Jeff Klingelhofer, Aristotle Pacific

A smaller part of it. So I was employee number three on the taxable fixed income side and just really grew it from there. So ultimately became a portfolio manager on all their strategies and was head of investments for about the first last four or five years of my career and then decided that I wanted to get back home to Newport Beach, which is kind of where my family is and where I grew up in Southern California. So yeah, you're right. I've been with Aristotle here for the last couple of years. Just an incredible team, an incredible fit and alignment with my background of what we'll talk about, I'm sure, in relative value investing. Yeah, we're definitely going to get into that. But I always have to ask people before we talk business, any hobbies? What do you like to do

When you're outside of work? Well, I love the ocean. I'd like to say I'm a great surfer. I'm a horrible surfer, but I literally get angry if my feet don't touch the water or the sand at least a couple times a week. So that was a little bit tougher being in Santa Fe, New Mexico and Thornburg. So excited to be back. My real passion, I would say, is sailing. So I'm a sailor. I play tennis. Those are my two things. And then family as well just keeps me busy on the day-to-day. But yeah, swimming, sailing, tennis, those are the big things. Love it. So it's so funny. Every time I talk to somebody on... I'm over in Pittsburgh. Every time I talk to somebody who's in that Newport Beach,

California area, it's the same hobbies. It's like, I love the beach. And I'm over here, I got to grind six months through winter while you guys go sailing. Yeah. It comes with its own costs, right? And literally some of the cost side of things. And so I feel like there's no reason to be here if you're not going to connect with the water. And so I think you've just got a natural selection. A lot of folks just naturally would gravitate towards the beach, the ocean, being outdoors because you pay the price in terms of housing. So you kind of got to get out of the smaller house occasionally and just take advantage of what you got. Love it. So let's talk about Aristotle Funds. The firm has $16 billion across mutual fund

Lineup. And July 30th of this year, you guys launched your first three ETFs. So can you give us just a quick high level of Aristotle and what got the firm into the ETF wrapper now at this stage? Yeah. So Aristotle has been around for a decade and a half really at this point, or really two decades. And so the name changed a little bit ago, but it was prior known as Specific Asset Management. So it was under the guise of Pacific Life. So the team really has been together since about 2007 or even before, but it was incepted in 2007 for all intents and purposes. And eventually it made its way under the Aristotle Capital brand. So Pacific Life also started PIMCO, which is where I started. They've got a pretty good heritage of launching some pretty great firms.

But eventually, many of them do move on. And so there's been a long, rich history of really the philosophy of the firm, which is looking to capture relative value across the credit spectrum. And so our foray into ETFs, honestly, it's nothing magical, right? That the world has been moving towards the ETF side for quite some time. They're not new products, but we really wanted to be very thoughtful about how we rolled them out to our audience. And so a lot of it was just kind of waiting and watching what our clients wanted, how they consume them, how we thought that we could bring our unique flavor into that product. And so ultimately, we decided to launch with a suite of outcome-oriented products on our multi-sector fixed income suite. And so they really take all that same

Application. Now there are nuances, but really focusing on that relative value side. But there's nothing magical about why now or why the ETF wrapper beyond we want to meet our clients where they are. And we feel like this is a great foray and ability for us to take what we've been doing and just apply it in a slightly different wrapper to meet our clients in a nuanced way. Well, let's get into the funds. like I said, you launched three fixed income ETFs, ARCP, which is your core plus, ARMS, which is your multi-sector income, and SDUR, which is your short-term income fund. Start us off with the big picture. What does this suite give investors and why launch all three together? Yeah. Well, again, I think a lot of this is

Every firm has its own unique flavor, right? When clients are speaking with managers or doing due diligence, I think it's really incumbent on the manager to explain not just why they're going to return good performance. That's what everyone is after. But to me, it's much more about the how, right? What specifically are we trying to access? In what way? How is our team oriented? How do we train people? How do we compensate them and motivate them? And all trying to look at the world in a slightly nuanced way because there's lots of firms out there and there's lots of good firms out there and there's no one single way of being successful. And so really the way that I would talk about it is the multi-sector fixed income side, we can think about Aristotle in kind of two quasi-distinct arms.

