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BARRON'S COVER

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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 TCW Total

Return Bond Fund (ticker: TGLMX) finished in

the top 2% of all funds invested in intermediate-

term bonds for the 10 years that ended just prior

to his departure, according to Morningstar. It

finished in the top 1% for the five years ended just

before that watershed event.

Michael Grecco for Barron's

Jeffrey Gundlach

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Gundlach's legendary success has continued at DoubleLine, which he founded shortly after

leaving TCW. His DoubleLine Total 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 intermediate-

bond-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 EXTRAORDINARY, 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 interest-

rate 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

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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

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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 TO 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.

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TCW'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 mortgage-

backed 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 P-

PIP 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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