Q: How has Guggenheim’s fixed income fund team evolved?

We have both been with Guggenheim for a number of years, James for 8, starting as a credit analyst before moving into trading, and Anne for almost 10. Guggenheim launched its very first closed-end fund, a fixed income 40 Act Fund, in 2007, and the last one before the financial crisis really hit, in late 2007. 

Between 2009 and 2010 Guggenheim purchased some fund complexes, Claymore and Rydex, from which it grew its distribution, but that did not include assuming any fixed income fund teams or management. Virtually all of our fixed-income growth has been organic, stemming from the original team formed back in 2000. 

In 2011, we launched three funds which are a part of our $154 billion of fixed-income assets under management. Many original team members from the founding of the investment management division are still with the firm, and our investment philosophy and thought process remain the same under the continued leadership of Scott Minerd, our Global Chief Investment Officer. 

Q: What range of strategies do you employ in taxable fixed income fund management?

James runs three different strategies covering multiple categories in the taxable mutual fund space – Short (Guggenheim Limited Duration Fund) Core Plus (Guggenheim Total Return Bond Fund and Guggenheim Total Return Bond ETF) and Multi-Asset (Guggenheim Macro Opportunities Fund). Each strategy has substantial allocations to the structured finance asset class, particularly ABS (asset-backed securities), including CLOs (collateralized loan obligations).

Enhanced short and limited durations feature in two funds – Guggenheim Enhanced Short Duration ETF (GSY) and Guggenheim Limited Duration Fund. GSY targets about a quarter-year duration. Our Limited Duration Fund has about a one-year duration, or half its benchmark, the Bloomberg Barclays Aggregate 1-3 Year Index. Our Total Return Bond Fund and Total Return Bond ETF (GTO) have longer durations than the previous two funds as they are benchmarked to the Bloomberg Barclays U.S. Aggregate Bond Index. Our Macro Opportunities Fund is our unconstrained bond fund and absolute return strategy that invests in our highest conviction ideas and maintains a low absolute interest-rate duration. 

Depending on the fund or strategy, the credit risk and interest rate risk varies. Each fund has unique target sector weightings, average credit quality, position sizing and spread and interest rate duration targets. These targets change as the firm’s macro views change and as the relative value and attractiveness of fixed-income sectors evolve. It provides retail investors a complete family of fixed-income funds and access to our institutional asset management style. 

One thing that separates us from our peers is how the very same portfolio management team that manages our pension plan and other institutional clients also manages our retail funds, giving the retail investor the same management team, knowledge, and process our institutions benefit from. That’s rare. 

Q: How would you describe your investment philosophy?

Our investment philosophy is grounded in behavioral finance, stemming from the Economics Nobel prize-winning work of psychologist Dr. Daniel Kahneman on loss aversion by investors. 

Simply put, he determined that investors value avoiding loss above gains, above outperformance. This loss aversion focus works particularly well in fixed income, where avoiding loss is integral to long-term and positive returns. In addition, part of the philosophy also involves removing emotional decision making from investing. As such, we have separated the investment process into four unique and distinct teams.

Q: What drives your investment process?

We view fixed-income markets as inefficient. The credit and bonds available in the U.S. fixed-income markets make up about $37 trillion. Less than half of that is reflected in the Bloomberg Barclays U.S. Aggregate Index, the industry’s benchmark. We prefer a broader set of choices, particularly because indices rarely lead to superior risk-adjusted returns. 

We have a buy-to-own investment approach versus a buy-to-hold, and do extensive research up front prior to purchasing investments. We also believe that consistent investment income over time generates excess returns, so, to our minds, the best way to make money in fixed income is to collect more investment income over time, relatively speaking, and avoid losses. 

Q: How do you organize your research and portfolio management teams?

We have offices in Santa Monica, California; Chicago; and New York; and one in Dublin, Ireland, for our European credit team. Our corporate credit group is in New York, and our other teams, including the macroeconomic team, are in Santa Monica. Guggenheim’s portfolio managers are more geographically diverse across the country, but the taxable mutual fund managers are headquartered in Santa Monica, under James’s leadership. 

Many asset management firms have a single portfolio manager who does everything—those managers gauge which direction interest rates are headed, predict Fed policy and Gross Domestic Product. They talk to Wall Street analysts. They do their own securities research. They trade directly with the broker dealers. They talk to clients and do portfolio and risk management analyses. 

We have deconstructed that because it is not a scalable model. Instead of one person doing everything, we have four individual teams working together. Each team is evaluated on separate criteria. 

