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Jeffrey Gundlach Is the King of Bonds -…
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| MONDAY, FEBRUARY 21, 2011
The King of Bonds By JONATHAN R. LAING
Brilliant and controversial, bond-fund manager Jeffrey Gundlach has outperformed nearly all his rivals, first at TCW, which fired him, and later at DoubleLine Capital, which he founded. Celebrated bond-fund manager Jeffrey Gundlach has a healthy -- some might say overdeveloped -- ego. In the course of several interviews at the Los Angeles headquarters of his new investment firm, DoubleLine Capital, Gundlach drops any number of boasts. He can do the Sunday New York Times crossword puzzle in a half-hour. On a good day, make it 20 minutes. Gundlach, 51 years old, was a top student at Dartmouth, where he majored in mathematics and philosophy before entering a high-powered Ph.D. program in mathematics at Yale. He left, claiming boredom, to become a rock drummer in L.A., before drifting into money management. "Look, I have a gift, or some would say a curse, of being able to have stunning insight into the reality of markets and the economy," Gundlach says, dressed resplendently at this particular moment in a well-tailored Italian suit with matching green tie and pocket square. "I don't often know where my ideas come from. Maybe it's the fact that I'm obsessively regimented in my analysis, borderline autistic. But whether it's bond selection or asset allocation, we can do it better than just about anybody around." It is easy to dismiss such swagger, but Gundlach has the performance record to back it up. At Trust Company of the West, where he worked for more than 20 years until he was fired in December 2009, his flagship $12 billion T CW T otal Return Bond Fund (ticker: TGLMX) finished in the top 2% of all funds invested in intermediateterm bonds for the 10 years that ended just prior View Full Image Michae l Gre cco for Barron's
Jeffrey Gundlach
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to his departure, according to Morningstar. It finished in the top 1% for the five years ended just before that watershed event. 1/6
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Gundlach's legendary success has continued at DoubleLine, which he founded shortly after leaving TCW. His DoubleLine T otal Return Bond Fund (DBLTX), with $4.5 billion of assets as of Jan. 31, outperformed every one of the 91 bond funds in the Morningstar intermediatebond-fund universe in 2010, despite launching only in April. It notched a total return of 16.6%, compared with returns of 8.36% for the giant Pimco Total Return Fund (PTTAX), run by the redoubtable Bill Gross, and 10.74% for TCW Total Return Bond, now managed by Metropolitan West, an able fixed-income shop acquired by TCW to replace Gundlach and his team. Gundlach's DoubleLine Core Fixed Income Fund (DBLFX), with assets of $112.8 million, is no slouch, either. It returned a total 7.5% from its June 1 launch through the end of December, nearly three times the performance of the Barclays U.S. Aggregate Index in the same stretch. EVEN MORE EXT RAORDINARY, Gundlach achieved this record by investing almost exclusively in his specialty, securities backed by home mortgages, during a decade when the mortgage-backed market underwent tectonic shifts, destroying many less able investors. First, plummeting mortgage rates led to waves of refinancings, forcing mortgage-backed holders to reinvest pre-payments at ever lower rates. Then came the housing bust in 2007, and a tsunami of foreclosures and mortgage defaults that continue to this day. Gundlach, who had warned of a coming residential-mortgage debacle as early as 2006, including in the pages of Barron's, deftly rode out the storm by switching out of private-market securities and into government-guaranteed agency paper issued by the likes of Fannie Mae and Freddie Mac. More recently he has burnished his results by buying private mortgage debt at fire-sale prices of 60 to 70 cents on the dollar, reaping both rich yields and price appreciation. Gundlach's performance has been "nothing short of tremendous," says Eric Jacobson, Morningstar's director of fixed-income research. "He has slaughtered the indexes during an extremely difficult time. The only cavil might be that Gundlach is far less diversified across fixed-income sectors than, say, a Bill Gross, who has a mandate to go virtually anywhere, from government bonds and investment-grade corporate debt to sovereign paper and high-yield. So some might argue that any comparison of Gundlach's performance to most other managers is somewhat apples to oranges." That's baloney, Gundlach and his associates say, maintaining they can replicate most interestrate and credit risk extant in the bond market in their specialized sector. Gundlach had responsibility for $65 billion of TCW's $110 billion of assets under management, and made many of the security selections and asset allocations in TCW funds invested in all fixed-income sectors. Some even had a mandate to invest in stocks. Gundlach rarely is shy about offering his opinion on markets. Like most bond honchos, including Gross, a member of the Barron's Roundtable, he seldom likes stocks, which are, after all, bonds' primary rival for investment dollars. "Though I rarely go public with specifics on stocks, I think the Standard & Poor's 500, which is now over 1300, will hit 500 in the next couple of years," he says. "I usually couch my belief by saying merely that 2011 will be a tough year for equities." Nor has he made a secret of his bearish views on the U.S. economy and the seemingly inexorable …barrons.com/…/SB500014240529702…
