Back in the mid-2000s, John Carswell, the founder, CEO and Chief Investment Officer of leading Canadian institutional investment management firm Canso Investment Counsel Ltd., ruffled a few feathers when he began warning about the risks building up in financial markets.
“We’ve believed for a couple years that there has been a securitization mania going on and that the separation of credit analysis from credit origination was a very dangerous thing,” he said in a June 2008 profile in The Analyst, a magazine published by the CFA Society of Toronto. “The breakdown in securitization … means that banks are going to see a lot of assets coming onto their balance sheets.”
The rest, as they say, is history. In September 2008, just months after that interview’s publication, venerable Wall Street investment bank Lehman Bros., saddled with hundreds of billions of dollars in toxic subprime mortgage debt, declared bankruptcy after more than 150 years in business. It was the largest bankruptcy filing in U.S. history and the climax of the Great Financial Crisis. In financial markets, liquidity dried up and stocks and bonds plummeted. Only with extraordinary government intervention, such as the U.S. Troubled Asset Relief Program (TARP), which bailed out financial institutions by buying more than US$400 billion in bad debt, did confidence slowly return.
Carswell’s 2008 analysis of the underpinnings of the sub-prime crisis is still cogent today. He put much of the blame for it on credit rating agencies and their over-reliance on long-term historical data, ignoring the periodicity inherent in market movements. On top of that, “there was no link between who was doing the credit analysis and who was accepting the credit risk,” he told The Analyst. “Short-term statistics were being used for new vehicles like sub-prime mortgages that were based on spreadsheet estimations of capital loss. They then converted these quantitative results to the rating agency’s rating scale, based on history—with no real connection to the characteristics of these new vehicles.”
In a more recent interview with The Analyst, published 16 years to the month after the 2008 article, Carswell recalls how, early in his career when he was a partner at a Toronto investment firm, his idea of focusing on corporate bonds was met with a lot of skepticism. “It seems strange now, in these days of credit fund mania, but when I pitched starting a pure corporate bond credit mandate to my partners, they didn’t think our clients would want it,” he said. “I started Canso in 1997 to do just that, since I believed so much in credit as a specialty area. I think I won the argument.”
Over the past 27 years, Canso has grown to one of the most significant institutional investment managers in the country, with $47 billion in assets under management. It has got there in large part by following Carswell’s commitment to in-depth research and specialized knowledge of credit. “Success comes down to understanding fundamentals,” he said in 2008. “Day in, day out, my partners and I conduct bottom-up bond analysis.” That gives Canso the assurance “to invest in things others think are risky,” he told The Analyst this year. “We don’t silo our portfolios; instead, we invest across the spectrum in AAA to D [Defaulted] issues.”
Yet there’s another key element in Canso’s success: the willingness to take contrarian positions when the evidence supports doing so. Part of that willingness is opportunistic. Carswell clearly sees the potential of “buying when people [are] selling in fear and selling into strength in a hot market,” as he put it to The Analyst recently. But that takes courage, as well. “Bravery,” said Carswell in 2008, “is doing the right thing and practicing your craft, no matter whether it’s fashionable or popular, and to keep on doing it.”
One of his current points of departure from industry consensus concerns private debt. The asset class has boomed as investors chase alpha, and private credit funds have rapidly gained popularity even among retail investors. But Carswell questions whether either the firms peddling private debt funds or their investors truly understand the risks—or are being adequately compensated for those risks. “We have been a large investor in private bond issues for many years,” he said in this year’s interview, “but only when they’re cheap compared to public equivalents or offer us protections that we can’t get in public issues.”
Now, the bond market widely expects central banks to reverse the course of rate tightening they started two years ago. But Carswell said that there is still “more money out there than people understand.” As the Canso team has pointed out in their recent Corporate Bond Newsletter and Market Observer quarterlies, generous wage settlements and the risk-on environment in financial markets suggest that there is still plenty of money in the system, as does Canso’s tracking of money supply in Canada and the United States. In short, central banks might still have a long way to go in their mission to destroy demand and contain rising prices, and “there could be higher inflation than the two per cent the bond market expects” for quite some time.
Carswell said that his “investment blessing, which is also a burden, is that I think differently than the consensus.” Of course, it’s too early to tell if his viewpoint in 2024 will prove as spot-on as his concerns in 2008. But contrarian thinking has certainly served Canso well over the past three decades. And given that Carswell has been so often right when others thought he was wrong, it might make sense for investors to pay attention.
This story was created by Canadian Family Offices’ commercial content division on behalf of Canso Investment Counsel Ltd., which is a member and content provider of this publication.