Our macro research team of economists is charged with forward-looking analysis and expectation of Fed policy, GDP, macroeconomic views and events, and so on. Our sector teams are broken up by sector type: ABSs (asset-backed securities), CMBSs (commercial mortgaged-backed securities), corporate credit, municipals, etc. Each team specializes in one area of expertise. They talk to Wall Street and handle the trading and research within their respective specialties. These teams are evaluated solely on credit performance. 

In addition to the macro research and sector teams, we have our portfolio construction group and portfolio management team that sit in the middle, working hand in hand with the other groups. The portfolio construction group coalesces the information from the other teams into model allocations and risk management analysis. The portfolio management team is ultimately charged with synthesizing the macro views and the bottom-up ideas from the sector teams into actionable portfolio allocations. The team assembles portfolios aligned to the model allocations set by the portfolio construction group. The portfolio management team is evaluated solely on performance and aligning portfolio allocations with the investment object and risk constraints of a given fund. 

In this way, our clients, whether institutional or retail, benefit from the same resources, the identical expertise, something they would not get from most other firms. 

Q: How does your research process integrate sector- and macro-level developments?

The portfolio managers are ultimately responsible for portfolio performance. We maintain a high degree of communication among the four teams: they all meet every two weeks, by phone or video conferencing, to formally discuss both the individual macroeconomic view and the various sector team views. 

We distribute a deck of sector team and macro view information to all attendees at this bi-weekly meeting. Afterward, our portfolio construction group distills the information into an outlook, which is disseminated to those portfolio managers charged with implementation.

To ensure everyone is on the same page and that there is a feedback loop at the end of every quarter we hold performance review meetings. At these meetings portfolio management presents how well execution occurred in line with our outlook and target positioning. This meeting is run by both the Chief Risk Officer and the CIOs. We want our teams to be consistent in performance and positioning portfolios. 

On a smaller scale, on a daily and weekly basis, our macroeconomic and sector teams meet internally to do research and discuss individual credits. Each sector team has its own investment committee to review individual credits and parse the trends or elements happening in the markets at that time. 

Q: How does this structure work to benefit your investors?

We believe this knowledge dissemination ultimately helps long-term performance. To do so, the process needs to be repeatable, predictable, and consistent. This way we can put together a proper portfolio, one with the right sector allocation and right risk limits, and set with the portfolio management and portfolio construction teams and risk management. By managing to internal risk limits and variable sector allocations, we can freely allocate capital among the various fixed income sectors. 

For example, some credits make more sense for limited-duration strategies or a strategy like Total Return Bond, which benchmarks against the Bloomberg Barclays Aggregate, versus a non-traditional bond fund designed to take increased credit risk. The sector portfolio management team tends to find the best ideas within their sectors on a daily basis. Accordingly, portfolio allocations rarely change suddenly and turnover is often organic. 

The portfolio management teams have certain risk parameters. An example is our target below investment-grade corporate credit allocation. At this time we have a target range in our GIBIX fund of 5-10%, but historically this range has extended up to 20%. The portfolio management team has the flexibility to allocate within the defined range. The range and ultimate allocation is a function of market technicals, relative attractiveness and ultimately our view on the economy and corporate default cycle. While we are benchmark aware, given where spreads are and the macro economic forecast, it is the portfolio managers who decide whether to put approved credit within the sleeve or allocate capital elsewhere. 

Q: How do you construct portfolios across the different strategies in the fixed-income space?

Again, we look for opportunities that lie outside the benchmarks. And while we remain aware and respectful of rating agency ratings, we do not rely on them—we prefer to do our own credit work, and in some cases we look to invest in unrated but creditworthy securities. 

Fixed income has four levers to generate returns. The two traditional ones are duration and credit. Longer duration with an upward-sloping yield curve gives more yield, while lowering credit generates a higher credit spread. The other two tend to sit under most radar but are where, over cycles, we think we can outperform peer groups or benchmarks, with less volatility. They are structure and liquidity. We term these last two levers as the “information premium”. 

In terms of structure, we believe the fixed income markets are inefficient. Equities are priced instantaneously versus bonds, which you can trade in some cases through electronic platforms. Some are registered with the SEC, the Securities Exchange Commission. Some securities are either trace eligible or not. Many of the securities we are buying are issued in the institutional debt markets, known as the 144 (a) market, which is open to qualified institutional buyers and accredited investors. The key is figuring out, within all these securities, and within an issuer, where there are many different parts within the structure, where to invest. 

Q: Can you provide an example?

Back in 2014, in our Total Return Bond strategy, we had a much higher allocation to the preferred debt of a lot of U.S. banks. While admittedly a subordinated position, given the spread and the current economic cycle we were paid enough credit spread premium to invest on the preferred level versus the senior unsecured level, which might be found in the benchmark. 

