Interview 009_Bond H. Griffin
Jun 11, 2012
byInvestment in Japan
Bond H. Griffin, CFA, is a senior portfolio manager and is the head of portfolio management for Agency MBS, Non-Agency RMBS and Consumer ABS for Declaration. He specializes in the management of credit and prepayment risk of residential mortgages. He has been in the industry since 2003. He joined Declaration in 2007. Previously, Mr. Griffin worked for Hyperion Brookfield Asset Management. He has an M.S. in Financial Engineering from Columbia University and a B.S. in Electrical Engineering from the University of California, San Diego. He is a member of the CFA Institute and the New York Society of Securities Analysts.
Please tell us your investment philosophy, the background of company name and how you invest?
We are an active fixed income manager with a specialty in securitized assets including Agency and Non-Agency RMBS and CMBS. Our goal is to construct and implement risk efficient portfolios through a combination of securitized and non-securitized assets. We seek to capture security specific differences in market pricing versus our views on longer term fundamental or intrinsic value. That value capture is related to either credit performance or interest rate and prepayment realization.
By combining assets with prepayment and credit specific risks, we believe we can achieve higher risk adjusted returns in our portfolios. We have always been cautious and judicious in the use of leverage. Most of our strategies do not use leverage, and we recognize that securitized assets can be highly illiquid at times. At the security level, we prefer securities with a large margin of error around our loss and prepayment forecasts (i.e., a cushion against losses). We are not prone to reaching for the last 50 basis points of yield. We allocate our capital on a security by security basis and manage overall volatility and downside risk at the portfolio level.
Declaration Management & Research LLC (“Declaration” or “DMR”) was formed in 1989. DMR is an SEC-registered investment adviser with approximately $8.5 billion in assets under management. DMR is a part of Manulife Asset Management, the asset management arm of Manulife Financial which has approximately $200 billion in assets under management as of March 31, 2012. Declaration’s investment focus is securitized strategies based on more than twenty years’ experience managing mortgage-backed and asset-backed securities for its parent company and institutional investors in the U.S. and Japan.
To the average investor with no experience in your sector, please give the simplest description of a securitized asset and its opportunities.
All securitized assets involve (a) collateral, such as residential or commercial mortgages, and (b) notes issued from the securitized trust. The notes vary by seniority, coupon, quality rating and tenor. They derive their cash flows of principal and interest from the underlying collateral pool. The risk factors which affect the notes are directly tied to the performance of the collateral pool (defaults, losses, prepayments) and the structural features which give senior notes a higher claim on cash flow than subordinated notes. Securitization allows investors with different risk-reward profiles to buy bonds collateralized by mortgages, credit card or auto loans and many other receivable types. Securitization provides increased funding and liquidity to the lending markets. From the investor’s standpoint, securitizations are a significant source of spread assets of all types.
The securitized markets are segmented along the risk spectrum from stable, low volatility assets to distressed securities, sometimes within the same securitization itself. Investors with different investment needs can find a deep supply of bonds in sub-sectors of the securitized markets. This opportunity set also creates a fertile environment allowing for tactical flexibility to alter a portfolio’s risk profile (up or down) as market conditions change.
Securitized assets are complex since in-depth analysis requires detailed knowledge of collateral and issue structure. This complexity represents an information barrier for many investors and a source of excess return for managers with specialized skill in structured finance. Due to information barriers, we observe that the number of securitized specialists is small compared to the larger number of active bond managers in core, HY bond and bank loan space. When managed and executed properly, significant risk premiums can be captured in securitized assets. These risk premiums include factors such as credit and prepayment, liquidity, downward ratings migration, and potential external factors such as government intervention.
What is Declaration’s competitive advantage versus other managers who also invest in securitized assets?
We have been investing in structured finance since 1989 with experience over several market cycles - most importantly, through high macro volatility periods. Our skill is based on solid research capabilities, loan level analysis, trading experience, insight into intrinsic value and first-hand knowledge of the volatility characteristics of securitized assets up and down the capital structure. We strive to take a neutral view on relative value within securitized space between commercial mortgage credit, residential mortgage credit, and agency mortgage securities. Our team has specialists in all those areas and our portfolio managers have extensive experience comparing relative value within a cross sector, risk neutral framework. Our performance history through the cycle demonstrates risk management (downside risk control) and solid excess returns in strategies ranging from lower volatility to higher volatility.
