Steering one of the biggest and most successful unconstrained bond funds through a pandemic has led Guggenheim to draw on a blend of behavioral finance and battlefield strategy. In fact, the $260 billion asset manager built its portfolio management team on a foundation of behavioral finance, said Anne Walsh, chief investment officer for fixed income, who co-manages Guggenheim’s Total Return Bond Fund (GIBIX).

“Good investors recognize their inherent weaknesses and try to drive them out of their investment processes,” said Walsh. “If we’re not aware of those traps in today’s unique investment environment, we can fall into them.”

The $21.9 billion GIBIX has returned 11.93% year-to-date, according to Morningstar, easily outpacing its fixed income category, which returned an average of 6.01% year-to-date, and Morningstar’s comparison index, the Bloomberg-Baclay’s US Universal Total Return index, which has returned 5.97% year-to-date.

Walsh said that Guggenheim established its investment processes based on the work of Daniel Kahneman, whose book “Thinking Fast and Slow” laid the groundwork for behavioral finance. In that  book, Kahneman divided human thought processes into “Type 1,” or automatic, instinctive, emotional and “fast” thinking, and “Type 2,” organized, process-driven and slower thinking.

“We’ve set up our investment process to drive out system one behaviors while keeping in our system two behaviors,” said Walsh.

While in traditional asset management, investment committees are built using what Walsh calls a “star system” where decision-making flows through the hands of a single “star” portfolio manager – which in Guggenheim’s case would be herself or Chairman and Global CIO Scott Minerd, Guggenheim takes more of a decentralized team approach to managing its funds.

Areas of portfolio management and decision-making are  broken down into component parts representing individual responsibilities, and then those responsibilities are designated to independent teams. Teams are organized around their areas of best knowledge.

“Ultimately, it has served to slow down our decision-making,” said Walsh. “We have different teams making recommendations based on whatever component part of the investment process they’re engaged in. For example, we have a macro team that develops the house view with regard to our economic outlook, GDP and Fed policy, and that creates our roadmap for the future.”

Sector teams focus on areas like corporate credit, structured credit and other types of fixed income instruments, said Walsh. Portfolio management decisions are divided between two groups – one responsible for portfolio construction, and the other responsible for ongoing management like risk management, risk budgeting and model allocation functions.

Guggenheim’s teams do not always see eye-to-eye—which is a good thing, said Walsh, because it helps the asset manager avoid group-think.

But how did an approach intended to slow down the investment process impact Guggenheim’s ability to make decisions during the coronavirus  pandemic’s more volatile days? Walsh said that while Guggenheim’s process may sound complex and inefficient, the firm has embraced some battle-tested tactics to make sure it can be responsive when necessary.

“I struggled for a long time on best way to describe our team construct, because it can can sound chaotic to some,” said Walsh. “I was introduced to a book by (former JSOC Commander) Gen. Stanley McChrystal called ‘Team of Teams.’”

That book, subtitled “New Rules of Engagement for a Complex World,” describes a decision-making process among geographically and functionally distributed teams, which seeks to keep the process separate but ultimately coherent.

“You have to have teams work together to react to, in McChrystal’s case, a hostile enemy environment or situation,” said Walsh. “He took an otherwise stagnant military hierarchy structure and broke it down to create levels of autonomy and leadership that were collaboratively able to meet the demands of the battlefield along a timeline set by a nimble adversary. That’s a good way to describe what we do – we’re actually quite agile. We’re actively engaged in real time and we are in constant fluidity.”

Every two weeks Guggenheim has a strategy review meeting—a formal meeting encompassing all of its teams that often has hundreds of participants chiming  in from dozens off different locations. These large, formal meetings are intended to free information and opinions from “silos” that can limit decision-makers’ access to data.

Smaller, more focused – and more team oriented—meetings fill the interim. While it may seem like a “star system” led by a single portfolio manager might be more efficient, Walsh says that one manager is likely more prone to behavioral biases, and may miss or overreact to information in the market.

“System-one thinking leads to more trading, and in our world, trading should be an outcome, not a function,” she said. “You may have a team of people who trades for you and believe that their trading is adding a lot of value to what you do. In our world, the act of buying and selling a security is an outcome of our research and selection process. The way we look at it, trading is not a value-add activity. Investors tend to trade too much. The outcome of many investment processes is just more trading, not necessarily better performance. Dr. Kahneman famously said that we’d all have better investment outcomes if we just made fewer decisions.”

Despite her success as a portfolio manager, as 2020 begins to wind down, Walsh acknowledges that it has been a difficult year to run a bond fund. “We came into the year with our macroeconomic outlook being one of caution, expecting risk, not knowing the catalyst, and then, as that developed and we saw all the volatility in late March and into April, we were able to have our sector teams engage very rapidly to source great securities that had gotten unnecessarily cheap,” she said. “We were able to buy those very quickly.”

As the market turned, GIBIX moved out of Treasurys and agency securities and into “cheap” investment grade and high yield corporate bonds, said Walsh.

Walsh also warns that monetary easing combined with fiscal stimulus has created a dangerous scenario for investors.

“I think we made a bad situation worse,” she said. “We’ve issued $2 trillion of new corporate debt year to date, with $1.5 trillion of that issued in the U.S. alone. Year-to-date, approximately $310 billion in securities have been downgraded to non-investment grade ratings, so-called fallen angels. S&P put out a piece estimating that another $330 billion will be downgraded before year end. We know that the default rate is now 7%. Our expectation is that the default rate will go to the low double-digits.”

The influx of stimulus and cheap debt  has led to a growing number of “zombie companies” that wouldn’t otherwise be able to remain in business, said Walsh.

“Whether it’s Neiman Marcus, Hertz or various energy companies, retailers, etc., a wide-ranging set of issuers is only just now filing for bankruptcy, and there’s more to come as a wider set of issuers are downgraded,” she said. “That will lead to even more zombie companies, and even with all of this money in the system, some of them won’t work it out, they’ve deteriorated beyond their ability to borrow cheaply.”