Jeffrey Gundlach, Bond SavantBy
DoubleLine Capital’s new office is high up in a downtown Los Angeles skyscraper, with unobstructed views of the famous Hollywood sign. As you walk out of the elevator, a huge canvas with the firm’s logo greets you; DoubleLine founder Jeffrey Gundlach painted it himself. Pass a six-foot-tall faux terra-cotta Chinese warrior and you’ll find a conference office called the Van Gogh Room. The Van Gogh Room has no Van Goghs, though it does display a pair of landscape paintings and looks out to a reception area adorned with other paintings Gundlach won at auction. It also, on this visit, contains Gundlach, sitting at the end of the conference table in a crisp button-down shirt, with a goatee and rust-colored hair, cut short.
The idea was to interview Gundlach, whose company is the fastest-growing mutual fund startup in history, but the conversation quickly turns into a kind of test. Gundlach wants you to know he is a connoisseur of fine art. He also wants you to know you don’t know squat.
“Do you know the total U.S. debt?” he asks.
Around $15 trillion?
“Right,” he says. “Do you know what percentage of national revenue comes from the income tax?”
“You’re forgiven for not knowing that,” he says. “It’s not what you do. But if you’re managing bond money, it’s the least you should know. Was it Socrates who said, ‘It’s that I know that I don’t know everything’?” Gundlach is fond of quoting the great and ancient in the service of macro bets: A recent PowerPoint presentation on the future of bond yields started nearly every slide with a quotation from Shakespeare.
He dives into why he alone can trounce the competition in bond funds. “I can still do about 7 percent in a world of 2 percent,” he says. “You stress-test your portfolio constantly. You think about it and analyze it to death. Other people don’t know how. I wish I could teach it to somebody.”
Since DoubleLine first took investor money in April 2010, it has amassed $34 billion in assets. Even as it quadrupled in size last year, DoubleLine’s $22 billion Total Return Bond Fund outperformed 99 percent of its rivals. The firm takes in $80 million to $100 million in new client dollars every day.
Unlike the reigning bond king, Bill Gross, manager of Pimco’s $259 billion Total Return Fund, DoubleLine Total Return invests primarily in mortgage-backed securities, which Gundlach says he can combine into a portfolio that posts higher returns even during economic downturns. In January, Barry Ritholtz, the New York finance blogger who helps manage $500 million in high-net-worth assets, moved all of his Pimco assets to DoubleLine. Ritholtz says that with the Federal Reserve maintaining its zero-interest rate policy and Treasury bonds yielding so little, Gundlach’s less understood mortgage market expertise was needed to get his clients higher yields without having to make a firmwide bet on interest rates. “It was a straight-up trade for me,” Ritholtz says. “Bill Gross for Jeffrey Gundlach—no player to be named later.”
DoubleLine is not only the fastest-growing mutual fund startup ever, it may also be the fund with the strangest genesis. Two and a half years ago, Gundlach was fired by his old employer, Trust Company of the West, where he and his team managed 70 percent of that firm’s $110 billion in assets. It was a messy departure that involved mass defections, a stash of porn and drug paraphernalia, and an acrimonious trial. The rival firm Gundlach founded may outgrow its ancestor.
Gundlach grew up in Buffalo. His father was a chemist at a company that made wax for bowling alleys, and his mother was a housewife. Although his uncle Robert Gundlach invented the photocopier and his grandfather Emanuel Gundlach formulated a hair tonic popular in the 1950s called Wildroot Cream-Oil, he says his family scraped to get by. “When our drying machine broke, it didn’t get fixed,” he says. “My mother would just run clotheslines all across the backyard.”
What he lacked in privilege, Gundlach says, he made up for with hard work and intelligence. “Look, I’ve never needed to network,” he says. “I was always at the top of my class, always got straight As. I got a near-perfect math SAT.” He went to Dartmouth on financial aid, graduated summa cum laude in math and philosophy in 1981, and entered Yale’s applied mathematics Ph.D. program. Two years later he dropped out and drove to California to become the drummer for a rock band called Radical Flats. He had a Flock of Seagulls pompadour and a day job at insurer Transamerica. A year later, broke and watching Lifestyles of the Rich and Famous on a little black-and-white TV, he resolved to become an investment banker.