Now, both of them access that relative value perspective. But when you do it within a single silo part of fixed income, just bank loans, for instance, just corporates, just securitized or CLOs, it's a little bit different in how you apply that relative value lens versus the multi-sector lens. And so all three of these products that Esther, ARCP and arms look a lot like many of the mutual funds that we've had in our multi-sector suite for quite some time. And really the crux of them is accessing what I will argue is a very inefficient market because of the way that many firms have what I believe to be an old construct of looking only at the individual silos within the context of multi-sector.

And so many firms are still set up to invest under a low tracking error, just benchmark-centric approach. And all of these products represent what I will talk about as being a suite of outcomes, right? And to me, that's what clients really should care about. They want a product to do something specific. They know when it's going to do well, they know when it may do less well, and that's okay because they know how it fits into the context of their portfolio. So really the way I would think about this suite of products is we have a little bit from left to right on the duration spectrum, how much interest rate exposure do you want, as well as up and down on the credit spectrum. How much risk are you willing to take in pursuit of a different outcome

And different return goals? So at the heart of all three of these funds is a relative value process, like a bottom-up credit research combined with top-down positioning. Can you walk us through what relative value actually means in a fixed income wrapper and how your team actually implements that? Yeah, it's something I'm passionate about. So I'll give an example here in a second, but let me first answer the question and then hopefully I can bring it to life and something that really matters, right? So to me, relative value is the world of fixed income is all about income. It's all about yield. And so you can think about a suite, right? In today's fixed income world, bonds can range anywhere from three and a half, four-ish type percent yields all the way to low to mid-teens, you know,

On the riskier side of things. And so if I want to access, let's just say 5%, just, it doesn't matter, pick a number, but 5%. I will argue that there are lots of ways to get 5% and there is the one with the lowest potential volatility, right? This is an asset class that is usually meant to be less interesting, just more day-to-day, a little bit more balanced to an investor's portfolio. And so the way I like to talk about it is much of the world of fixed income approaches it from a, how do I get a lot of additional yield, a lot of additional return, and be willing to accept just a little bit of additional risk along with that? And at the

Security level, I think that's the wrong approach. So relative value to me is almost the exact opposite. How do I get that yield target that I'm after and use the world of relative value to take potential volatility out from that actual investment? And the reason why I think that exists, and so now I'll come to an example, is because, again, the world likes to think about the broad array of fixed income as almost distinctly different asset classes, right? And so if you walk into many investment teams, what you will see is a distinct asset-backed desk, a distinct CLO desk, a distinct investment-grade corporate desk, a distinct high-yield corporate desk, a distinct bank loan desk, treasury desk, and on down the line. And every one of them is tasked with looking within

That realm to find good value. But the question becomes, who's looking across those individual desks? And so I think the world is just wrong in the sense that it tends to think about fundamentals and valuations as two separate parts of the investment structure. And so we try and keep those married throughout. Now, let me give you one example of how this really kind of came to play. So this is a very volatile time period, but it's just such a stark example that I love going to it. So if you think about February of 2020, COVID was all over the front page of the Wall Street Journal, New York Times. Everybody knew about COVID, but the world wasn't scared of COVID yet, right? The markets were doing just fine. And so in mid-February, you had American Airlines, which is a

Large global air carrier, right? Price a brand new five-year corporate high-yield bond at 3.7%. And so on that day, mid-February, the market said, issuer American Airlines, 10 or five years, 3.75%. That is the going rate for that amount of risk. And on that same day, you could go access American Airlines, five-year debt, 3.75% roughly in a slightly different form. And think about this as basically secured financing. So it trades more like an asset back. It's called a WTC, Enhanced Equalment Trust Certificate. I won't get too far into the weeds, but basically when you step on an airplane, there's a good chance that airline doesn't own the aircraft. What they do is they buy a bunch of aircraft, they put it in this special purpose vehicle off balance sheet. And so long as they make lease payments to that, they have the

