. What our analysts are always trying to do is try to find the sweet spot within the capital structure. Where is the best risk- return based on our view of the company and where the valuations are? For a while we felt that the convertible bonds were the sweet spot. What's happened is, and it was over the summer, we saw the valuation of Bitcoin, obviously, move higher. These convertibles had become very sensitive to the underlying equity. Remember, convertibles have sensitivity to the equity, as the equity moves higher the convertible bonds start to act like the equity a little bit more.

[00:08:06] We had a great discussion with our CIO back in Boston. He said, this maybe is getting too much risk into the portfolio. We said, look, we like the company, what they're doing, here's a new security that they've issued, 10% yield, minimum exposure to the underlying stock which is driven very much by the price of Bitcoin, here's a great way for us to continue investing in a company we like but doing it in a lower risk manner with a different return profile. That's a way that we can alter the risk profile of our portfolio of a position by looking at the different pieces of the capital structure. That was a great opportunity for us to say, okay, let's take down the equity risk that's associated with Strategy. Let's focus on the yield opportunity, the collateral which is the Bitcoin, and get a really interesting 10% type yield which we can't find in the preferred market. It's really hard to find even in the triple-C and below rated part of the stressed or distressed part of the high yield markets.

Adam Kramer: [00:09:02] You can't find that type of yield even in the distressed market pre-tax, you'd have to be in the high teens on the coupon.

Glen Davidson: [00:09:08] Sticking with convertibles, Scott, Adam won't admit this but he's considered the king of convertibles. Is that still the case?

Scott Mensi: [00:09:17] Yes, I would say so. When you look at our fund, one of the things we always say is the convertibles are the secret sauce of our portfolio. They allow us to toggle equity risk in the strategy without having to buy equity. It's a great tool. Adam, along with his co-manager, Rick, on the Convertible Bond Fund, they've done a great job there. When we look in the convertible bond market there's always these new emerging themes. Last year it was a lot about companies that used to mine Bitcoin turning their business models into data centres. That was a great win for us.

[00:09:48] Now there's all these other things that are happening in the market. We've got a company called Rocket Lab which competes with SpaceX. We've got batteries, a lot of different types of themes. We never know what's coming, which is the great part. What a great way to get exposure to some of these themes who tended to be in mid and small-cap stocks without having to own the stock, because with a convertible bond it's a bond so if you're doing your credit work right and you know the company is going to pay you back your downside is somewhat limited. But if the company does really well you get to participate in the upside. Again, what a great way to participate in some of these stories without having to own the most volatile part of the capital structure which is the equity.

Glen Davidson: [00:10:28] Adam, it is the secret sauce of the portfolio. Take us through how you became the king of convertibles and then where you see that space today.

Adam Kramer: [00:10:36] Well, it's very nice of you to say that. I do go back a long way with the convertible market. My first convertible bond was as an analyst in the High Income and Alternatives Group. We have a lot of people from our group watching today, probably. We have close to two and a half dozen analysts that are looking for that sweet spot in the capital structure. In my case I looked at my first convertible bond in 2001, it turned out to be an oil tanker company. That's where I actually got to know that industry as well. One of our top 10 holdings started as a convertible bond and we held on to the equity in that case. I started as an analyst in 2000, covered around 14 different industries for the first eight years and started managing convertible bond portfolios in 2008, so 17, 18 years right now. That's how I really sort of realized the power of these convertible bonds.

Glen Davidson: [00:11:27] You mentioned oil tankers. I think it was in the spring we talked up here and you talked about oil tanker but people in the audience were saying oil tankers, whatever. You've been covering oil tankers for a long time. In fact, that's a specialty of yours as well at Fidelity. It's much more topical today. You've even talked about the shadow fleet. Take us through oil tanker where you stand today.

Adam Kramer: [00:11:47] Very timely. We spoke about it last time and a lot of the thesis is playing out real-time right now. Oil tankers, basically, are boats that transport oil or gas from point A to point B and it's driven by how much oil goes onto the waters. It's driven by OPEC production but it's also driven by supply of the ships as well. Around 17% of the world fleet, maybe it's a little less than that, has been operating in this, call it, shadow fleet for Iran, Venezuela and Russia. What we're seeing right now with case in point Venezuela, as sanctions get lifted those vessels can't find insurance. They have nowhere to go. They get replaced with the compliant fleet that the oil majors use, publicly traded companies that we have in our fund.

Glen Davidson: [00:12:27] Which you've been investing in.

Adam Kramer: [00:12:28] We've been invested in, we have two in the top 10. They get replaced, they get more business. I was always saying that these oil tankers do very well as a geopolitical hedge in this portfolio in down times when trade routes get disrupted. The ultimate secular story for this would be if there's peace because of that supply that comes out. We're starting to see that play out right now. A lot of these companies in the industry are getting rates that are four or five times their free cash flow breakeven costs and they pay it 100% to their net income, 80 to 100% of the net income in dividends. That's why it really fits into this portfolio.

Glen Davidson: [00:13:04] Very, very interesting. Special situations are very interesting as well. Scott, could you tell us about those?

