Jeffrey Gundlach, on his year as new ‘King of Bonds’

December 15, 2014

Gundlach, star bond investor and head of DoubleLine Capital LP,  is photographed during an interview in New YorkWhen Bill Gross shocked the investment world on Sept. 26 by storming out of Pimco, the most prominent bond investor in the world didn’t stop leaving people stunned.
It was later revealed by Reuters that Gross had paid an unlikely visit to his fiercest rival: Jeffrey Gundlach.
For two decades, the two had no relationship or interaction at all, even though their personas were intertwined, compared and contrasted often in the financial media and by other bond market players. (Morningstar named Gross “Fixed Income Manager of the Decade” in 2010, an award for which Gundlach was a finalist. Then in 2011, Barron’s magazine anointed Gundlach as the new King of Bonds.)
Gross not only unexpectedly departed his firm for under-the-radar Janus Capital but also considered joining Gundlach’s DoubleLine Capital. Gundlach said the so-called “Dream Team” didn’t work out but “you never know what will happen in the future.”
Overall, the gesture by Gross officially affirmed the investment world’s long-held view that Gundlach had been anointed the new Bond King.
What follows are excerpts of my hour-long interview – unfortunately, not on the north loggia of Gundlach’s Los Angeles home — about Gundlach’s investment calls (old and news ones), his competitors, the future of fixed income and his firm’s fifth year anniversary which was celebrated on Sunday.

WHAT HAS BEEN THE OVERRIDING THEME THIS YEAR?
This year was rates aren’t gonna rise. That was the theme this year for sure. Long Treasuries would outperform junk bonds and emerging market debt would be a good performer. Treasury rates were not going to fall as much as they did, but they weren’t gonna go up. Junk bonds most overvalued in history versus long Treasuries and they massively underperformed this year.

HOW DID SO MANY GET THE RATES CALL WRONG?
People extrapolated the rate rise and the reason they did that is they basically said that the Federal Reserve is going to be cutting bond purchases, and there’s going to be an incremental negative for Treasury bonds because there is going to be one major buyer that’s gone and they also thought themselves, “Gosh, the absolute level of rates at 3.03% on the 10-year is still very low, so there’s lots of room for the yields to go up and just to continue to  momentum from the end of April until the end of December of last year.”
You’re either still at a relatively low absolute level and the track had been kind of in place for 8 months and the Fed was going to stop buying. And now what I talked about was there were a number of variables people weren’t thinking about.

The three biggest variables were 1) Relative value Treasury bonds in the United States looked very attractive versus junk bonds and other developed sovereign bonds. And that was a theme that people were slow to get on to. It took them probably five months. And now you hear that all the time.
People now understand that the Treasury market, still sadly, at 2.25% represents decent relative value versus not so much junk bonds anymore but certainly developed market bonds. Italy is less than 2% now. Spain is down at 1.75%. I mean, that makes Treasury bonds look incredibly attractive particularly because the dollar was likely to strengthen this year and it did strengthen this year – a lot, particularly in the last few months.

The second variable was that stocks went up 30 percent last year. Bond yields rose. This meant that corporate pension plans had a substantial improvement in their funding status and they were likely to shift from stocks to bonds early in the year and many did. So there is a source of demand is that crossover buying into Treasuries.
And then finally, the positioning of the market was so overwhelmingly short and negative, you looked at duration surveys, you looked at Bull-Bear surveys, you saw what people had poured their money into during 2013, which was unconstrained bond funds, which were short Treasuries to take the interest-rate risk down. And leveraged ETFs that are leveraged
short against long-term Treasuries. That’s where the money was.

HOW DOES THE PLUNGE IN OIL PLAY INTO ALL OF THIS?
The first quarter of this year commodities went up. They actually had a very good start to the year. It’s hard to remember because they are down so much. The CRB index started the year at 280 and at the end of April, it was at 310 – it was up 10 percent. And so, there was some logic to this kind of inflation concept leading to the Fed raising rates. And you saw so many people talking about how the long end was so vulnerable. Oh, long rates are going to go up! Well, no they’re not. They’re not going up when you have crashing – at this point – crashing commodity prices particularly in the energy complex.  I mean the CRB is now at 248, down from 310. It’s down 20% in six months. The theme of this year has been the lack of progress towards higher interest rates against the consensus view point of exactly the opposite.

