Why We're Not Completely Sold on This 5-Star Bond Fund
Guggenheim Total Return Bond's limited albeit stellar record is marked by risk-taking and staff turnover.
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Guggenheim Total Return Bond boasts a compelling strategy and stellar record but has historically produced more risk than most peers with a record modest in length and untested in a major crisis. Staff turnover and tenure give reason for pause. The fund carries a Morningstar Analyst Rating of Neutral.
The fund boasts a novel process and staff that is divided into functions meant to encourage specialization and foster a deliberate, slowed-down process; its leaders argue that the depth and quality of its underlying research differentiates its structured credit work and portfolio design. Guggenheim's business has grown by leaps and bounds, and its staff has ballooned, but while it boasts a cadre of senior members with roughly 15-30 years in the industry, the overall group is light on experience and firm tenure.
Of its 18 structured-credit analysts (not including two software specialists), 12 joined the team after March 2017, nine were new to Guggenheim, and only seven have more than 10 years in the industry. The firm views the large size of the corporate credit team responsible for analyzing underlying loans in its collateralized loan obligations as a critical complement, but that team saw notable turnover after mid-2017, too.
That is important given an approach of exploiting inefficiencies among out-of-benchmark bonds, which has meant a large, eclectic mix of securitized fare. The team trimmed risk across its offerings based on macro and valuation calls in 2017-18, but this one still carried 21% in CLOs, 16% in nonagency residential mortgage-backed securities, and 12% in commercial mortgage-backed securities as of Sept. 30, 2018.
Its profile has helped the fund to peer-busting returns and modest volatility, and it is significant that the firm has been peeling back risk across its funds, showing that it is more than a yield-and-return-chasing risk-taker. This fund has benefited from mostly friendly markets over its lifetime, though, and the additional risks it has taken compared with most peers in the intermediate-term bond Morningstar Category have yet to be seriously tested.
Process Pillar: Neutral | Eric Jacobson 11/26/2018
Influenced by Nobel Prize winner Daniel Kahneman, CIO Scott Minerd splits his staff into discrete groups. That is meant to encourage specialization and foster a deliberative, slowed-down process. The groups work closely, but each is focused on, and holds decision authority over, its own discipline. Nothing goes into a fund without sector/security team approval, the macro team sets top-down themes, the portfolio group mixes the inputs into model portfolios, and fund managers assemble and optimize them.
Pursuing inefficiencies among bonds outside most benchmarks has produced an eclectic portfolio heavy in asset-backed securities (mostly CLOs) and nonagency residential and commercial mortgages. As of Sept. 30, 2018, that left room for a modest 16% allocation to government debt.
The system is well-conceived and has produced excellent returns. But while the fund has faced market challenges, few have been truly severe. That is notable because the firm has been content to take liquidity risk, up to 30% stakes in low-rated debt, and at times even some leverage; that has historically meant peer-topping yields.
In tandem with deliberate risk reduction, though, the fund’s yield came down sharply over 2017 and 2018, while the firm has been investing heavily on risk-management technology and doubled that staff since mid-2017. That may portend more balance in the future, but for now the fund carries a Neutral Process rating overall.
After holding large stakes in corporates and bank loans in its early years, that stake totaled 3.7% at Sept. 30, 2018, reflecting a strong bias toward securitized assets. The largest allocation was to ABS (33%), inclusive of 21% in CLOs. The fund also held 16% in nonagency residential mortgages and 12% in commercial mortgage-backed securities. That left room for a relatively small 16% allocation to government-related debt.
Those numbers marked a notable turn of caution beginning a couple of years ago, away from assets Guggenheim believed were becoming pricey, and that trend accelerated even more during 2018. The fund began to more strongly favor AA and A rated CLO tranches by early 2017, for example, based on valuations and a deterioration of structural protection in lower-rated pieces. That represented an explicit effort to get into recession-resistant, less-market-sensitive tranches, and the efforts continued across 2018. Guggenheim’s macro expectations continued to soften over that period, and by September 2018 the fund’s AA and A rated CLO exposures were down to 7% from 19% at the end of 2016. In turn, the portfolio’s AAA CLO tranches had risen to 13% of the fund and thus comprised well more than half its 21% stake in the sector as of September. Among its most dramatic changes, meanwhile, was a buildup of 14% in cash for a fund that has been willing to develop leverage in the past.