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rise in government debt. But he sees little chance in the near term of a surge in inflation that would send Treasury-bond yields soaring. A jump in the yield on 10-year bonds to a range of 4% to 4.5% from a current 3.6% would cause economic growth to short-circuit, he says. By the same token, a renewed slowdown in the economy would drive 10-year bond yields sharply lower, but not below 3%, unless a banking panic similar to last year's euro-zone crisis ensues. As for the U.S. housing market, Gundlach expects home prices to fall by another 10% to 15%. Gundlach's views on different bond sectors probably deserve more attention than his other pronouncements. He foresees a major collapse in the municipal-bond market, beyond the declines to date, given the parlous condition of both state and local government finances. He is preparing, he says, by having established a joint venture with the Chicago financial firm RiverNorth. Among other things, it expects to scoop up closed-end municipal-bond funds in the next year or so when the predicted apocalypse arrives, driving fund prices down, he says, to as little as 40% of net asset value.
What makes the $2.7 trillion muni market particularly vulnerable, Gundlach says, is its weak psychological underpinnings. Many investors in municipals are wealthy individuals who buy the securities purely because of their tax advantages and have little knowledge of the fundamentals of the paper they own. They tend to be "all-in" investors, owning little else, and thus will be prone to panic, he figures, in the face of surging defaults. "Look, I don't know whether the market will suffer $10 billion or $30 billion in defaults, but the actual amount doesn't matter, Gundlach says. "There will be a panic at the margin, and muni bonds from the highest-rated on down will plummet, in part because other sorts of investors tend …barrons.com/…/SB500014240529702…
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not to step in." One of Gundlach's biggest regrets is not having had the mandate to buy high-yield corporate bonds in his TCW fund. Thus, he was unable to take advantage of the succulent values available in the high-yield market in late 2008, at the depths of the global financial crisis. His DoubleLine total-return fund can invest up to a third of its assets in high-yield debt, although he is hanging back from that market now, concerned that prices have rallied too much. Gundlach's cautious take on high-yield is the result of an aperçu or intuitive flash he had several weeks ago, that the yield spread between high-yield and government bonds should be calculated using the 20-year government bond, rather than the entire Treasury yield curve. That's because high-yield paper, though maturing sooner than 20-year bonds, shares similar price volatility. The current 300 basis-point, or three percentage-point, spread between yields in the high-yield market and on 20-year bonds is as narrow as it has been at any time in the latest credit cycle, he notes. DoubleLine has been careful about quality. It still avoids pools of subprime debt and securities backed by high loan-to-value mortgages. It prefers borrowers with high credit ratings, which implies such homeowners have the ability, if not the desire, to refinance. Pre-payments in this environment can provide a windfall profit, as the fund gets paid 100 cents on the dollar for mortgages that cost, say, 60 cents. DoubleLine also shies away from subordinated-debt tranches, which could be wiped out in restructurings, and pools with lots of smaller mortgages, as high fixed closing costs deter refinancings of such debt. GUNDLACH CLAIMS T O HAVE the finest mortgage-securities team in the country. Nearly all its members left TCW out of loyalty to him after his firing. In the DoubleLine trading room, more than 30 traders, managers and analysts sit at trading pods, arrayed in rows in front of Gundlach and DoubleLine President Phil Barach, who preside over the noisy throng like a pair of prankish camp counselors. Trading decisions are made quickly, and the esprit de corps is palpable. Traders laugh and whoop it up when, during a recent CNBC interview, host David Faber proclaims Gundlach the best bond manager of the past decade. When the graphic under Gundlach's image elevates him to best bond manager on the planet, the cheering grows even louder. DoubleLine's funds currently are hedged somewhat against a possible double dip in U.S. housing, which would hurt the firm's private-sector securities positions. Gundlach claims his market opinions are right about 70% of the time, but just in case, the Total Return fund has a substantial position in long-term Ginnie Mae securities and various pass-through government-guaranteed collateralized-mortgage obligations, or CMOs. These alphabet-soup securities tend to trade like long-term government bonds, with prices rising and yields falling in bad economic times, and the reverse occurring as the economy strengthens. Likewise, they have little pre-payment risk, as lower home prices have snuffed out much of the equity that even creditworthy borrowers had. …barrons.com/…/SB500014240529702…
