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   Interview

    Guest Interview:

   MPI Investment Management

    15 Salt Creek Lane Suite 404
    Hinsdale,IL 60521

    Telephone: 630-325-6900
    Fax: 630-325-8167
    E-mail: info@mpi-invest.com

 

    Interview Quarter: 1Q2012

 David Pequet

 President/CEO &
 Senior Portfolio Manager

  Give us an overview of MPI Investments and its history?  
  MPI Investment Management is an independent registered investment advisory firm that specializes primarily in short-intermediate duration high quality fixed income separately managed accounts. We have a 20 year GIPS compliant track record for our taxable fixed product. MPI’s portfolio management team has been together that entire 20 year time period and MPI’s fixed income portfolios have never had a down year in performance. We have been fortunate to have received several recognitions over the years for our low risk fixed income style. Our firm also offers a balanced equity product. MPI was proud to celebrate its 25th year of operation in 2011. During that time period we have obviously been thru both good markets and bad and feel that our broad experience adds value to our account relationships. We are located in Hinsdale, IL, a suburb of Chicago.  
  What are the most important factors emphasized in MPI’s fixed-income investment philosophy?  
  Safety of principal, liquidity, and current income are the primary factors that MPI’s investment philosophy emphasizes. Customized client solutions are also an important part of our equation.  
  Why does MPI prefer to concentrate its expertise towards fixed-income investing?  
  MPI has had a focus on fixed income for nearly two decades. My investment background started in the fixed income world. Prior to starting MPI Investment Management in 1986 I was a fixed income broker for 10 years. We noticed many years ago that there was a niche for independent separately managed accounts in the high quality short/intermediate fixed income asset class for many high net worth investors and mid size institutions. The market place has always been such that separately managed accounts for these investor groups are only available at very high minimum account sizes. MPI bridges this gap by providing individual portfolios and customized solutions with direct access to portfolio managers.  
  How do you use short/intermediate term fixed-income securities to provide investment stability?  
  It is our opinion that investment stability in the fixed income world is measured by risk adjusted returns. Liquidity, quality, volatility, and competitive current income are all important factors. We have found long term success by managing bond portfolios in the 2-5 year average maturity range and utilizing high quality fixed income securities. This approach has worked well for us in all interest rate environments. Historically MPI has been able to deliver competitive returns of approximately 75% of the available yield as measured by intermediate interest rates in our asset class with only 30% of the risk as measured by volatility.

In our taxable strategy, we primarily use securities that fall under the U.S. Government guarantee umbrella. This includes government treasuries, agencies, GSEs and mortgage-backs. In some cases, depending on a client’s investment mandate we will also use a small percentage of high quality corporate bonds. In our opinion credit quality is a major component of investment stability and therefore a very high quality taxable bond portfolio supports that objective.

In Muni portfolios we also have a bias towards high quality issues. MPI municipal portfolios have a AA average credit rating. MPI focuses on general obligation (GO’s) and essential service (water, sewer) municipal bonds. Portfolios are well diversified by state and structure. We utilize broad range of analytical tools in addition to the typical rating agency input. The strategy of using a broad base of research tools and not just solely relying on the credit rating agencies is something that kept us out of trouble in the last couple of years when the rating agencies failed in delivering solid credit information.
 
  Tell us about your Tax-Free Municipal Bond Portfolio, its average maturity length and general bond quality.  
  Our current muni portfolios have an approximate average maturity of 3.8yrs and an average AA quality rating. The yield to maturity is in the 1.6% range.  
  Do you also manage municipal bond portfolios in states other than Illinois?  
  We manage tax free accounts for investors nationwide.  
  Why do you think the fixed-income market has generally performed better than the equity market over the past decade?  
  For the ten year period ending 12-31-2011 the equity market, as measured by the S&P 500 index, was up 2.88% on an annual basis. During that same period MPI taxable accounts were up 3.94% net and MPI tax free accounts were up 3.04% net. Fixed income accounts outperformed the last decade not because their performance was above historical averages but rather because equity performance was significantly below historical averages. The 100 year average equity return is in the 9-10% range well above the trailing 10 year number of 2.88%. That said we are still very proud of our long term returns.  
  What would you do if interest rates were to begin to rise significantly?  
  Currently our portfolios, both taxable and tax free, have average maturities of approximately 3.5 years. MPI’s management style is very well suited to a rising interest rate environment. We have successfully navigated thru several rising rate markets in the past 25 years. When interest rates begin to move higher we will gradually shorten our duration even further. At the bottom of the last interest rate cycle in 2003 MPI portfolios had an average maturity of approximately 2 years. As interest rates rose the following 24 months MPI portfolios captured higher portfolio yields and gradually extended maturities to current levels of approximately 3.5 years.  
  Do you offer combination fixed-income and equity portfolios and how do you allocate between them?  
  We do offer balanced portfolios. Asset allocations are determined at the time of account setup and are driven primarily by client input based on individual risk tolerances and income requirements. Allocations are reviewed periodically to assure they are within investor objectives and guidelines.  
  What is your general investment strategy for your equity portfolios?  
  We utilize a diversified approach of individual stocks, ETFs and mutual funds. We have an asset allocation model that is approximately 50% US large cap, 20% international and the balance in small caps and natural resources related issues. We have believed strongly in international markets for several years. We have also had a bias for natural resources, energy and the agriculture/commodity industry sectors. This sector emphasis has provided solid long term performance.  
  How do you adjust your equity portfolios for investment risk?  
  Our conservative bias managing fixed income carries over to our equity management style as well. We begin with a high quality diversified portfolio and pay particular attention to balance sheet fundamentals and growth potential. Individual security position size is generally 3-5% of the total portfolio. We also favor stocks with strong dividend records. These characteristics generally help provide a lower risk portfolio. Portfolios are monitored daily and asset allocation is adjusted generally on an annual basis or more frequently as required by market conditions.  
  What kinds of stocks would I generally find in your equity portfolios?  
  Large cap growth and above average dividend stocks would be typical. Our top equity positions are:

