Math whiz Jeffrey Gundlach, co-manager of the $204 million TCW Galileo Total Return Bond Fund (TGLMX), knows the ins and outs of the mortgage-backed securities market. His fund, which concentrates on this area, has returns that rival the best bond funds. For the last 10 years, the portfolio, which Gundlach runs with Philip Barach and Frederick Horton, has risen 7.38%, vs. a 6.58% average annualized gain in the Merrill Lynch Asset-Backed Securities index. It's just one of the reasons that Gundlach, Barach, and Horton have landed on the annual S&P/BusinessWeek Excellence in Fund Management Awards list for the second time.
BusinessWeek's Lauren Young recently spoke with Gundlach about his investing strategy. Edited excerpts of their conversation follow:
Q: What kind of debt is the fund invested in?
A: Our fund is concentrated in mortgage-backed securities. We look to have a dual objective. We want to perform competitively with mortgage funds like Vanguard's Ginnie Mae fund. We're also a core bond fund like Pimco Total Return. To do both, we run the fund very consistently. We fund it with a maturity structure that's consistent with intermediate-bond funds.
Q: What's happening now that the refinancing boom is winding down?
A: A year ago, there was a frenzied mortgage-refinancing boom going on. In 2003, there was a big difference in the maturity structure of mortgage-backed securities. Mortgage funds are like money market funds. They have very short maturities. Our fund was shorter than virtually every thing else out there.
Now the refinancing has gone away, and all the new mortgages issued in the last 18 months are not in refinancing condition. But while the universe which the fund invests in has changed, and there's more volatility and a lot higher yield, our exposures haven't changed that much. We are investing about one-third of the portfolio in adjustable-rate securities. They're very popular in mortgage financing. The rate is fixed for five years, and then it adjusts.
Q: How do you manage risk in the portfolio?
A: Ginnie Maes have the highest risk-adjusted returns historically of any U.S. asset class. Look at their returns vs. volatility. They're higher than stocks, junk, corporates. The relationship between the yield and the volatility is persistently more favorable in mortgages. By concentrating in mortgages, we have an edge over more diversified funds.
We also own more collateralized mortgage obligations than we had a year ago -- about 35% of the fund [CMOs are derivative debt securities that are backed by a portfolio of mortgage loans and mature when you receive the final principal payment.] We buy them at discounts, and they help to build in protection should rates fall.
Q: What's your interest rate outlook?
A: A lot of people are worried about rising interest rates. And they think higher rates are bad for the fund because many of the adjustable-rated mortgages we invest in reset every few years. The thing is, we know they're worth par in four years. Everyone talks about rates going up, but they seem to be stuck at this level.