AMERICA’S TOP COLLEGES AUGUST 12 • 2013 EDITION

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AUGUST 12 • 2013 EDITION

INVESTING FIXED INCOME

Dodging Disaster Guggenheim Investments grew to $180 billion in assets by spreading its bets and heading away from the crowd. BY DANIEL FISHER

I

t’s 8 a.m. on a Monday in early July, and 50 people cram into a conference room for the daily credit meeting at the Madison Avenue headquarters of Guggenheim Investments. The mostly young male analysts don’t wear ties, but they snap to attention as the voice of Global Chief Investment Officer Scott Minerd comes over the speakerphone from the firm’s Santa Monica, Calif. office. The 54-year-old, 300-pound competitive bodybuilder is more commanding in person, but his message today is compelling on its own. “This is the worst bond market since 1927,” Minerd rumbles as he walks the young analysts through the potential fallout from a steep rise—from 1.7% to 2.7%—in the yield on ten-year Treasury notes over the previous eight weeks. “People are going to be looking to sell stuff.” Meaning Guggenheim will be looking to buy. With $180 billion under management, most of it in fixed income, Guggenheim must put $4 billion a month into new bond and fixed-income investments, regardless of conditions. It does that by ranging widely across the credit markets and, at key points, moving ahead of or against the crowd—a direction that seems to come naturally to this unusual, privately held firm. Its parent, Guggenheim Partners, was formed

in the late 1990s when current CEO Mark Walter combined his Chicago financial advisory and investment firm with the Guggenheim family office. Famous for their art collecting and museums, the Guggenheims trace their fortune back to Meyer Guggenheim, a poor Swiss immigrant who built a mining and smelting empire in the late 19th century. The namesake family retains a small stake, while Guggenheim executives own nearly 50% of the firm. Sammons Enterprises of Dallas, which uses Guggenheim to manage its insurance companies’ portfolios, owns another 30%. Ultrawealthy clients, investing through hedge funds with $1 million to $25 million minimums, are still a key part of its business, but Guggenheim has also been moving into the retail market, picking up exchange-traded-fund manager Claymore in 2009 and adding the Rydex funds family in 2012. The $40 billion retail business, the hedge funds and the institutional money all come under Guggenheim Investments President John Klein, 50, a Citibank veteran. Meanwhile, Guggenheim Partners’ president, Todd Boehly, 39, is out scouting for the next expansion opportunity. Recently he has been visiting troubled European banks, shopping for advisory businesses to add to the Guggenheim

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FORBES AUGUST 12, 2013

INVESTING FIXED INCOME platform. (Last year he took a pass on Deutsche Bank’s U.S. mutual fund business, but he says he remains convinced the Euro banks will have to sell attractive assets to raise capital.) Yet with all its history and reGuggenheim cent growth, Guggenheim Partis calling ners these days is best known Bernanke’s for arranging the financing for a bluff. It sees group led by Walter that bought the Los Angeles Dodgers for a growth hefty (some say excessive) $2.2 slowing and billion in 2012. Walter is now rates falling chairman and controlling owner before the end of the team. Boehly, a college wrestler who worked in leverof the year. aged buyouts for J.H. Whitney & Co. before signing with Guggenheim in 2001, also has a stake in the team and insists the purchase was, at its heart, an infrastructure play (i.e., a stadium) with a big fixed-income component, namely the Dodgers’ 25-year, $9 billion broadcast contract with Time Warner. A stretch? Perhaps. But taking a wide-angle view of fixed income has been profitable for Guggenheim. In the five years ended Mar. 30, 2013 its $75 billion in core go-anywhere fixedincome accounts had an average return of 9.14%, beating a broad fixed-income benchmark by 3.6 percentage points a year. Another $21 billion that’s restricted to investment-grade bonds returned an average 9.95% during the period (which includes the financial crisis flight to quality), beating its benchmark by 2 percentage points. Boehly breaks the fixed-income market down into broad segments, including lending to the government, lending to municipalities, and fixed- and floating-rate corporate debt. Anticipating a rise in interest rates, Guggenheim began selling Treasurys in May 2012, when the yield on the ten-year note fell to 1.63%. “The idea that the ten-year Treasury is the risk-free return is just ridiculous,” says Boehly. “It’s return-free risk.” On the corporate front it boosts yield by making bespoke loans at rates that frequently top 9%. During the morning credit meeting executives tick through deals the firm is involved in or investigating. It took a $70 million slice of the financing for Vista Equity Partners’ $1 billion takeover of Websense, negotiating directly with Vista for two months to secure a rich 725 basis points over Libor. It is passing on a bridge loan to finance Carl Icahn’s bid for Dell, after in-house lawyers balked at the terms. “There were a couple of scenarios where we wouldn’t get paid,” says Minerd. Another pending deal draws chuckles when an executive notes that Guggenheim might have to wait a while to get in on the expected 12% notes: “The CEO just got blindsided by a divorce,” the executive says.

