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Q&As and Interviews
Kiril Nikolaev Mar 10, 2016
Anne Walsh (A.W.): We believe the future of any core fixed-income strategy lies in the ability to break from the reliance on benchmark weights in determining how to allocate a fixed-income portfolio. Fixed-income managers must actively identify where real value lies, shifting when markets shift, and leveraging their expertise to find opportunities outside of the benchmark where value remains largely unexploited.
For core investors, achieving yield targets is obtainable in high-quality investments, but it requires more credit work and diligence than a portfolio that is largely constructed based on each sector’s weight within an index. Achieving yield targets without assuming undue risk has proven extremely difficult under the traditional framework, but we believe the Guggenheim approach to constructing diversified core fixed-income portfolios offers a more sustainable way to generate income and improve risk-adjusted returns in today’s low-rate environment.
A.W.: We’re one of the few managers, if not the only one, that adheres to the school of behavioral finance and its tenets. Our philosophy was developed in the late 1990s to early 2000s and is based on the work of psychologist Daniel Kahneman.
Though not an economist, Kahneman won a Nobel Prize in economics for his contributions to decision theory, specifically how it affects investment decisions. The substance of behavioral finance is that investors—whether individuals or institutions—value avoiding loss more than they value what is now termed “alpha.” Avoidance of loss filters through everything we do and is particularly relevant to fixed-income investing.
Another belief is that investors trade too often. The industry tends to make knee-jerk reactive decisions regarding sector allocation and individual security selection. In contrast, and in following the school of behavioral finance, we are buy-to-own investors—not buy-and-hold investors. We don’t trade as often as other asset managers and have a lower turnover in our portfolios.
MutualFunds: Many of your fixed-income mutual funds are actively managed. Generally speaking, active managers have not been able to outperform their benchmarks net of fees. Why do you think investors should look to gain exposure to active instead of passively managed mutual funds?
A.W.: A fundamental aspect of our investment philosophy is that fixed-income markets are inefficient, which is contrary to what many others believe. By remaining tightly aligned to the Barclays Agg, which is currently bloated with low-yielding, government-related debt, investors are giving up the flexibility to take advantage of undervalued sectors and to limit exposure to unattractive ones.
The U.S. fixed-income market is about $37 trillion, made up of investment alternative choices, but less than half – about $17 trillion – are contained in the Barclays Agg. It’s impossible for this to be efficient; no one can know every single security or have complete information on all of them. We’ve set up our investment teams and process to take advantage of these market inefficiencies.
MutualFunds: The Guggenheim Total Return Bond Fund (GIBIX) has a Morningstar rating of 5 stars. Could you explain what has contributed to this bond mutual fund’s success?
A.W.: Many portfolio management processes share the same weakness: they are vertically integrated and set up around a star system. A sole portfolio manager may make decisions about security selection, have a view on interest rates, handle client communications, and also talk and trade with the Street.
We believe no one person can do everything well for an extended time. Adhering to the fundamental tenets of behavioral finance, we have more than 160 dedicated fixed-income investment professionals working on behalf of clients in a team-based approach we believe leads to better decision-making outcomes.
Accordingly, our organization features separate groups that specialize in the different functions of investment management: Our Macroeconomic Research Team identifies and provides outlooks on key economic themes; our Sector Teams conduct rigorous fundamental analysis to make specific security recommendations; our Portfolio Construction Group determines investment strategy, portfolio positioning, and sector weightings based on macroeconomic and relative-value sector analysis; and our Portfolio Managers implement and optimize investment strategies.
The groups work autonomously, but are interdependent within our investment process.
A.W.: For one, we don’t hug a benchmark. Bond indices like the Barclays Agg, which most core managers follow pretty closely, are investable but they don’t maximize risk-adjusted returns.
Guggenheim Total Return Bond Fund has very little overlap – about 10 percent – with the Barclays Agg. As a result, our portfolio doesn’t look like the index because we seek value outside of the index.
Approximately 30% of the fund’s portfolio is in asset-backed securities and another 20% are in non-agency mortgage-backed securities. Those are real differentiators.
A.W.: We’ve had positive flows into our retail fixed-income mutual funds in 46 of the last 48 months. In 2015 alone, the assets in Guggenheim Total Return Bond Fund almost tripled, and we launched an ETF version of the fund in February (GTO).
Investors and advisors alike continue to look for managers who can provide strong, risk-adjusted returns by seeking value outside a benchmark like the Barclays Agg.
A.W.: We believe the U.S. economy is fundamentally sound, and find no reason to anticipate a recession in 2016.
After their first annual loss since 2009, select high-yield bonds look attractive again on a risk-adjusted basis. We also believe bank loan investors are being well-compensated for risk. Despite ongoing volatility, we believe solid credit and growth fundamentals will support the loan market.
In municipals, the areas we find the most attractive generally are revenue bonds—those supported by dedicated revenue streams, such as state-level transportation bonds, public health care, and utilities.
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