‘GO AHEAD, MAKE MY DAY’
More interestingly, in a historical context, it is interesting that rates fell when everyone thought they were going to rise but what’s more fascinating is how there was never any significant setback for yields ever during the year. Like ever. I mean, it’s just not that they fell – it’s that they never went up. If you look at 2011, you see, a big drop in rates in 2011. You see the 30-year Treasury bond in 2011 – that was a big rate decline year – it declined from a high of 4.75% at the end of January down to a low at year end of 2.90% so it fell 200 basis points. But there was a setback when the yield rose 75 basis points in about three weeks. So there were times during 2011 which had a huge rate decline where rates backed up and gave the people who were long Treasuries, some anxiety. This year the biggest rate rise from trough to peak was from using closing data was from August 28 at 3.08% to Sept. 17 at 3.37% — I mean, not 30 basis points. So it’s just a persistent decline. No ability for rates to rise all year in the context of history.
As I’ve said repeatedly in the last several months, it’s like the long end of the bond market is taking the line from Clint Eastwood in Dirty Harry: “Go ahead, make my day. Raise short
interest rates.” Because all you’re going to do is import deflation if you raise short-term interest rates. The dollar is going to get smoking hot – even hotter than it is and there’s deflation everywhere. If you use one variable econometric model which is a great oversimplification, but it’s one that works pretty well, if you use the price of oil, to predict inflation, inflation is going to be zero at some point. So where’s this inflation problem?

BONDS vs STOCKS
There were bond inflows in the first part of the year but  they are quite flat in the last few months. First, they dropped because of Pimco. so there was an artificial drop. They recovered but they’ve been largely flat for a while. What you are seeing is the money moving around. I think bond flows will probably stay about where they are unless rates rise. The bond flows are a lagging indicator of interest rates. What happens is when interest rates rise, bond investors pull money if they sell low. People pull their money out of bonds when they should’ve been putting money into them. The greatest example is my hedge fund. Last December, I did a call for my LP, the hedge fund. And I told the investors that we are going to make money on bonds because rates are probably going to fall and I took the duration to 9. And an investor said, “What?” And I said, “Yeah, I think we’re going to make money on bonds. Profits.” And the guy says, “I don’t want to be long the 10-year (Treasury).” I remember one guy specifically said that. And I said, “we’re not long the 10-year. we own other things but we do have a duration that’s longer than the 10-year by a little bit.” And the guy said, “Forget it, I am pulling my money out.” And I said, “I thought you wanted me to manage your money with my highest-conviction best ideas?” And the investor said, “yeah, that’s true but not when your ideas are stupid?” That fund is going to be up potentially 20% this year. It’s already up 17 and change through November. So a third of the investors nearly pulled their money out because I allow redemptions on a 45-day notice at month end. And so 30% of investors pulled their money out. and They’re like: “We’re not interested in this bond thing. we hate interest rate risk.” I said, “Well, I am not going to be second guessed on this. You can second guess me on other strategies but not in my best ideas strategies.” I’m not going to be moved by the fact that you don’t like it.

WHAT HAS LIFE BEEN LIKE AT DOUBLELINE AFTER THIS REORDERING OF THE BOND MARKET POST-BILL GROSS?

Have I turned accounts down? Yes. I’ve turned accounts down on fees, I’ve turned accounts down on just contractual issues. What happens is, “I’m looking for a new manager in place of Pimco. Yeah, yeah, take a number.” And then, they’ll say, “we’ve asked a bunch of firms and here’s the fees that they are doing — we want to hire you but we can’t pay — you need to match these other fees.” I say, “Sorry, it’s not gonna happen. I’m not matching them.”

If you want a Porsche, you gotta pay for a Porsche. You can’t pay for a Volkswagen and get a Porsche. You should turn down some business. If you take all the business, you’re probably making a mistake. You gotta have some sort of a vetting process.