Guggenheim has also negotiated complex long-term lending agreements secured by real estate and other assets with companies like Wyndham Worldwide. (Henry Silverman, former CEO of Wyndham predecessor Cendant, is now vice chairman of Guggenheim Investments.) “You need to be thinking of yourself as a provider of liquidity at a premium,” says Boehly. Such hands-on lending earns Guggenheim investors not only a fatter yield­—often exceeding the yield on unsecured debt issued by the same companies— but also protection against rising interest rates. Want a piece? If you don’t have the minimums for Guggenheim’s hedge funds, you can buy in through two new public funds: Guggenheim Macro Opportunities and Floating Rate Strategies. Both have hefty 4.75% upfront loads (waived in many brokerage accounts) and annual expense ratios over 1%. Rising rates were, of course, the subject of Minerd’s warning to the young analysts in early July. The Wharton graduate was running Morgan Stanley’s fixed-income desk in London back in 1994, when the Federal Reserve sparked chaos in the debt markets by unexpectedly hiking rates. Now he lays out a scenario for a credit market meltdown: Rates continue to rise fast. Desperate traders try to sell their longer-term investments and, when that fails, end up shorting Treasurys to protect themselves. That sets off a spiral of falling liquidity and rising rates that can crush leveraged players. Fortunately Minerd puts the probability of this doomsday scenario at just 10% and (with a FORBES reporter present and taking notes) predicts—correctly, it now appears—that Bernanke will back away from his hints of an impending end to the Fed’s bond buying. Rising mortgage rates, Minerd reasons, have already led to a decline in applications for new-housing permits, meaning fewer housing starts later this year. Housing, by his estimate, accounted for 1.4% of the 1.8% of GDP growth in the first quarter. “Sub-1% growth is not going to meet Dr. Bernanke’s expectations,” he says. Minerd’s most likely scenario: Fed bond buying will continue, and the ten-year Treasury rate will drop by the end of the year. At the start of this year Guggenheim sold junk bonds, convinced that yield-hungry investors were paying too much, and, in anticipation of rising rates, shortened the duration of its portfolio. (That’s a mathematical expression, in years, of how much a portfolio will be hurt by rising rates.) Now, as spreads between high quality and junk widen, Minerd is telling his troops to be on the lookout for higher-yielding bonds even if that means lengthening duration. By the end of the year Guggenheim will have placed at least $16 billion in bets on a slower-than-expected but improving economy that keeps interest rates low for longer than expected. “All markets are weird,” says Minerd. “They’re all perverse in some way.” F

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GuggenheimPartners.com The article referenced herein is for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The article should not be considered research nor is the article intended to provide a sufficient basis on which to make an investment decision. Any opinions contained herein are not necessarily those of Guggenheim Partners, LLC or its subsidiaries and are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and nonproprietary research and other sources. Guggenheim Partners, LLC’s assets under management are as of 06.30.2013 and include consulting services for clients whose assets are valued at approximately $39 billion. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: GS GAMMA Advisors, LLC, Guggenheim Aviation, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Investment Management, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners India Management, Guggenheim Real Estate, LLC, Security Investors, LLC and Transparent Value Advisors, LLC. This material is intended to inform you of services available through Guggenheim Investments’ affiliate businesses.

