[The Institute for Innovation Development recently talked with Luis Maizel, Co-Founder and Senior Managing Director of LM Capital Group - a leading San Diego-based, global fixed income investment manager servicing public funds, corporations, foundations, top financial advisors and is also the adviser to the LM Capital Opportunistic Bond Fund (LMCOX).
Besides a rather singular perspective drawn from extensive experience with the global bond markets, the firm’s investment process utilizes proprietary methodologies, including a matrix construction and future-focused scenario planning to address rapid change and uncertainty in business environments and markets. This brings up an important question of how do you adapt your investment approach to an environment of accelerating change and growing uncertainty?]
Hortz: Can you describe your proprietary methodology utilizing a global matrix to analyze current data? What does it reveal for you and how does it allow you to weather the volatility of the global bond markets?
Maizel: The matrix analysis is based, in principal, on the work of Nobel Prize-winning economist Wassily Leontief and has been refined for use in our investment process. Leontief advocated input-output analysis, which explores how changes in one sector may impact others. It is a key ingredient in our investment process and part of our value proposition.
LM Capital’s matrix is composed of the following six economic factors: Inflation, Employment, Trade Balance, Budget Deficits, International Influences, and GDP Economic Indicators. Our Investment Strategy Group (ISG) also reviews additional indicators that can impact the above. Within this matrix we thoroughly examine major global bond market indicators, as well as several lesser developed markets on a quarterly basis with a one-year outlook.
It is important to note that investing to achieve consistent returns is about a lot more than dollars and cents. It’s about more than watching interest and employment rates, etc. It’s about identifying a variety of global trends and assessing those trends from the perspective of bondholders. Once we assess whether or not economic trends are attractive, we determine as a team the duration and sector targets. Our position on the yield curve and sector selection creates a diversified portfolio with attractive risk-adjusted returns. We are able to weather volatile markets by participating in up markets and offering downside protection.
Hortz: While on the Harvard Business School faculty you developed and refined a scenario-planning process. What exactly is scenario planning and how do you apply it to the investment process?
Maizel: Scenario planning is typically the last step in our investment process. It is a proactive, forward-looking tool that provides a blueprint on how to react should the unexpected occur. Once the initial portfolio allocation and construction are complete, qualitative “what-if” scenario planning is deployed to determine which market reactions may occur in response to unexpected future events, either political, economic or social.
When we determine a new “what if” scenario, we contact regional “network partners.” We examine local newspapers and other news and information sources. We query experts in political science, logistics, geo-political issues, etc., depending on the issue or issues. We then build several outcomes, using a decision-tree process, to plan our responses without trying to forecast the possibility of it happening.
There’s always the chance that the so-called “invisible hand,” may surprise us. This is not necessarily in the form of a traditional economic event. It can be an extreme weather event, a strike, an earthquake, or a sudden military act or the threat of one. We peer behind the curtain to examine the good, bad, and ugly prior to making provisions for such events. It can be difficult to quantify a subjective event, which is why, for each scenario, we model our portfolio so we know how to respond.
Hortz: What does that add to the investment process? How can it be an effective risk-management tool?
Maizel: Let me provide some background. I advanced the Scenario Planning process while a faculty member at Harvard Business School. Royal Dutch Shell approached our department for advice. Subsequently, we applied different scenarios and probability outcomes for disruption within the international energy sector. It covered areas such as environmental and geo-political events, as well as price and supply-chain disruptions. The exercise demonstrated its value by pointing to a wide range of outcomes.
“What-if” Scenario Planning is a dynamic process that seeks to account for a variety of possibilities that may affect the markets. It is not necessarily a linear thought process but rather a different and dynamic phenomenon. It includes thinking and analysis that can challenge assumptions. By design, it forces everyone involved to think differently. Not to rely on a cliché, but it encourages “out of the box” thinking, forcing one to steadily look at sequences of potential events and re-evaluate components. It’s more than asking simply “Why?” We take the investigation a step further, in fact, several steps further, and ask: “Why not?” It’s about never being satisfied with the status quo or general consensus. Progress and innovation are typically achieved by those who think differently. The same holds true for the investment business.
Hortz: Can you describe a typical scenario for us?
Maizel: Due to the premise that each scenario is unique, there is no “typical” scenario. A recent example, however, would be Brexit. In this case, we modeled the portfolios in accordance with each side of the vote. When the decision was announced, we already had an action plan and, consequently, went longer in duration in our portfolios.
Hortz: You have written about how active team collaboration is a driving force within your investment process. How does a collaborative effort add to your process?
Maizel: Each aspect of our investment process is team-based. When I use the word “we,” I am referring to our Investment Strategy Group (ISG) that comprises the four LM Capital portfolio managers with input from the Credit Research team. A lot of businesses claim they are team-oriented but we actually are.
We further believe that each team is only as good as the people on it – from the coaches in the locker room to the players on the field. From the top down, we are a diverse team. We believe that professionals from different backgrounds can add value to our process due to the potential for providing unique insights. This coordinates with our belief that many opinions based on experience, judgment, and objective research help us help our clients. This is not necessarily an easy exercise, as we continuously allow room for debate. However, we feel it is a worthwhile one, and the only way to keep on top of a rapidly changing environment.
Hortz: What is different about your insight or experience in emerging markets in regard to recent political events as well as historical issues?
Maizel: This is an area where we are very comfortable. Presently, we are seeing more investor interest in emerging market debt, as individual countries benefit from stronger governance structures, less contagion issues, capital flow, and attractive yields relative to such a low-yield U.S. environment. Also with emerging markets, you have to frequently visit the regions where you have exposure due to a higher number of qualitative factors.
From our experience, when investing in emerging market debt (EMD), we believe in the need to invest in people more than financials. In many cases, the founding family still runs the company. You need to understand whether you are lending them money to grow the business or to buy a more luxurious jet.
On one occasion, a CEO of a large public company invited me on a pre-IPO “dog and pony” show, saying proceeds would be used to pay down debt. That night over dinner, he negotiated a major new acquisition that would use all the IPO money and increase leverage. I left the tour and never touched his paper again.
We also do not invest in countries where there is no rule of law, such as in Venezuela, Russia, and Nicaragua. Emerging market debt is like a minefield where you are well paid for successfully crossing it. If you truly do your homework, you can generally avoid the hazards and glean the rewards.
Hortz: What was your reason and strategy for launching a mutual fund?
Maizel: LM Capital has been managing institutional portfolios for over 27 years, using a proprietary, time-tested and differentiated investment process. We believe that the mutual fund marketplace can use something different and have seen increased demand in creating our product offering for retail clients.
We built the LM Capital Opportunistic Bond Fund (LMCOX) to be a low beta, low turnover, low expense fund that aims to exceed its benchmark, the Bloomberg Barclays U.S. Aggregate Index, over a full market cycle. Our unique investment process aims to eradicate risk for downside protection. The fund avoids derivatives and uses no leverage. These key differentiators have typically delivered very consistent returns. LM Capital has managed to avoid the minefields and our portfolios shine in tough times. Having a mutual fund also opens us up to partner with leading financial advisors across the country looking for a risk-averse bond strategy for their clients.
This article was previously published on Financial Advisor Magazine Online.
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