Mon, 12 Sep 2011
A creative bond portfolio will likely outperform equities in 2011 as the possibility of an economic slowdown in the back half of the year rises, says DoubleLine's Jeffrey Gundlach.
Jason Stipp: I'm Jason Stipp for Morningstar. With the environment for fixed income looking hazy at best, we're checking in with DoubleLine's Jeffrey Gundlach. He is the manager of DoubleLine Total Return, and we want to get his take on the market's areas of opportunity and areas to avoid. Thanks for joining us today, Jeffrey.
Jeffrey Gundlach: Glad to join you, Jason.
Stipp: The first question I have for you is a timely one. We're getting headlines out of Washington that it's basically bogged down in these budget talks. I'm interested to get your take on government debt because about a month ago, you said there were some short-term opportunities in government debt which was different than what some other folks were saying about government debt.
It certainly seems like there are headwinds for government debt with inflation coming up and with some of the budget problems that we're having. What are you seeing on that front? What are the things that you are looking at there?
Gundlach: Well, at DoubleLine we have been looking for somewhat of a range-bound, Treasury-bound market for the year 2011, and that's pretty much been taking place now that we are pass the first quarter. The idea is that with the commodity inflation and with the concerns about the second round of quantitative easing going away, it's quite likely that we will have at times bond yields that would move up toward 4% on the 10-year Treasury.
At the same time, ultimately, I think that the solution to the government debt problems and also the aftermath of the commodity price increases will lead to a substantial slowdown sometime later this year in the U.S. economy as a result of the consumer and also from cuts in government spending and government programs. So, there is not that much pressure on Treasury rates to go higher.
So, I think that the economy wouldn’t be able to take a 10-year Treasury rate much over 4%, and we haven't even gotten above 3.75% so far this year. At the same time unless there is another deflationary panic episode, I just don't think you can get 10-year Treasuries back down into the 2s. Nobody buys the 10-year Treasury with a two-handle yield because of investment value. They buy it because they want to park money on a flight-to-quality concept, and I'm not sure we're going to get one of those until at least very late this year.
So, we are looking for a range between the low 3s and really the low 4s. Therefore, when Treasury rates are at 3.50 or higher, we think there is short-term capital gain potential, and we did think that, at about 3.70 on the 10-year Treasury, it turned out that it was the Japanese disaster that caused the profit opportunity. But 10-year Treasuries did fall to 3.15, and at that level it is supposed to be, with this range-bound concept of seller.
Stipp: OK. I wanted to ask you a broader question about the fixed-income market versus the equity market in general. So we're hearing from a lot of managers that say the equity markets don't look like a screaming buy right now, but when you compare the prospects for returns in a fixed-income portfolio versus an equity portfolio, the odds are for better performance out of equities right now given the forecast.
What's your take on fixed income versus equity and where investors might be putting their money to get the most opportunity right now?
Gundlach: That has a lot to do with how creative you are in the expression of your fixed-income strategy. If you're just going to buy a generic index fund or Treasury securities, it's pretty likely that you're going to do at least as well in equities I think. But in the more creative areas like our total return fund, we were able to get yields at about double the yield of an index fund.
That puts us up to paying out a dividend that's more than 8% net of fees to the investor. I have a hard time believing the equity market is going to be able to top that. So it really depends on how you're approaching the fixed-income market. My view on the equity is they are awfully high versus where they were a couple of years ago, and it's true that the second round of quantitative easing has been obviously targeted at moving up the prices of risk assets. But that's going away at the end of June, and at some point fairly in the near future, I think the equity market is going to start discounting what will be a weaker economy later in the year.
So, I'm not a fan of new commitments to equities. Those that are the dollar-cost averaging should probably continue that discipline. We're running a multiasset fund that does buy equities and bonds, and we're holding back substantial cash at 30% to buy equities cheaper, mostly non-U.S. equities ultimately when that happens. I do notice on U.S. equities, it is interesting just how poorly the global equity markets are actually performing. It's hidden by the U.S. market which is being spurred on quantitative easing.
Most of the emerging markets topped out in November, and some of them have fallen substantially. So the message from the global equity markets is for weaker global growth and was baked in back in November, and I think the U.S. is going to follow suit fairly soon.
Stipp: Follow-up question for you there. You mentioned that you had some opportunities for yields of around 8%. For an average investor, they might say, well, that sounds like it could be really risky to get a yield like that in a low-yield environment that we're having right now. How do you control for risk or how do you find opportunities that are relatively safer but are still yielding something that's high as 8% right now?
Gundlach: The trick is to take risks and be paid for taking those risks, but to take a diversified basket of risks in a portfolio. So one way you get high yields is taking interest-rate risk, but you don't want a lot of interest-rate risk because interest rates are low and they could rise from time to time during the course of this year or could even break out to the upside ultimately in the future.
So, you want some interest-rate risk, but we also can take default risk. In the nonguaranteed mortgage market, there is still a market that's plagued with defaults. And the way to think about it is if those defaults get better, that would be the sort of scenario of higher interest rates and a better economy if the defaults slow down. So actually those securities don't have interest-rate risk, and yet you get paid for taking the default risk. So the secret is to marry together opposite moving investments relative to interest rates while getting paid on both sides of the trade, and that's why we've been so successful with the DoubleLine Total Return earning those yields.
Stipp: Would you say that as you're looking to make that balance, do you see any scenarios as potentially more likely or less likely? Are you tilting the portfolio in one way or the other even if you do have a somewhat balanced outlook for the different sorts of assets that you're holding?
Gundlach: Yeah, we do on a tactical decision. So for example when the 10-year Treasury went down below 2.50, which we were calling for 2010, we started to reduce the interest-rate exposure of the fund and put more into the so-called inflation side that is relying upon a better economy to help the investments. Then when the 10-year Treasury goes up above 3.50 to 3.75 or so, it's time to take some interest-rate risk.
So you want to be handling the sculpting of the portfolio relative to those tactical opportunities, so we'd have moved the funds. We're reaching our one-year anniversary here tomorrow for the DoubleLine Fund complex. We've raised about $6.5 billion in the first year, which we're very satisfied with all the investor support. In that one year, we have had a couple of resculptings of the portfolio as these opportunities have changed with interest rates.