Right to fly that aircraft. So February, market said, same issuer, same tenor, same yield, same risk, same thing. Well, fast forward to March. Now the world is afraid of COVID. And that corporate bond that priced just a month prior in February is now trading at 27 cents on the dollar. That WTC, still not a good investment, but it's trading at 65 cents on the dollar. And so all of a sudden, what the market said, same issuer, same tenor, same yield, same risk. One month later, they say, well, one is worth more than double what the other one is worth. And why? My argument would be because two different people sitting on two different desks, maybe at two different offices on two separate continents, looked at those in isolation.

And it wasn't that they missed that understanding of what each one had and what didn't. It was because generally, the top level portfolio manager, a CIO and investment committee, they just allocate capital to those individual silos. Maybe they said, we think corporates are more interesting. So here you go. And so really, the crux of it is, we try and keep that decision married throughout the investment process. And that takes place, maybe just to give one more example. And today, like data centers are all over the news, we all know they're borrowing, and they're issuing debt in asset backed form, CMBS form, investment grade corporate form, high yield corporate form, bank loans, private credit. They're very thoughtful about how they raise capital. But we on the investment side, I think,

As a broad industry haven't adapted to the way the world works today. And so that really is the crux of that relative value is finding ways to keep that yield at a similar level, but take out a lot of potential volatility for the various states of the market in future times. Well, let's get into like the funds specifically themselves and how this process can kind of apply to each one. So let's start with ARCP, which is your core plus income. This is designed to deliver excess return over core bonds with minimal added volatility. So what is core plus actually doing? And how does ARCP compete with names like, the ag or your former PIMCO core plus fund?

Well, so you bring up an interesting kind of point, kind of that active passive debate if it's just the ag. And of course, very much an active manager who's right up the street from us with the PIMCO side. And I'll talk about them a little bit differently, because I really do think that they serve a different place in investors portfolios. I think the ag is a very inexpensive product. And so the biggest benefit is you're not paying a manager to generate those returns. And what the ag is after, we have to always keep in mind, it's not after anything in particular, right? It's not after income, it's not after a certain interest rate exposure or quality exposure or anything. It's just a set of rules that define what the benchmark is. And then they're just trying to mimic that

Benchmark. And so its duration can move all over the place. And it's gone from four to six, right over the last decade, the quality component has come way down as the Treasury and Fed are buying treasuries or terming out debt or engaging in operation twists, things change. And so it's not after an outcome. But it's great if you just want a go to bond that looks like the ag and you accept that it doesn't have your end goals in mind along with it. So I think active manager has a place to play regardless, just because we are after an outcome. I am very cognizant of the difference between a duration of four and six and how quality shifts and relative value shifts. So that would be kind of the biggest thing. But the way I think about the ag is, or sorry,

Just core plus bonds and the ag included within that is, its outcome is meant to be kind of a teeter-totter of both things. Clients generally want an interesting level of income, an interesting level of total return. And they also want right along with that, ballast to their portfolio, right? It's meant to be a low volatility investment. Ideally, in many times, the value of it will actually go up as the value of equities go down in a recession, let's say. And so that's really what we're trying to accomplish with it. We're trying to say, all right, you have an ag in mind. We're trying to outperform that by 100 to 150 basis points throughout a cycle. We've delivered well more than that for other very similar products. And we don't think we have to give you a whole lot of

Additional volatility in order to achieve that outcome. And so that application of how we look at the world would be very different than the application of how PIMCO looks at the world. A lot of fixed income managers like to start from the top down. What's the Fed going to do? Are we going to be in a recession in 26 or 27? What might be happening with oil and the war and Russia, Ukraine and all of these things? And that's okay if you believe that they have a leg up on doing that and that's part of their process. But we're going to approach the world from a very different perspective, right? What are the individual companies doing? What are consumers telling us? And where can we