Scott Mensi: [00:13:10] Sure. Within our team, and Adam talked a little bit about it, we have these credit analysts, 25 credit analysts. It sometimes toggles a little bit more and a little bit less than that but around 25. But also helping out our analysts and helping out our portfolio management team we have our special situations group. This is a group of analysts who are attorneys by training and their job is to help us in situations where we can be liquidity providers, where there's something wrong with the company or they have a maturity coming due and they need a bridge to get them across to the next project or just to cross the finish line to where they need to be next. What this team will do is they'll go out there and engage with the management teams, talk with them, get to understand what their goals are, what they need from a capital perspective, and then talk with our portfolio management team and say, okay, here's what I'm hearing, where are you willing to invest, what's the right price, what's the right structure? Then we can be that liquidity provider and help that company move along.

[00:14:12] There's been a couple opportunities recently. We talked a little bit about high yield bonds already where we've actually been involved in special situations within the high yield bond market. There's a company that we've had in the portfolio called EchoStar. You might know them as a satellite TV provider. That's a business that's in secular decline. We followed this company, it's been in the high yield market longer than I've been at Fidelity so we've been following it for a long time. One of our coportfolio managers on another strategy, Brian Chang, actually covered it many, many years ago. Essentially, the value of that company is not the dish, the satellite TV, it's the spectrum, the wireless spectrum that they own. We've always liked it and for a while we owned a convertible bond that was issued by that company but it was not secured by the spectrum itself but we knew there was value there. This convertible, and the company had an issue with the maturity coming due, our special situation group reaches out to that company and says, hey, look, we like the value of this asset, we want to help you get through this process, what can we do to provide you that liquidity?

[00:15:21] What we were able to do is take that convertible bond, we were able get a new convertible bond issued to help refinance that existing one. The strike price was lowered so that means it lowers the risk for the specific bond. It's also now secured by that wireless spectrum. What we did through that process is we decreased the risk of the convertible, got seniority in the capital structure because this is now senior, and then we also got collateral based on the spectrum that we've always loved in that capital structure. Lo and behold, there's been some pressure in the US from regulators for them to do something with that spectrum. You've seen them sell it to AT&T and most recently to SpaceX. That's a way that we can do something that's very different, be the liquidity provider, use the resources we have at Fidelity to get what is a very unique convertible bond in the portfolio that the rest of the market really doesn't have access to.

Glen Davidson: [00:16:18] You've got a great partner in Nate Van Duzer from that group as well. Can you talk a little bit about him?

Scott Mensi: [00:16:22] Nate's a great guy. He helps with our Distressed Opportunities Fund it used to be called, Credit Opportunities Fund now. He's working closely there in distressed situations and defaults. What I would say is that ... you can search his name online, there was an article many, many years ago, not many years, a handful of years ago, about him and the negotiations he did with some governments in South America to help restructure that debt. This guy is no nonsense. He went to the Military Academy in the US. He knows everybody in this industry and it's a great resource, unique resource that we have. You put him together along with the other folks that are with the group and you've got over half a century of experience in this restructuring special situations world. It's great resource that we can add into the portfolio.

Glen Davidson: [00:17:13] Another great partner. We've just got a few minutes left so I've got to come to Canada. You've come up from Boston but you have to talk to us about Canada. Let's go to Alberta.

Adam Kramer: [00:17:19] We look for opportunities everywhere in the world. In the top 10 we've had an Alberta utility company. We always had coverage in the US of the utility companies, they did very well as they signed deals with the electricity for data centres for the hyperscalers. Alberta was sort of left behind with regards to the valuation. There's a lot of vital capacity. That's an area for us to invest in Canada, get some Canadian currency exposure but also buy a utility company, or unregulated utility company at a discount to the US, a lower volatile way to invest in the AI theme. We like to sprinkle the portfolio with a lot of 25 basis points small-cap positions, some of which are in Canada. I remember just sitting in Montreal in a lady retailer store with my daughter buying a dress and we found an idea that way. Turned out to be one of the best parts of the portfolio. We do like to find these real areas of mispricing. So much of that, so much to the bond market, fears about the economy, inflation, the bond market, they go into mid-cap and small-cap stocks so we like those as well.

Glen Davidson: [00:18:25] Sitting in a retailer with your daughter and getting a great idea reminds me of a Peter Lynch story, but that's for another time. It's wonderful. Emerging markets debt, very quickly.

Adam Kramer: [00:18:34] Very quickly, in the top 10 we have a one-year bond from from Brazil, it's in local currency. The yields are very, very high there in Brazil so this is a 10% local currency yield that's trading a little bit below par. We're going to get par back in a year. It's a lower risk way for us to invest in the currency there which is really going to be driven by what happens with the fiscal outlook, that's going to be driven by the election that's going to happen in October. That's an interesting way to collect the coupon, get paid to wait for something possibly that could help the currency over there. This is the type of opportunities we look for.

Glen Davidson: [00:19:11] Beautiful. You've got an award-winning fund, run like a balanced fund but with so many inputs, it's incredible but also extremely active so we should do this again tomorrow and talk about where you're at. We've got a 20-minute break. Adam, Scott, thank you so much for being here.