Called everything from the Bond God and the Bond Savant to the Bond Whisperer, Jeffrey Gundlach is branching out into equities, using some of the same innovative thinking he’s known for in the fixed-income world.
Gundlach co-founded Los Angeles–based bond specialist DoubleLine Capital with Philip Barach in 2009. TCW Group had dismissed Gundlach; he, Barach and other top lieutenants in TCW’s mortgage-backed securities group met at Gundlach’s house the next day and agreed to launch their own firm. Ultimately, 45 former TCW employees joined DoubleLine. Gundlach says he’s starting to manage stock portfolios because most strategies underpinning equity investing have gotten old. Investors end up paying active management fees for indexlike portfolios, asserts the DoubleLine CEO and CIO, whose firm has $60 billion in mostly fixed-income assets and is one of the fastest-growing money managers ever. For the three years ended July 1, DoubleLine’s $39 billion Total Return Bond Fund posted an 8.75 percent annualized return, according to Morningstar, putting it in the first percentile among intermediate-term bond funds.
Gundlach blames the ubiquitous style box, which defines a stock picker’s category, for many active money managers’ woes. Institutional and retail investors choose managers from a list of style boxes that includes small-cap, midcap, large-cap, growth and value, and build portfolios that end up being complex, duplicative and overdiversified. “Investors have this guy doing small-cap value companies with a health care tilt here and this guy doing growth companies with a technology emphasis there,” Gundlach says. “When you really think about it, all they have is an expensive index fund.”
But Gundlach thinks style boxes’ limits on managers pose the most danger to investors. He regards the system as a “stick” preventing managers from shifting their holdings based on market conditions and valuation. For example, a high-yield bond manager must keep buying those bonds even now, when yields are at historic lows. Investors should be seeking true active management to guard against downside risk and preserve their principal.
Gundlach, 53, takes this view from his experience in fixed income since 1993, when he launched the TCW Total Return Bond Fund. He helped pioneer the move away from hugging bond indexes in favor of shifting tactically among fixed-income sectors depending on the opportunities. Now bond fund managers are increasingly using that approach to negotiate the tough interest rate environment.
Style boxes are meant to be a guide, not a recipe. Russel Kinnel, director of fund research at Chicago-based Morningstar, says they’re a way to capture information on what managers are doing. “It’s not a coloring book where you are prohibited from coloring outside the lines,” he explains, adding that the categories give investors guidance on mixing growth, value and other styles. Kinnel sees much variety even among managers in the same categories, but he also finds that most managers who are bunched together exhibit a certain consistency. “It’s a valuable lens even if no data point does it all,” he says.
In January, Double Line hired Husam Nazer and Brendt Stallings from Los Angeles–based TCW, where they managed about $5 billion in small-cap stocks. Gundlach says he targeted this niche first because most good small-cap managers quickly reach their maximum capacity of $1 billion to $2 billion. “By the time a small-cap fund gets a good record, it’s too late to invest in them.”
Once DoubleLine reaches capacity in its small-cap effort, it plans to offer an equity fund that can invest in all corners of the market. Gundlach intends to keep all equity funds under $5 billion — in some cases well under that amount — because he believes size is the enemy of performance. “Megasize funds have to basically buy the market, and portfolio managers have limited flexibility in moving money around,” he says, noting that mobility is essential to his approach. The funds will use a mix of macro calls and fundamental bottom-up research.
Gundlach’s decision to offer equities comes at a time of low interest rates and unprecedented loose monetary policy by central banks worldwide. Although many experts believe demand for fixed-income products will keep growing no matter what interest rates do, asset managers that offer only bond funds can be hamstrung. Other bond fund managers have made similar moves to diversify. Pacific Investment Management Co., home to co-founder Bill Gross’s Total Return Fund, has $50 billion of its $2 trillion in assets in equity funds, many of which are performing well. In 2009, Newport Beach, California–based Pimco hired Goldman Sachs Group alumnus Neel Kashkari to significantly expand its equities division, but he had limited success and left the firm last year to enter California politics.
Gundlach dismisses any criticism of Double Line’s equities gambit. As he points out, he’s invested in stocks before, including a small amount in TCW’s Strategic Income Fund. More important, his approaches to money management have always been contrarian and ahead of the trends. “People are always skeptical and want to throw the usual nails in your path,” he says. “Time will tell whether it succeeds or fails.” • •