Access those individual balance sheets, whether they be a consumer balance sheet, a corporate balance sheet, a government balance sheet in a nuanced way to deliver that return, but hopefully with a lot less volatility than its yield might suggest. So taking a look at ARMS, which is the multi-sector, first quick question, biggest difference between core and multi-sector, just you can go more places? That's the biggest thing, right? So we start with core, which is kind of investment grade only. And then our core plus strategy, which is also very similar to many other, you start introducing the ability to buy in the high yield market, the below investment grade side, but not too much, right? You still want it to be just that ballast. When you move to the world of multi-sector,

ARMS, strategic type products, you really open up that box. And so the traditional multi-sector portfolio is 60% investment grade, 40% below investment grade, and that's very similar to our ARMS products. But what you get for that is instead of just beating the egg by 100 to 150 basis points throughout a cycle, now we're targeting 250 basis points, right? Two and a half percent. And so for clients that are saying, great, I've got my fixed income allocation, or maybe I don't need a core plus product in my portfolio. I want something more interesting, a higher level of yield and total return, but I still don't want the volatility of equities or private credit or private equity, right? That's kind of that next step out. So it's a different return target. And investors accepting

Also along with that a little bit higher volatility versus a core plus product. So just curious, like how much flexibility the team has there in terms of being able to go anywhere, or do you have to keep certain amount of exposures in certain parts of the market, like investment grade, high yield, or floating rate? Or is it just, hey, this is where our team sees opportunity. This is the direction we're going to go. Or does it stay like fairly diversified? It will always stay fairly diversified. But right along with that, there is a lot of flexibility to ourselves and many managers in how they can migrate all of those different asset classes. And so I'll go back to something I said earlier, I think it's really incumbent for

Right the end user or their advisors to make sure they understand where, how and why a manager might pull those individual levers. And so, in something like ARMS, we can have as little as 25% below investment grade, right? And we can have up to mid 60 type percent investment grade. And so we really want to be very cognizant of where and how we might pull that lever. Because in just a very broad brush, the world of high quality versus low quality, at times, you may be paid to take that lower quality risk. I would argue today, you're not being well paid. And so we don't want a whole lot of it. And so we are very much on the low end of that range. But I'll also go back, it's not just as nuanced,

Or I shouldn't even say, it's not even just as simple as saying, well, how much is investment grade, and how much is below investment grade. Because there might be time periods where agency mortgages look tremendously interesting versus corporates. And agency mortgages are backed by the government. So the default risk is de minimis to zero, we can debate that, but very, very low, right? You're getting a very different risk. I always talk about bonds as, we'd like to talk about them as distinct things and different wrappers and different terminology. But at the end of the day, how much cash am I going to get? When am I going to get it? And how likely am I to get it? So just timing, probability and quantity of cash flows. And all of a sudden, it's just a bond, right? It doesn't matter what wrapper

It is. And so that's how I really think about the world. And we at Aristotle think about the world from a multi sector lens. And so it's not just about investment grade or non investment grade, it's also CMBS or CLOs will have a very different risk return profile for the same rating versus corporates, for instance. And so it's really quite a flexible product in terms of following that relative value. But what I will say is we're very cognizant of the risk that we're taking on. And that's to me what a benchmark does serve is it's not a benchmark of returns per se, and it's absolutely not a benchmark of duration or asset class allocation. It's how much risk am I willing to take into the portfolio?