He opened a phone book, flipped to “Investment Managers,” and talked his way into a meeting at TCW. He knew nothing about bonds, but the firm was impressed enough by his math skills to offer him a job. By the time he showed up for his first day of work as an analyst on the bond desk, he’d already mastered the math in Sidney Homer and Martin Leibowitz’s Inside the Yield Book, which lays out the field of bond analysis. “Very few people can do that,” he boasts. “Like, very few. I quickly realized I knew more than most people who worked at TCW for years.”
As he immersed himself in the bond market—duration analysis, the yield curve, prepayment risk—Gundlach quickly rose up the firm’s ranks. By 1987, as the savings and loan crisis took hold, the 28-year-old had a reputation as TCW’s mortgage wunderkind. The firm gave him $500 million to manage, and he finally quit his band, which by then was called Thinking Out Loud.
The bond market is a grinder’s playground. A big winner, like Gundlach in 2011, might deliver 9.5 percent. Gross’s Total Return Fund last year, with its more diversified strategy, earned 4.2 percent. A long-term winner might deliver annual returns of 6 percent or 7 percent. Managers can invest in Treasuries, among the safest securities on the planet, but with yields near record lows—a 10-year government bond earns 1.9 percent—it takes other vehicles to deliver a competitive return, especially after fees, taxes, and inflation. (Bond funds are chiefly measured against the Barclays Capital Aggregate Bond Index, just as equity funds aim to beat the Standard & Poor’s 500-stock index.) To increase returns, a manager can buy riskier foreign sovereign and corporate debt, but such an approach can go very wrong. That happened at Pimco last year when it avoided Treasuries just as they staged one of their best rallies in history.
Gundlach favors mortgage-backed securities, which are themselves portfolios of home loans. There are two types: guaranteed and non-guaranteed. Guaranteed mortgages are backed by Ginnie Mae, Freddie Mac, and Fannie Mae, which are sponsored by the government. They’re more secure and thus have lower yields than their non-guaranteed counterparts. These bonds must still yield more than Treasuries to compensate investors for the risk of homeowners prepaying their mortgages. Like Treasuries, they increase in value when the bond market gets anxious about risk. That’s what transpired last year, amid fears of a European meltdown.
Non-guaranteed mortgage securities are directly issued by financial companies and banks not associated with the government, and come with no credit guarantee. The higher risk is reflected in higher yields. If the economy and housing do well, and investors prefer riskier assets to government bonds, non-guaranteed mortgage securities will both pay a nice yield and appreciate in value. The Gundlach theorem: A portfolio with a blend of both kinds of mortgage securities will combine credit risk and interest rate risk in a way that throws off higher returns.
Gundlach has been playing the mortgage market for decades. In 1990 he took home his first million-dollar paycheck. Over the following decade, his pay swelled into the tens of millions. At TCW Total Return, Gundlach rode through the worst of the financial crisis, from 2007 to 2009, to return 9.1 percent a year. By 2009 he was making $40 million a year, and his team was managing most of TCW’s assets.
Just after lunch on Friday, Dec. 4, 2009, Gundlach, then 50 and TCW’s chief investment officer, watched as the bond market closed on the East Coast. It had been a great year: His TCW Total Return Fund had posted more than double the average return of its peers. Morningstar had nominated him Fixed Income Manager of the Decade, and he was on track, he says, to collect hundreds of millions in salary and bonuses over the next couple of years.
Gundlach headed upstairs for what he believed was an executive meeting. Instead, in the boardroom, he was met by TCW’s chief counsel and an attorney from Quinn Emanuel Urquhart & Sullivan. They presented him with a document alleging gross misconduct, including an attempt to steal staff and confidential client and trade information to launch his own rival firm. His 24 years with TCW were over, effective immediately. His BlackBerry was already disabled.
Gundlach kept an office on the west side of L.A., where he would work some mornings to avoid rush-hour traffic. Figuring he’d go collect his belongings, he pulled out of TCW’s garage in his Porsche and headed to Santa Monica. At that office, he recalls, he found the door broken and the desk drawers ransacked. TCW would later claim Gundlach kept in his office a stash of porn, sexual devices, and pot-smoking accessories. In a letter to DoubleLine clients, Gundlach called those items “vestiges of closed chapters” of his life. TCW spokesman Peter Viles says the office was company property that security personnel entered with a key.
Back at TCW’s trading floor, Chief Executive Officer Marc Stern informed Gundlach’s team that their boss was gone, and that TCW was acquiring rival Metropolitan West to plug the hole. The following morning, 15 senior members of Gundlach’s team repaired to his house. Gundlach’s then-wife, Nancy, made coffee. (That’s her, second from left, in the band photo at the beginning of this article.) Louis Lucido, a deputy at TCW, brought donuts.
