Gundlach’s Bet on Rates Wins Most Cash as MBS Funds LoseAlexis Leondis
Jeffrey Gundlach defied conventional thinking earlier this year by betting that interest rates would fall rather than rise. Investors are rewarding him for the call.
Gundlach’s $34 billion DoubleLine Total Return Bond Fund gathered assets as the majority of rival mortgage-backed securities funds lost investors in the first half of the year. DoubleLine Total Return also had the biggest 12-month yield along with the second-highest returns as of July 31 in the group of funds.
“The first thing people say about why they invest with us is the performance with a capital A,” said Gundlach, 54, the co-founder of DoubleLine Capital LP, who this year added a drip painting by abstract expressionist Jackson Pollock to his art collection. “But, the small letter b, as one guy said to me, is we like the way you move.”
As the Federal Reserve began tapering its bond buying in January, signaling a possible rise in interest rates, Gundlach wagered correctly that they would fall due to a sputtering U.S. economy and a shift by pension funds to bonds from stocks. He sold cash and added Treasuries and government-backed MBS with longer durations to DoubleLine Total Return. He also bet that agency MBS prices would increase even as government purchases of the securities declined because of less issuance.
Gundlach made money too with riskier mortgage securities not backed by the government, which make up 27 percent of the fund. He started adding them to his portfolio in 2008 during the housing crisis when they were priced for more severe defaults. They have rallied since 2009 with the U.S. housing market recovery.
“Gundlach’s reputation as a bond manager is still very attractive to advisers who need to put investors into bond funds,” said Jeff Tjornehoj, an analyst at Denver-based Lipper, a research firm. “He’s got stability for most of the portfolio and then he’s aggressive with a smaller portion. That smaller portion has been shooting for the moon and done very well.”
Investors put $1.2 billion into DoubleLine Total Return through the first six months of 2014, according to research firm Morningstar Inc. It was one of eight to have net deposits out of 22 MBS-focused mutual funds with at least $100 million, Morningstar said. Gundlach attracted almost five times the money that went to the second-most popular fund, TCW Total Return Bond Fund, which lured $265 million.
Many managers in 2013 did not anticipate the exodus from bonds when then-Federal Reserve Chairman Ben S. Bernanke spoke in May about exiting quantitative easing. Gundlach predicted in June that Treasury yields would fall by the end of 2013. That didn’t happen, with the benchmark 10-year note rising to 3 percent in December. Still, his fund returned 0.02 percent last year, ahead of 86 percent of rivals.
DoubleLine Total Return, which is the largest of the five mutual funds managed by Gundlach, suffered from eight straight months of redemptions as investors fled bond funds in expectation of rising interest rates.
They began returning to the fund in February while competitors such as the $225 million Pimco Mortgage-Backed Securities Fund and $2.5 billion JPMorgan Mortgage-Backed Securities Fund have suffered withdrawals this year.
DoubleLine Total Return gained 4.8 percent this year, ahead of 89 percent of peers, according to data compiled by Bloomberg. The fund has advanced at an annual return of 5.2 percent over the past three years, beating 96 percent of rivals, Bloomberg data show.
Gundlach started Los Angeles-based DoubleLine in December 2009 after he was dismissed from TCW Group Inc. over a dispute. DoubleLine, which manages $52 billion in assets, began with more than 40 people from TCW.
DoubleLine’s logo, designed by Gundlach, is a reference to abstract Dutch artist Piet Mondrian. The investor’s contemporary art purchases have included works by Mondrian and Jasper Johns.
DoubleLine Total Return’s holdings include cash, Treasuries, agency, non-agency and commercial MBS, and collateralized loan obligations. Gundlach has a larger allocation of non-agency bonds than most MBS fund managers while avoiding the riskiest of these securities, said Keith Berlin, director of global fixed income and credit at advisory firm Fund Evaluation Group in Cincinnati, who started recommending clients invest in DoubleLine funds in 2012.
“I just think the pool they fish in is broader,” Berlin said.
The Franklin U.S. Government Securities Fund, which had the biggest redemptions in the group with $623 million, mostly invests in mortgage bonds offered by Ginnie Mae, which are backed by pools of Federal Housing Administration loans. It returned 3.1 percent this year.
“Even though it’s a mortgage-focused fund, it’s well diversified within the mortgage space, so it looks more like a core fund,” said Todd Rosenbluth, director of mutual-fund research for S&P Capital IQ in New York, referring to DoubleLine Total Return. That means investors turn to it for broad fixed-income exposure rather than thinking of it as a niche product like some MBS funds, he said.
Gundlach cut the fund’s cash allocation to about 4 percent in December and extended its duration, or its sensitivity to interest rates. A fund with a longer duration generally performs better amid falling rates. The yield on the 10-year Treasury note fell to 2.48 percent as of yesterday compared with 3 percent in January.
He has positioned the fund for a rise in rates if economic growth improves. Gundlach increased the cash portion of the fund to about 11 percent as of June 30 and is maintaining a shorter duration of 3.35 years. The fund’s 12-month yield is 5.1 percent. That means investors get a relatively big payout for a smaller amount of interest rate risk.
The $8 billion TCW Total Return Bond Fund has also won investor deposits this year because of its performance and broader investments relative to other MBS funds, said Mitch Flack, a co-manager of the fund. The fund returned 4.1 percent this year and an annual 6.2 percent over the past three years.
Flack has been adding agency-backed CMBS and other securitized products like student loans guaranteed by the government for diversification. The duration of the fund is 3.8 years compared to the Barclays U.S. Aggregate Index’s duration of about 5.7 years.
“We’re fairly agnostic on rates in the very short term, but we are seeing reasons to believe rates are likely to be higher rather than lower in coming years,” Flack said.
Some investors may be fleeing MBS funds that invest mostly in agency bonds and choosing funds that buy corporate bonds for higher returns, said Flack, who’s based in Los Angeles. Agency-backed mortgage bonds returned 3.8 percent this year while corporate bonds gained 6 percent, according to Bank of America Merrill Lynch indexes.
Others are pulling money from some MBS funds that have large holdings of agency-backed mortgage bonds on concerns that prices of the securities will drop if the Fed stops buying them at the end of the year, said S&P IQ’s Rosenbluth.
DoubleLine Total Return is positioned to capture some of these investors because of its more diversified bets, Rosenbluth said.
“Thirty years ago I said if I can deliver higher yields, higher returns and lower risk, people should like it,” Gundlach said. “Nobody cared and then they finally started to care.”