VANGUARD’S GLOBAL BOND CHIEF RECENTLY SAID THE FIRM HAS TIGHTENED CONTROLS AT SOME OF ITS LONG-TERM BOND FUNDS TO SCREEN OUT “HOT MONEY” AMID HEAVY CASH OUTFLOWS FROM PIMCO

Vanguard is particularly susceptible to hot money because they run an index fund. The money that initially leaves Pimco first either goes to cash or goes to an existing manager or fund an investor has or it goes to an index fund. So Vanguard is correctly and intelligently looking at this and saying, if this money, if $100 billion comes from Pimco, it’s probably going to be here for like six months because it is fleeing from Pimco, it’s not fleeing to an index fund. It’s just a way station for them to figure out where ultimately they want to put the money, so they are smart. They are saying all that is going to happen in a market where the opportunities are not exactly a cornucopia, we’re going to have to dump all this money into the market only to redeem it in a few months. And they’re smart. When people come to me, they’re not coming to me for six months. Most of them who came in the first two months came because they already had money in my fund. They already know it. So they’re just doubling the size.

HOW DO YOU RESPOND TO CRITICS WHO SAY YOUR TOTAL RETURN FUND SHOULD BE CHARACTERIZED AS A MORTGAGE FUND RATHER THAN AN INTERMEDIATE-TERM BOND PORTFOLIO?

It is very heavily in mortgages, that’s true. We do have some Treasuries and we have a little bit of the CLOs which is corporate credits but it’s securitized.

But look, I’ve been dealing with that one for nearly 30 years. When competitors are under performing, what they do is try to find something to make the comparison look less difficult to them. So they pull something out of the hat. What matters in categorizing an investment is its risk profile. That’s what matters. So if we invest the portfolio so that it has a mix of government credit and a mix of non-government credit and those mixes are not that dissimilar from the index against which we are measured, then it is a completely appropriate comparison.

PIMCO AND ITS ‘BLOAT’ PROBLEM

Pimco had so much market penetration that them being close to $2 trillion meant that they were really 10 firms, sort of. In terms of they’re deliverable to the market. Let’s say that the SEC decided that asset managers fell into a too-big-to-fail category and should be precluded from growing to that too-big-to-fail stage, and so the SEC implements a law that no money management firm can be over $200 billion. Well, there’d be nine more substantial fixed-income firms, at least, if they were all exactly $200 billion. Well, there’d be nine of them that don’t exist today because of the lack of that rule. So Pimco’s bloat $2 trillion not just puts tons of money in motion, it also necessarily creates the environment where there aren’t that many places to go. Let’s be extreme about it. Let’s just say there was one fixed-income firm in the world that managed the entire market and people decided that didn’t like that organization anymore. There’s nowhere to go. There’s only the one firm. So with one firm being so big, it meant that there are necessarily – it’s not a coincidence – it’s cause and effect.

There are fewer alternatives because of the size of that one fund.

WHAT DOES THE FUTURE HOLD FOR DOUBLELINE NOW THAT YOUR FIRM CROSSED $60 BILLION IN ASSETS UNDER MANAGEMENT? ARE YOU LOOKING TO GROW YOUR FIRM EVEN MORE FROM HERE?

I was told that Charles de Vaulx (of International Value Advisers, LLC, IVA, since May 2008) had the record for the most successful mutual fund complex start-up in the one-year mark. In May 2011, for some reason, Charles and I had some line of communication through the president of my mutual fund company. So I went to visit him and he was open to the meeting.

I went in and I said: “Hey, I’ve got this great idea. We’re looking for sub advisories and joint ventures to help build our firm. How about if we do this, You, Charles, do the stocks. And I do the bonds. We’ll take over the world. You’re the most successful stock start-up and I’m the most successful bond start-up. It is a winning combination. This is great.”

And Charles says, “I love it, I love it. I’m not doing it!” And I said: “What? Why?”

He said: “I’m closed. I like it the way it is. I manage $18 billion. I have a manageable firm. I like what I am doing. I like the people I work with. Enough is enough.”

And it just opened my eyes. I said: “Wow. You know what. I think there is something to this ‘closed’ concept.” Most people think the definition of success is more. It’s gotta be more all the time.

Charles de Vaulx opened my eyes and said, “That’s not true.” There’s a quality of life aspect and a way of maximizing the probability of success.

What you don’t want is to raise a bunch of money and go around the world saying: “I’m sorry” because of poor performance.

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