How best would you protect client assets?
We monitor portfolio risk carefully. In our view, risk is the probability of permanent loss of capital. There is no such thing as upside risk. If we are not comfortable with the opportunities in our markets, we can reduce exposure, go outright short (in some mandates), or hold cash until conditions change. In some “opportunistic” strategies we have managed in the past, we returned capital to investors ahead of schedule after our investment thesis had been realized in full.
At the portfolio level, we manage risk through asset diversification, limits on issue size and asset tenor, tactical asset allocation to reduce exposure to higher beta credit risk assets when risk premiums are narrow, and through patience in entry point and limited use of leverage (most strategies do not use leverage). At the security level, we analyze collateral using loan-level information and quantitative models to forecast default, loss and prepayment trends. We also evaluate risks which are beyond the scope of models, such as mortgage servicer behavior or government policy risk. We generally avoid securities with a large degree of unquantifiable risk from such exogenous factors. We run extensive scenario analysis and test each security’s expected return under base case and numerous stress cases. We focus on senior classes which have a margin for error and a relatively flat risk-return profile over a range of scenarios because of their lifetime senior claims on collateral.
Would you please explain why you have decided to be a portfolio manager? What do you always try to do and what would you never do?
I’ve had a strong interest in investing and in the financial markets from a young age. Even while studying engineering as an undergraduate, I always expected to be involved in finance. Markets have always fascinated me with their displays of extreme human emotion, at times irrational crowd behavior, as well as their more objective mathematical underpinnings. The market discounting mechanism is a mysterious one and not as efficient as many textbooks would have you believe. Portfolio management is dynamic, intellectually satisfying work that requires wearing many different hats and asking a lot of hypothetical questions in order to improve the investment process.
As a portfolio manager I strive to keep the longer term goals of our clients in mind as I make decisions around their portfolios. Where do they want to go with this portfolio and what kind of volatility are they willing to accept to get there? Am I communicating my current market views effectively? I never make a decision that is not in keeping with a client’s risk profile and tolerance. It isn’t good business for us and it certainly is not good for the client if things don’t turn out well. Relationships are invaluable and we strive to build them transparently one step at a time.
Would you recommend a particular book on investing and why?
I’d highly recommend This Time is Different by Carmen Reinhart and Kenneth Rogoff. Reinhart and Rogoff help orient oneself in the annals of economic and market history in terms of where we find ourselves now. They provide a wealth of valuable information about how a wide range of countries behaved heading into and out of difficult economic and financial environments. Developing an understanding of how the current situation in the United States and Europe compares to historical precedent is key in constructing our longer term views. Economic recoveries from financial and property busts typically are quite sluggish and prolonged even with extraordinary levels of fiscal and monetary support. Defaults, devaluation, and inflation are common features throughout history and are highly likely to appear again.
Please describe the information sources you regularly refer to for your investment research. How do you properly manage ‘information overload’?
We use a number of different information sources in our investment research. They range from the traditional sources such as newspapers like the Wall Street Journal, Washington Post, and New York Times to periodicals including the Economist and Grant’s Interest Rate Observer. We also follow all investment bank research on the securitized markets. Since we are heavily involved in real estate, we religiously follow pricing and credit statistics on housing and property markets. We also read everything that comes directly from the Federal Housing Finance Administration (FHFA) in order to keep our fingers on the pulse of the residential mortgage market. Such a large part of mortgage finance in the United States is currently government funded thus we pay careful attention to this important source of supply and its role in implementing policy.
One can easily be overwhelmed by the sheer amount of information and opinion that is available about the markets and economy. By necessity, a portfolio manager must develop an effective means of processing that information. Our approach must be open to incoming data and opinion (conflicting or confirming) but backed by a core set of principles that has stood the test of time. These principles include our views on how the economy and markets work and especially how to manage risk in investment portfolios. Those core principles allow us to accurately analyze new information and determine whether any adjustment is needed to our investment views and portfolio makeup. We strive to be flexible and tactical on a near to medium term basis while slowly updating our longer term economic views as data avails itself.
Managing Director, Investment and Research
• This article originally appeared on March 16, 2012. Any views presented in this article are as of such date and are subject to change
• This article and the information provided therein is not a recommendation to purchase or sell any security, nor is it intended to constitute the marketing of, or a solicitation for investment in, any investment product.