By noon, 14 of the gang of 15 had resigned from TCW. The holdout was Philip Barach, co-manager of the TCW Total Return Fund. Surrounded by a circle of mutineers, Gundlach, who says he got misty-eyed, persuaded Barach to join them. The two men shook hands and hugged, and the reunited team applauded Barach as he thumbed out his own resignation on his BlackBerry. “It was a total leap of faith,” recalls Barach, now DoubleLine’s president. “I wasn’t poor. But this was all or nothing.” That night, he says, TCW CEO Stern drove to his house and offered him a minimum of $10 million a year over six years to stay, with an understanding that the 57-year-old could retire and collect his entire package in just three years. Barach turned down the offer.
“TCW made a multitude of miscalculations,” says Gundlach. “Even if they’d kept most of the team, the clients would have fled. They knew that I ran it.” TCW’s spokesman, Viles, responds that the acquisition of $30 billion MetWest more than made up for the loss of Gundlach.
By the following Wednesday, Gundlach had his 15 colleagues, plus 17 more who had also bolted from TCW, running around town to get the new operation running. Lucido bought 30 laptops with a personal credit card at Best Buy. Others Googled client names; TCW had seized their computers and Rolodexes. Barach and Gundlach prevailed upon Oaktree Capital, a $67 billion investment firm run by former TCW Chief Investment Officer Howard Marks, to kick in an undisclosed amount. On Dec. 14, five days after Gundlach was fired, DoubleLine put out its first press release.
On Jan. 7, 2010, TCW filed a lawsuit against Gundlach alleging conspiracy, breach of fiduciary duty, and theft of proprietary information. The suit claimed Gundlach had been planning for months to leave TCW and start a rival firm, and that his behavior was “erratic” and “increasingly and openly confrontational.” Forty-five out of 65 of Gundlach’s old TCW team had since decamped for DoubleLine.
“The day we were sued, the phones stopped ringing,” says Bonnie Baha, one of Gundlach’s crew of defectors. “Each of us had families to support. Not one of us was drawing a salary.” On Feb. 10, a month after TCW filed its suit, Gundlach put out a press release announcing a countersuit to recoup $1.25 billion in fees he says TCW owed him and his team. “I believe the facts stack up overwhelmingly on our side,” he said in the statement. “I would be delighted to see this case go to trial tomorrow, if that were feasible.”
DoubleLine in its early days, says Gundlach, faced the chicken-or-egg problem of not yet having nearly enough client assets to prove itself—which, of course, it could hope to do only with enough client assets. He says he realized his last best hope was opening DoubleLine to the masses. “If we were going to make it,” he says, “it would have to come down to mutual funds. It was like putting my record up to a popular vote.”
On April 6, 2010, with staff in and out of depositions related to the trial, DoubleLine launched its own Total Return Fund. A Merrill Lynch brokerage office immediately wired $65 million. By December 2010, the fund had crossed $7 billion in assets under management. One early adopter was broker Kurt Brouwer of the $700 million investment adviser Brouwer & Janachowski in Tiburon, Calif. “We used TCW Total Return, so we were comfortable with him,” he says. “The transition wasn’t traumatic. We just left TCW and moved over to DoubleLine. People are motivated when they start new funds. The messy, sordid details weren’t important to us.”
In September 2011, after six weeks of trial, an L.A. jury awarded Gundlach and three associates $67 million in unpaid wages. While the jury also found them liable for breaching their fiduciary duty to TCW and misusing company secrets, it didn’t deem the breach important enough to award TCW any damages. In December, before that decision was finalized, Gundlach and TCW agreed to settle their dispute; terms of the deal are confidential. As for that pleasure stash in Gundlach’s office, the presiding judge ruled in July that it was immaterial to the case. The jury never learned about it.
Gundlach says he will consider closing DoubleLine’s mortgage-backed investments to new money when they hit $50 billion in assets. “Do you realize that the week after TCW got rid of me, $30 billion in assets left the firm? That’s $150 million in annual fees,” says Gundlach. (TCW’s Viles calls those numbers “wildly inaccurate.”) Gundlach continues: “They figured that changing fund managers was no different than changing branch managers at the local bank.” He stops to tick off his achievements—a decade at the top of his category, taking DoubleLine’s assets from zero to $34 billion in three years. “Find me anyone else in this industry that did that.”