The reference to Guggenheim’s “core go-anywhere fixedincome accounts” in the article means Guggenheim’s Core Fixed Income Composite (“the Composite”). That Composite is comprised of accounts with a total return objective and invests in broadly diversified portfolios of primarily investment grade fixed income instruments, rotating opportunistically among sectors where perceived relative value exists. Derivatives may be used to hedge interest rate and credit risks. Leverage may be employed when appropriate market conditions exist. Derivatives are used to hedge various risk components of the composite and may make up a material part of the composite strategy. Interest rate derivatives are used to hedge interest rate risk and credit default derivatives are used to hedge underlying credit risk. The use of leverage may be employed when appropriate market conditions exist, generally in the form of reverse repurchase agreements and securities lending. For comparison purposes the Composite is measured against the Barclays U.S. Aggregate Index. The Barclays U.S. Aggregate Index represents securities that are SECregistered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and assetbacked securities. Benchmark returns are not covered by the report of independent verifiers.

GUGGENHEIM: CORE FIXED INCOME COMPOSITE RETURNS

As of 03.31.2013

GROSS

NET

BARCLAYS U.S. AGGREGATE INDEX

YTD

1.52%

1.39%

-0.12%

1 YR

10.03%

9.48%

3.77%

3 YR

10.78%

10.23%

5.52%

5 YR

9.14%

8.60%

5.47%

7 YR

8.21%

7.68%

5.94%

10 YR

7.24%

6.71%

5.02%

SI (01.01.1999)

7.29%

6.76%

5.66%

As of 12.31.2013

GROSS

NET

BARCLAYS U.S. AGGREGATE INDEX

0.97%

0.46%

-2.02%

7 YR

7.09%

6.56%

4.91%

10 YR

6.71%

6.18%

4.55%

SI (01.01.1999)

6.88%

6.35%

5.23%

1 YR

PRINTED COPY7.56% FOR PERSONAL READING ONLY. 7.03% 3.26% 5 NOT YR 9.60% 9.06% 4.44% FOR DISTRIBUTION.

3 YR

GuggenheimPartners.com The reference in the article to the performance of Guggenheim’s “core go-anywhere fixed-income accounts” is not intended to imply that Guggenheim’s investment style is always profitable, nor does it imply anything about the performance of the Macro Opportunities Fund or the Floating Rate Strategies Fund. Those funds do not use a core fixed income strategy and are not included in the Core Fixed Income Composite. In addition, any hedge fund offered by Guggenheim that uses a strategy similar to those used by the Macro Opportunities Fund or the Floating Rate Strategies Fund may have significantly different fees, performance, risks, and portfolio holdings than the Macro Opportunities Fund or the Floating Rate Strategies Fund. Past performance does not guarantee future returns. The value of any investment may rise or fall over time. Principal is not guaranteed, and investors may receive less than the full amount of principal invested at the time of redemption if asset values have declined. Individual account performance may be greater than or less than the performance presented for this composite. Gross-of-fee (“Gross”) returns are presented net of non-reclaimable foreign withholding taxes applicable to U.S. investors and includes the reinvestment of income. Net-of-fee (“Net”) returns are calculated by reducing gross-of-fee returns by the strategy’s highest applicable management fees, which includes incentive or

performance fees where applicable. Performance numbers for time periods greater than one year are annualized. All performance is expressed in U.S. dollars. Investment Grade Bonds Sector returns are comprised of Investment Grade Bonds securities and related derivative instruments purchased for client accounts, regardless of investment mandate. Sectors do not represent an investable strategy and their returns are not representative of a client account. Sector returns are calculated by beginning asset weighting each security and adjusting it for security flows. Sector returns do not reflect the impact of cash, may exclude the reinvestment of income and other earnings, include transaction costs, and do not reflect the impact of fees or expenses. Past performance does not guarantee future returns. All performance is expressed in US dollars. The reference in the article to “another $21 billion” in investment grade bonds may include bonds that also are included in the $75 billion of assets in the “core go-anywhere fixed-income accounts.” For comparison purposes the sector is measured against the Barclays U.S. Corporate Index. The Barclays U.S. Corporate Index covers USD-denominated, investment grade, and fixed-rate, taxable securities sold by industrial, utility, and financial issuers.