Because that's how I think an investor should think about a benchmark of you're giving a client or you're giving a manager the freedom and flexibility to go pursue an outcome. But they have to stay within a predefined level of risk in order to achieve that outcome. Because if I give you treasury like returns and equity like volatility, well, I've not done my job as a fixed income manager. So still a very keen eye on risk, but recognizing relative value ebbs and flows throughout the market and cycle. So let's talk about the third one, Esther, as you called it, the short term income ETF, which is obviously, you're more defensive short duration play. I guess my curiosity would lie of what's the case for actually using active management in short duration and these such

Defensive, hopefully low volatility securities. I would say it's the same thing, right? It's, it's recognizing that if you think about the world from a fixed income and just two broad levers, which is what most people would think about the world of fixed income in, you can pull an interest rate lever, you can bet on where the level of the Fed is going to move the level of the front end part of the curve, right? Two year treasuries versus 30 year treasuries. It's very much a topic that we're talking about right now, just given deficits and curve steepening, or you can pull a credit lever, you can say, well, I want to invest in very high quality companies or less quality companies. But the world is more nuanced than that. And we've covered some of that. But the way I would think

About short duration is, it's for a client that doesn't want that interest rate risk. And so the biggest benefit of interest rate risk is it tends to go in the opposite direction of credit risk. And we've emerged from a world where that has not been the case over the last three to five years. But we have to remember the starting point was, we started from a Fed that was pinned at zero because we were in a disinflationary environment. And today we're in an inflationary environment. So we won't go too far down that rabbit hole unless you want to. But the biggest benefit, I think, for a product like short duration is you're stripping out a lot of that potential interest rate exposure, which means you're stripping out a lot of that potential volatility. But you are still earning well in excess

Of what a low interest rate treasury would give you a low interest rate sensitive treasury would give you. So that product today is yielding about 5%, right, versus the front end of the treasury curve is well below that level. And most clients for a very safe investment would kind of be hard pressed to get much above four. Well, I actually do want to get into your macro read here in a second. But just curious, the active fixed income area and ETFs has been like one of the fastest growing segments of the ETF industry. So what is driving that shift? And how much runway do you think it still has? I think it's ETFs are easier to access. I think for many clients, they like that

If they just go on their brokerage account, once an ETF is up and running, it's really broadly available in most places, as where mutual funds are a little bit different, right? Mutual funds might be available on one platform and not another. And so the sales process right along with it is a little bit different. I will say the ETF wrapper itself has a lot of advantages. It has some disadvantages. But those advantages are much more applicable to the world of equity securities, where you truly do generate capital gains and capital losses. And it just has a different tax regime than a mutual fund would. And so as you start applying it to the world of fixed income, I think it gets very nuanced very quickly. To me, the biggest benefit is the ability to transact with in-kind securities. So I'm not

Having to buy something to sell something. It can just be a swap of cash for securities. And so again, it's a little bit more efficient. But I think the reason why we've seen such a big rise is because it's really caught on in the world of equities, where it really does have some truly tremendous disadvantages to the product itself. And then as clients have gotten comfortable with an ETF wrapper, they just want a lot of their other products to be in that wrapper as well. So I do want your macro read, right? Inflation still elevated, rates and yields are back in the news. Where do you see this? I'm not going to hold you to this. So don't worry. Where do you see rates going from here? And how's that shape and how you guys are

Positioned in all of your products? Yeah, well, whenever I kind of get that rates question, I always want to back up just a second and remind myself, this is really for myself, to remind myself that the world has changed. And it's changed tremendously. And it's because we as investors, for most people that are actively investing in their career today or saving as savers, most of us have existed in a world that is not normal. And that is a world where interest rates were artificially pinned very low and for good reason, because they were trying to increase demand. What central banks were trying to do in the context of price stability, of creating or keeping inflation in check was actually to push the level of inflation

Up towards their target of 2% is what most central banks say. And that's not the normal state of the world. But it's the normal state of the world for most of us and our financial history. And that world is now no longer the case, right? Today, inflation is too high, we're trying to pull it down, it's been too high for five plus years. And I think that sets up a very nuanced picture for answering the question of where interest rates are going to go, right? Today, we have an environment where inflation is too high, and it's been too high for too long, five years. And I think this Fed is much like we've transitioned from that world of low inflation to high inflation, the new Fed share is also doing the

