Last week I did an interview with Jonathan Burton, MarketWatchâ??s Money & Investing Editor. The subject was, Where to put your money now. Obviously, this does not cover all of my thoughts on where to invest now, but it does cover one mutual fund I like as part of an overall portfolio of mutual funds and ETFs. In this short video we talk about DoubleLine Total Return Fund (DBLTX).
(here is the link to the piece if the embedded video does not open for you).
I did a recent post on this fund as well and to make it easy, Iâ??m reproducing that post below:
Jeffrey Gundlach is the portfolio manager of the DoubleLine Total Return Bond Fund. Previously, he built an excellent record as portfolio manager of the TCW Total Return Bond Fund (TGLMX), which we used. Unfortunately, there was a rather messy breakup between Gundlach and TCW and we sold the TCW fund. Along with many of his colleagues at TCW, Gundlach formed the DoubleLine family of funds and we have recently begun using DoubleLine Total Return (DBLTX / DLTNX).
Gundlach recently wrote a provocative piece for Pensions & Investments in which he made his case that we are in a deflationary economic environment. Pensions & Investments requires registration, which is free. I have excerpted some of the key points from the piece [emphasis added below]:
Generating high cash flows and managing risk with inflation or deflation (Pensions & Investments, June 14, 2010, Jeffrey Gundlach)
"?The developed world engaged in a decades-long regime of debt-financed consumerism. That era is coming to an end, but itâ??s a protracted process. The banking and market crashes of 2008 only partially wrote down the developed worldâ??s over-leveraged balance sheet. In the United States, the private sector has continued to de-lever, but Washington is fighting it tooth-and-nail through massive borrowing and monetary stimulus.
Unfortunately, the unfunded liabilities are too large. Uncle Sam has failed to reserve, by actuarial estimates, for more than $60 trillion in federal promises to pay, the bulk in the form of Medicare and Social Security benefits. The private sector has hardly completed its balance sheet adjustment. Pensions are maybe 80% funded. State and municipal finances are in no better shape. And the housing crisis is far from over: non-performing mortgages now encompass 7 million households, and that number is risingâ?¦
Well, thatâ??s cheery isnâ??t it? Now, before you go out and slit your wrists, you must remember that the top bond fund managers tend to be rather gloomy types. Anyone who has regularly read Bill Gross of Pimco Total Return Fund has experienced that tendency as well. Unfortunately, this is not a normal environment and I believe Gundlach is probably correct in his assessment. He continues:
"?To date, the Keynesian and monetarist campaigns marshaled by Washington have failed to generate credible signs of a self-sustaining recovery. I find most telling the behavior of the U.S. labor market. Debt-financing, since the 1980s Washingtonâ??s antidote for recession, largely failed to spur private sector jobs growth out of the recession of 2001; it has utterly failed to do so in the wake of the recession that started December 2007. The old playbook is failing as our economy mutates away from its manufacturing base. In fact, I suspect that debt-based rescue schemes have become detrimental to the creation of productive jobs.
This last point (in bold) is critical. We are in an economic funk caused by excessive spending and borrowing. Why then would government stimulus programs, financed by deficit spending and borrowing, be likely to get us out of the mess?
With the commitment of trillions of dollars in stimulus spending programs and quantitative easing (printing money), the Federal government has been desperately trying to reflate the economy. What happens if this massive fiscal and monetary intervention fails? Gundlach continues:
"?So my base case is deflation and its attendants: recession, deteriorating credit and, at the long end of the Treasury curve, tame-to-falling Treasury yields...
â?¦Iâ??m fond of high-duration securities backed by the full faith and credit of the U.S. government. In particular, I like long-dated Treasuries and long-dated tranches of collateralized mortgage obligations (CMOs) backed by Agency mortgage-backed securities (MBS). The trained professional investor can obtain yields of about 7% in this corner of the mortgage sector. Furthermore, if yields narrow at the long end, prices on these securities should rally, reaping the bonus of capital gains while the investor clips the healthy coupon.
In this paragraph, he is talking about Treasury bonds as well as securities issued by Fannie Mae and Freddie Mac (also backed by the U.S. Treasury). These securities mentioned above represent about half of the DoubleLine Total Return portfolio now. But, he also considers what might happen if his deflation scenario does not pan out:
â?¦My base case is further deflation. What if my base case proves wrong and inflation accelerates? The likely result would be a surge in interest rates, the bane of high-duration investments. Another corner of the mortgage sector holds the solution. Portfolio managers can pair allocations to high-yielding high-duration securities with allocations to a different investment that also delivers high cash flows but exhibits negative duration "â?? in other words, an asset whose price rises with Treasury yields. Among the assets with these characteristics are certain distress-priced mortgage bonds whose principal is not guaranteed by the U.S. government, also called legacy non-Agency residential mortgage-backed securities (RMBS). The careful pairing of long-dated Treasuries/Agency CMOs with non-Agency RMBS results in lower portfolio duration than that of the Barclays Aggregate U.S. Bond Index.
Despite the 2008-2009 rally in many credit assets, certain senior non-Agency RMBS remained priced to depression-like scenariosâ?¦pricing of certain non-Agency RMBS can offer returns in the double digits even assuming depression-like fundamentals.
Because mortgage-backed securities suffered large price declines over the past couple of years, they offer opportunities for astute investors to buy at depressed prices. So, the current price reflects the deflationary or depression scenario, but it does not take into account a more positive environment in which we see higher inflation plus economic growth. Gundlach continues:
Now imagine a world of rising Treasury yields. That scenario is consistent with a world of economic growth and accelerating inflation, or at least consensus expectation of these phenomena. Growth and inflation are bullish for depression-priced credit. Default rates should fall, and recovery rates on liquidated collateral should improve. In such a context, depression-priced mortgage credit should rally...
â?¦In my view, this integrated trade solves the income problem while steering a safe course between the shoals of credit and duration risk. Investors can feed themselves without banking on dreams.
This issue â?? deflation versus inflation â?? is perhaps the central one we face as investors right now. I like the way Gundlach is approaching this issue and dealing with it.
Update: The folks at DoubleLine were kind enough to send me a link to the article. To see it, click here. You will not have to go through the registration process.
Kurt Brouwer owns shares in DoubleLine Total Return Bond Fund (DBLTX)
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Kurt Brouwer is a fee-only financial advisor with three decades of experience. He is the chairman and co-founder of Brouwer & Janachowski, LLC. Kurt has written books, articles and hundreds of blog posts on mutual funds, ETFs and other investment topics. E-mail: kurt.brouwer *at* gmail.com.
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