GUGGENHEIM: INVESTMENT GRADE BONDS SECTOR RETURNS

As of 03.31.2013

SECTOR

BARCLAY’S U.S. CORPORATE INDEX

YTD

1.69%

-0.11%

1 YR

11.66%

7.47%

3 YR

10.74%

8.12%

5 YR

9.95%

7.88%

7 YR

8.40%

7.04%

10 YR

7.27%

6.05%

SI (01.01.2002)

7.90%

6.51%

SECTOR

BARCLAY’S U.S. CORPORATE INDEX

1.04%

-1.53%

7 YR

7.44%

6.00%

10 YR

6.61%

5.33%

SI (01.01.2002)

7.33%

5.96%

As of 12.31.2013 1 YR

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GuggenheimPartners.com The Macro Opportunities Fund and Floating Rate Strategy Fund (the “Funds”) are distributed by Guggenheim Funds Distributors, LLC. Guggenheim Partners Investment Management, LLC serves as the investment adviser to the Funds.

Read a fund’s prospectus and summary prospectus (if available) carefully before investing. It contains the fund’s investment objectives, risks, charges, expenses and other information, which should be considered carefully before investing. Obtain a prospectus and summary prospectus (if available) at guggenheiminvestments.com. The Funds may not be suitable for all investors. ● The Funds’ market value will change in response to interest rate changes and market conditions among other factors. In general, bond prices rise when interest rates fall and vice versa. ● You may have a gain or loss when you sell your shares. ● It is important to note that the Funds are not guaranteed by the U.S. government. ● The Funds may have exposure to high yield securities, municipal securities, floating rate securities, foreign securities, derivative instruments, real estate, commodity markets and other fixed income securities. ● Exposure to high yield securities may subject a Fund to greater volatility. ● Investments in municipal securities can be affected by events that affect the municipal bond market. ● Investments in syndicated bank loans generally offer a floating interest rate and involve special types of risks. ● Investments in foreign securities carry additional risks when compared to U.S. securities, due to the impact of diplomatic, political or economic developments in the country in question (investments in emerging markets securities are generally subject to an even greater level of risks). ● Investments in derivative instruments can be more volatile and less liquid, increasing the risk of loss when compared to traditional securities. Certain of the derivative instruments are also subject to the risks of counterparty default and adverse tax treatment. ● Investments in real

estate securities subjects a Fund to the same risks as direct investments in real estate, which is particularly sensitive to economic downturns. ● When market conditions are deemed appropriate, the Funds may use leverage to the full extent permitted by their investment policies and restrictions and applicable law. Leveraging will exaggerate the effect on net asset value of any increase or decrease in the market value of the Fund‘s portfolio. ● Please see each Fund’s prospectus for more information on these and other risks. The comparisons herein of the performance of the Core Fixed Income Composite, the Investment Grades Bond Sector, and other strategies may not be meaningful since the constitution and risks associated with each strategy may be significantly different. Accordingly, no representation or warranty is made to the sufficiency, relevance, importance, appropriateness, completeness, or comprehensiveness of the market data, information or summaries contained herein for any specific purpose. The views and strategies described herein may not be suitable for all investors. Investors are urged to consider carefully whether such services in general, as well as the products or strategies discussed in this material, are suitable to their needs. Past performance of indices of asset classes does not represent actual returns or volatility of actual accounts or investment managers, and should not be viewed as indicative of future results. The benchmarks used are for purposes of comparison and should not be understood to mean that there will necessarily be a correlation between the portrayed returns herein and these benchmarks. Past performance is not indicative of comparable future results. Given the inherent volatility of the securities markets, it should not be assumed that investors will experience returns comparable to those shown here. Market and economic conditions may change in the future producing materially different results than those shown here. All investments have inherent risks.

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