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T CW'S FIRING OF GUNDLACH made headlines, especially as he had become the face of the firm on television and in the press, with his canny calls on the housing market and a bullish call on the stock market at its March 2009 low. Behind the scenes, however, Gundlach apparently had alienated TCW's well-heeled founder and chairman, Robert Day. Day had always been adept at finding and fostering talented traders, but had trouble keeping top managers due to disputes about ownership stakes in the firm. The tension reportedly grew after he and others sold their stake in TCW to the French bank Société Générale. In Day's estimation, managers such as Gundlach were sufficiently compensated. Gundlach was paid about $40 million in 2009. Gundlach was said to be disparaging of the "suits" running the company, as well as TCW equity managers who had performed poorly since the dot-com bust in 2000. He was also considered contemptuous of TCW's absentee owners in Paris, who paid more than $1 billion to acquire control of the firm. The warrants SocGen subsequently handed out to Gundlach and other TCW employees were rendered worthless by revelations in early 2008 that a bank employee had lost $7 billion in unauthorized trading in stock-index instruments. Most of all, TCW was worried, and with some reason, that Gundlach might be planning to leave the firm. Better to shoot him and toss him overboard first, as Day is reported to have said in a conference call to employees after the ouster. Although TCW offered many employees in Gundlach's fixed-income group financial inducements to stay at the firm, some 40 people followed their boss out the door. An estimated $25 billion of TCW's assets also departed, notwithstanding the company's simultaneous acquisition of Metropolitan West Capital. In addition, institutional investors who had agreed to put money in some $5 billion of mortgagebacked funds with hedge-fund-type fees reportedly sought to back out once Gundlach left. The U.S. government pulled out of a planned $4.4 billion Public-Private Investment Program, or PPIP fund that Gundlach was supposed to have managed, saying TCW had violated the key-man provision of the investment agreement. Five weeks after Gundlach's dismissal, TCW sued the manager, four subordinates and DoubleLine for allegedly stealing trade secrets, including client lists, transaction information and proprietary security-valuation systems. The suit also charged that a search of Gundlach's offices had turned up a trove of porn magazines, X-rated DVDs and sexual devices, as well as marijuana. After the suit was filed, institutional clients stopped calling DoubleLine. Instead of getting $20 billion in funds for which it had been negotiating, the firm got less than a half-billion. "Institutional gatekeepers have no incentive to do business with money managers caught in legal controversy, no matter how good their performance has been," Gundlach says. He charges TCW with employing "smear tactics…to destroy our business." As for "the sex tapes and such," he says, they represented "a closed chapter in my life."
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T CW FILED ANOT HER SUIT in December that sought to close DoubleLine's mutual funds temporarily or glom the funds' investment returns. A California Superior Court Judge hearing both cases dismissed the key counts against the funds and fund trustees. TCW refiled the complaint two weeks ago, absent the charges that would have affected the fund operations. The trial over the trade-secret charge is scheduled for July, and promises to be incendiary. While TCW claims more than $200 million in damages, Gundlach, in a counter-claim, seeks to recover up to $1.25 billion in future income that he claims his group was denied as a result of his dismissal. Court documents suggest charges of the "sex, lies and videotape" variety could fly in both directions. Both TCW and DoubleLine have been losers as a result of the legal fracas, although TCW noted, in a statement to Barron's, that assets under management are growing again, and that the investment performance of the funds managed by MetWest personnel has been strong. For that matter, DoubleLine's net inflows have been strong in the past two months -- Gundlach says the firm now manages about $7.5 billion -- indicating the battle hasn't intimidated all investors. The winner, however, is Jeffrey Gundlach, whose reputation as the king of bonds is growing by the day.
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