In corporate credit you might traditionally hear of a tradeoff between seniority of bank loans and high yield bonds. Even more so, in the structured credit space, whether you are talking about MBS (mortgage-backed securities), CMBS (commercial mortgage-backed securities), or ABS, the securitization rules govern investor priority to cash flow. In different environments and different scenarios, different parts of the structure will perform differently, and may claim more—or less—of the cash or assets within the securitization. 

Accordingly, an AA-rated collateralized loan obligation, or CLO, may make more sense for a total return bond or short duration strategy because it is a floating-rate security with a cash-pay yield versus a single A CLO tranche. The single A CLO-rated tranche may make more sense for an unconstrained bond fund since you get a decent yield pickup but still solid credit quality. Occasionally spread dependent, we may buy BBB-rated CLOs, which represent more mezzanine risk and exhibits more volatility prices and correlation to underlying loan spreads and prices. All three are investment-grade securities but with differing priority of payment and associated volatility. 

Overvaluation, in some sectors, may be technical-based such as “on-the-run sectors’ like investment-grade or high-yield corporate credit, if there is an asset class that has an ETF/exchange-traded fund or a mutual fund of high yield, bank loans, or preferreds. It is deciding where we want to be structured, and making those decisions over time, that drives our alpha. 

Q: How does the fourth lever, information premium, factor into your process?

You need some level of sophistication with these sectors. But more importantly, you need to have staff that can underwrite the securities, model the cash flow, either through proprietary software or software the different participants can use. You need a legal team that can read indentures, read the offering memorandums, and understand how terms are defined so we comprehend the cash flows. 

We see it as getting paid to do our homework. It is about who comprises the buyer base, what we can take the time to learn, and how to underwrite the credit. At day’s end, we need to be comfortable with the credit. That is our information premium. 

Q: What represents risk to you, and how do you apply risk management consistently among portfolios?

Risk to us comes in many forms, including liquidity risk, credit risk, interest rate risk and tail or systematic risk. Our investment process eliminates behavioral biases because the sector teams are evaluated on their credit process, their credit selection if they have a credit sell recommendation—those securities are sold. Sector teams worry about loss from default, and portfolio managers worry about daily and monthly underperformance, and attribution relative to both the benchmark and peer groups. In addition, portfolio managers and the portfolio construction team run stress testing models for overall possible portfolio draw down given systemic risks or when larger portfolio shifts are made.

Because the portfolio managers don’t have to underwrite each credit they are free to work with the portfolio construction team to set up the overweights, underweights, relative value targets and industry concentration risk limits for each strategy. 

Every time we scrutinize a security, every time we assess our target risk and where we are relative to that target, it is applied to every portfolio with that strategy. When a security is sold from one strategy, or bought, it’s considered with regard to all similar accounts. We maintain disciplined risk targets on a daily basis, and use such tools as daily attribution. Portfolio managers are expected to minimize performance deviation within strategies. 

Q: How does risk influence your investment strategies?

Our goal is always to find the best ideas in fixed income relative to the particular strategy’s risk. We identify the appropriate securities for each strategy and establish the risk limits of each. 

For example, it would be very easy to weight a limited-duration portfolio with Treasury bills, commercial paper, and add a lot of high-yield CCC credits, but what we try to do when applying some of those higher credit beta strategies is to determine the safer credits, the risk limits within those sectors, and what other asset classes might fill the goal. We do not barbell credit risk in strategies to add incremental yield. Strategies have diversified allocations across sectors, credit quality and repayment profiles, which tends to smooth performance and volatility.

What you will see in many of our limited duration strategies is a much larger allocation to structured finance, particularly investment grade asset-backed securities: floating-rate investment-grade rated securities—sometimes AAA, sometimes AA, and occasionally a single A, but very consistent, very stable. 

The structured finance sector does not have LIBOR floors, so to the extent interest rates rise, we can assemble a portfolio that can increase yield as interest rates rise instead of potentially experiencing losses if we were required to invest solely in fixed-rate assets, like the Bloomberg Barclays Aggregate Index, for example. We build portfolios bond by bond, largely investment-grade, floating-rate securities in structured finance, coupled with safer, shorter maturity products, such as consumer asset-backed securities, commercial paper, and/or corporates with a maturity of one or two years. 

We always remain aware of our benchmark and peer group, and believe that if we can put together a portfolio with a decent yield, we can outperform if we get the credit right. We stay consistent with securities that might yield in the LIBOR-plus-200 context overall for Limited Duration Fund or for Enhanced Short Duration ETF—call it 1%, with about a quarter-year of duration. We are convinced that yield tends to compensate over time in terms of producing alpha.