Apple Computer - AAPL
CA, Inc - CA
Eli Lilly - LLY
McDonalds -MCD
Newmont Mining - NM
Pfizer - PFE
Ishares Brazil - EWZ (International)
Ishares Canada- EWC (International)
Ishares Nasdaq 100 - QQQ (Technology)
Market Vector ETF Agri Business-MOO
 
  What kind of investors would be most suitable for your investment services?  
  Our clients are high net worth individuals and midsize institutions and corporations. The institutions include insurance companies, municipalities and police and fire pension funds. Because we have a conservative investment style within a more conservative asset class our clients are generally risk adverse in nature.  
  What portion of your managed assets come from institutions versus individual investors?  
  Approximately 60% of our assets under management are institutional and 40% high net worth individual  
  What are the advantages for clients to come to MPI Investment Management rather than larger money center bank or brokerage house?  
  The advantage boils down to a couple of fundamental issues. Do you as a client have direct contact with the person that is actually making the decisions for your portfolio? Are these contact people principals in the firm or marketing representatives? PIMCO, Vanguard or any other large entity, all do a nice job, but if you want to be able to talk to the people that actually are accountable and are managing your portfolio it would be impossible unless you’ve got maybe $100 million under management with them. Another important structural aspect is MPI takes fiduciary responsibility over your account. This is a much higher standard of care that many investment firms and brokers cannot contractually provide an investor. When you have your portfolio managed at MPI, you have full access to the portfolio managers and the operational people responsible for your account. We’re happy to spend as much time as you like with your questions or unique requirements. The other big difference is we can customize a portfolio. We have our standard products but many of our clients have situations that are little bit different; they may need us to help manage their portfolio around some life event, an acquisition or sale, a death or divorce, whatever it might be, and so we can customize a portfolio, customize their cash flows, customize their maturities or the durations or the risk profiles. That’s something that when you go to a Vanguard you just take whatever they give you and that’s that. We are also making the decisions of when to get into the market, out of the market, when to shorten, when to extend ect. You won’t have that with a “canned” product. You don’t have that active management component that you do with MPI Investment Management. We’re not a 100 billion dollar firm, but you can dial up MPI and have a talk directly to the person that’s managing your portfolio; you’re not able to do that at large money center institution. For some people, that’s important, and some it isn’t. It’s a personal preference. It’s not to say that large firms are not good companies; many have excellent track records, it’s just some people need a little different service level.  
  What sources do you use for your investment research?  
  We use a wide variety of research tools including Bloomberg Financial, Wall Street Journal and Barron’s online data bases, Morningstar and several financial periodicals and Wall Street Investment Banking research.  
  How did you do during the 2008 stock market meltdown?  
  MPI fixed income accounts performed very well in the 2008 financial crisis melt down. Client taxable bond accounts were up 4.98% net and MPI municipal accounts were plus 4.14% net. This solid performance was a reflection of MPI’s investment style and specific asset class: shorter duration higher quality fixed income. This performance was in line with our benchmarks. 2008 was a classic matter of being in the right place at the right time. However it is important to note that on average, across all fixed income asset classes and bond investment styles, the average bond manager was down over 4% in 2008. MPI equity accounts in 2008 were down in line with the equity index averages.  
  Have you made any significant changes to your investment methodology in the past few years?  
  MPI has made no significant changes to its investment methodology for many, many years. We believe that one of the keys to our investment success is a consistent, transparent and predictable approach to the markets. Style drift has never been a problem and clients take comfort in knowing MPI utilizes a conservative long term approach.  
  Do you use cash as an investment tool and when do you use it?  
  We do not use cash as an investment tool in our investment approach. However as a practical matter cash balances can grow at times to a 5-10% level before reinvestment occurs.  
  Who are the other portfolio managers at MPI and what are their investment backgrounds?  
  I am President/CEO and Senior Portfolio Manager for MPI Investment management. I founded the firm in 1986. We manage over 300 million dollars of primarily fixed income institutional and high net worth portfolios in the United States and in Europe. During the last two decades MPI has been nationally recognized several times for its fixed income investment management. Prior to starting MPI I specialized in fixed income at several Wall Street securities firms including Prudential-Bache and Mosley Securities. I earned an engineering degree from Michigan State University in 1974.