Same thing, right? The old Fed share took over a world of low inflation, exited a world of high inflation, this Fed share, Warsh, has come in and all he has to contend with is a world of high inflation. And so I think the reaction function is likely to be very different. But importantly, we've also moved from this mentality of, well, high inflation is transitory, right? First, we had a COVID shock, who can blame the world for that, right? We had a supply chain disruption, then we had the reopening trade, then we had low interest rates and housing that moved into the prices of rent and all sorts of things. And now maybe we have an oil shock or memory shock because of AI. And this Fed share, I think, is correctly looking at the world and being like,

Well, if we have one shock after the other, eventually, it's not a shock. It's just the world that we live in. And I make a joke, right? Every year on December 31, I'm going to be more healthy. I'm going to go to the gym, and something changes in the world. My friend has a party or a birthday or something, and I eat dessert. And then, oh, it's really nice. And I don't want to go to the gym today. And eventually, it just becomes my state of affairs for the rest of the year. I'm not quite as healthy as I want. And so I think this Fed chair is much more willing to pull that interest rate lever because really what it translates to is we have too much demand chasing too few goods.

And it's hard. It's a tough pill to swallow, but we need less demand. And so I think the immediate direction of interest rates is higher from here. I do think this Fed will ultimately acquiesce and raise rates. But I think that's the medicine and the ultimate cure is that inflation comes down. And so over the medium term, I think interest rates are headed lower. And I think that that's a really tremendous opportunity in the world of fixed income today. So we are a little bit above duration. And the first question I get is, well, why are you above weight duration if you think interest rates are moving higher? And the biggest answer and reason that I believe that is because they're an excellent hedge to some of that credit exposure. And so interest rates are probably moving a little

Bit higher. But today we exist in a world where everyone is stretched. I think when we're talking, right, everyone on the other side of this, myself, everybody, we all feel that pinch of higher interest rates, higher gas prices, higher food prices, everything costs more. And so it doesn't take that much higher level of interest rates to see that demand function pull back. And in that world, you'd see credit spreads widen. So ultimately, I like the hedge of that. And really what I like is, again, what is the outcome that we're trying to achieve? A lower volatility instrument that clients can use in concert with equities and other things. So I really want to focus on that downside protection, because I do think interest rates are moving lower over time. And the direction is certainly down

From here. So, last question, million dollar question, you kind of briefly answered it was, you've got these three ETFs, how would you tell an advisor who's already got an existing diversified model portfolio? How would you recommend they kind of use them in their practice? Or where would you put them? Yeah, to me, again, the most important question is, what are you trying to do? And what do you have that's trying to do that? And so one of the things I really have loved about my investing career, and one of the things I really love about being here at Aristotle Pacific is, the way that we generate returns is almost certainly going to be very different than the way that many other folks are

Attempting to generate returns. And so if nothing else, it's very complimentary, right? Not all things work at all times. And I would say that about ourselves. And I would certainly say it about anybody else. But it's, you want a little bit of things that will zig when the other zags. And so I would say, really get to know the outcome that your manager is after or the outcomes that we are after, and how we're going to generate those returns, and then where it potentially pairs well. to give you maybe a more succinct answer, you brought up PIMCO, partly because it's my background. Generally, they're going to invest from the top down. And so again, that's fine. But we're going to do things very differently. And so I think we're a very good complement to some of those larger managers that

Take a much stronger macro view within their portfolios, and they will win and lose by that, we aren't going to win and lose by the macro view. And so if nothing else, it's a pretty interesting compliment to many of the larger players out there that really, just because of their size, have to take a broad macro view instead of individual credits. And are you being paid to take that risk? And then where on the relative value spectrum? Jeff, I really appreciate you taking some time with me today. Before I let you go, where can people learn more about Aristotle and your suite of three new ETFs? Yeah, absolutely. Welcome to visit our website, so aristotelpacific.com as well as aristotelfunds.com. We'll both have those resources. And then I try and post pretty regularly on LinkedIn. And so if

Folks want to follow me there, that's where you can find me for some of those macro insights. Again, Jeff, thanks again for hanging out with me. Yeah, absolutely. Great conversation. Thank you. Thank you.