Performance Pillar: Positive | Eric Jacobson 11/26/2018
The fund has generated an excellent record since its November 2011 inception. Its returns since then placed in the top percentile of the intermediate-term bond Morningstar Category through Oct. 31, 2018, with lower-than-average volatility. That supports the fund’s Positive Performance Pillar rating.
Guggenheim argues that its focus on securities that tend to amortize (such as mortgages and other structured securities) has helped keep volatility in check. The team has also made some good decisions for this fund in terms of sector rotation and interest-rate sensitivity. The fund raised its exposure to floating-rate debt in 2013, for example, which helped limit its losses during the taper tantrum, and then benefited from raising exposure to nonagency mortgages in 2014 as that sector thrived.
The overall period since the fund’s inception has had some rocky periods but has not otherwise produced stretches of severe market stress. That is especially notable given the fund’s history of holding low cash balances, potentially illiquid holdings, often more credit risk than most category peers, and even employing occasional leverage. It is absolutely noteworthy that the firm has been peeling back risk across all of its funds, supporting the notion that it is more than just a yield-and-return-chasing risk-taker, so it will be worth continuing to monitor how that affects performance in the future.
People Pillar: Neutral | Eric Jacobson 11/26/2018
Comanagers Jeffrey Abrams and James Michal both left the firm since mid-2017, but CIO Scott Minerd, fixed-income-CIO Anne Walsh, Adam Bloch, and Steven Brown remain. Guggenheim’s system also distributes plenty of authority across a sizable staff, though, and employs attorneys who analyze documents and deal structures.
Those resources are impressive. Guggenheim’s business has grown by leaps and bounds, and its staff has ballooned. But while there is a cadre of senior members with roughly 15-30 years in the industry, the overall group is light on experience and firm tenure. Of its 18 structured-credit analysts (not including two software specialists), for example, 12 joined the team after the first quarter of 2017, nine were new to Guggenheim, and only seven have been in the industry for longer than 10 years. The firm views the large size of the corporate credit team responsible for analyzing underlying loans in its CLOs as a critical complement, but that team saw high turnover after mid-2017, as well.
It is pivotal that the firm doubled its risk-management team to 16 after mid-2017, but, given its focus on some of the industry’s most complex securitized investments, it would be best to see a group more heavily staffed with those who have experienced more-challenging markets and have worked together longer. Those factors underpin the fund’s Neutral People Pillar rating.
Parent Pillar: Neutral | Eric Jacobson 11/20/2017
Guggenheim Investments offers a suite of funds--totaling $243 billion as of September 2017--heavily tilted toward fixed income. The firm has agreed to sell its ETFs to Invesco in a deal expected to close in early 2018.
Many of its strategies have earned very strong, peer-beating returns and have seen torrid growth, though its three largest bond funds are younger than six years. CIO Scott Minerd separates his teams into macro research, sector/security selection, portfolio construction, and portfolio management. Once managers receive model portfolios from the construction group, they pull holdings from the sector/security team, which selects and trades them. The group's resources are unusually deep and broad. It includes several very experienced people, but its average fixed-income professional has 13 years in the industry and only four at the firm.
In 2015, the firm settled with the SEC for problematic violations in 2010. Employees involved are no longer with the firm, and it has invested heavily in compliance and training. November 2017 press reports implied that Guggenheim improperly managed conflicts of interest for some fund investments, but the SEC has not publicly reported any wrongdoing, and our scrutiny of information available to date hasn't yielded material fiduciary concerns.
On balance, the firm earns a Neutral Parent Pillar rating.
Price Pillar: Neutral | Eric Jacobson 11/26/2018
Four of the fund’s five share class fee levies rank as average or above average, and 85% of those dollars are in its institutional class, which ranks close to the middle of its distribution cohort. That puts the fund’s Price Pillar rating firmly in Neutral territory.
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