Bradley C. Smith is my partner on the portfolio management team and is a Senior Vice President and Chief Compliance Officer for the firm.

Brad has been at MPI since 1992 and started at Merrill Lynch Pierce Fenner & Smith in 1991. He graduated from the University of Iowa with a B.A. degree and earned his MBA in Finance with distinction from DePaul University.
 
  What is your outlook for interest rates?  
  It is no secret that MPI Investment Management is a strong advocate of bond portfolios with short average maturities. MPI has published white papers cautioning against higher rates 3 times in the last 12 months. It is also a fact that interest rates have spiked higher in a short period several times last 18 months and then retreated. However, in those situations, the pull back in rates and strength of the bond market was primarily the result of international “flight to quality” pressures from the Arab political turmoil in spring of 2011 and the ongoing EURO Credit crisis.

Recent economic data has been gradually improving. The Fed’s recent release of “stress test” results reflects this improving landscape. The general consensus in the market place has been that interest rates are going to remain low for an extended period of time out to June of 2014. The Fed has intentionally engineered a yield curve that has forced many investors out to the longer end of the yield curve. Longer maturities suffer the greatest volatility in a rising rate market. We have seen this first hand each time rates have spiked higher, specifically late last month in March, as well as in Q4 2010 and October 2011.

Sometimes history does repeat itself. The recession and recovery of the early 1990’s could end up being one of those situations. The U.S. was in a recession from mid 1990 thru mid 1991. The 1992-93 recovery was characterized by a sluggish employment recovery and the term “Jobless Recovery” was coined. Economic growth was modest and the general Wall Street consensus was the Fed would remain accommodative with low interest rates. And then the economy began to improve. Solid economic numbers began to emerge in Q4 1993 and in Feb 1994 the Fed began raising interest rates and did so 7 times in 12 months. The 30 year U.S. Government bond declined 12% in 1994, the worst performance since the depression.

The exact bottom in the current interest rate cycle will be clarified in the quarters to come. The fact is that interest rates are at historical lows and have no direction to go in the future but up. History has demonstrated that these moves can happen quickly. Between 2004 and 2006 rates were increased by the Fed 17 times.
 
  What advice would you give to fixed income investors at this time, and should they be wary of any challenges ahead?  
  Now is the time for investors to review their portfolios and make adjustments if they own long maturity bonds or bond funds. Sell longer maturities and buy shorter maturities.

Higher interest rates can be a positive for a properly constructed portfolio which maintains a short average maturity. Depending on an individual investor’s goals and objectives, a 3-5 year duration could be optimal. Focus on A rated or better issues and err towards higher quality. And lastly, be patient. Interest rates will trend higher. They are at all time lows and will not remain at these levels forever. Maintaining a shorter average maturity portfolio will allow you to “walk up” the yield in your portfolio as interest rates rise without significant risk to your principal. Higher interest rates will be a welcomed event for those investors that have a properly structured portfolio.

Stay short, stay high quality, I can’t emphasize it enough. In the last 18 months, the amount of new money that has gone into intermediate and long-term bond funds is approaching four standard deviations from the ten-year mean. So much money has gone into long bond funds that when rates turn, those funds are going to get hurt, they’re going to go down in value on paper. When we’re at 30-40 year lows in yields in the marketplace, you don’t have to be too scientific to determine that rates are going to go higher at some point in time in the future. It’s not if they will go higher it’s just when are they going to go higher, how fast and how long. What’s the momentum? What’s the velocity of higher rates? That’s the unknown.

The good news is that investors have a window at this point in time to make portfolio adjustments before the damage begins to occur in a rising rate market.
 
  Where can I get more information about MPI and what kind of information do you provide?  
  You can find additional information on the firm on our website which is: www.mpi-invest.com, or you can contact us at 630-325-6900. We are always happy to provide an in-depth portfolio review of your existing portfolio.  
 
 
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