On November 19, 2009 Jeffrey Gundlach was named a finalist for Morningstar's award for bond fund manager of the decade. For Gundlach, the nomination recognized 10 years of stellar results, exceeding even the returns of the legendary king of bonds, Bill Gross.
Two weeks later Gundlach was confronted, fired, and then pursued on foot out of a Los Angeles skyscraper by two lawyers working for TCW, the money management firm with $110 billion in assets where Gundlach had worked for 24 years.
Not only did TCW oust Gundlach, but the firm also announced that it was acquiring an entire company -- crosstown rival Metropolitan West Asset Management -- to replace him. That in turn set off a wave of defections from TCW, as 45 of the 60 staffers who had worked for Gundlach streamed out the door to join him at a new firm that he had opened within days of leaving.
Then things really turned nasty. TCW filed an incendiary lawsuit in January accusing Gundlach of conspiring with confederates at TCW to steal proprietary information as part of a long-running plot to form their own competing firm. The suit added a salacious twist of the knife, perfectly calibrated for maximum media interest -- Gundlach had allegedly stashed a trove of illicit material in his office: 70 pornographic magazines and videos, 12 "sexual devices," and several bags of marijuana.
Gundlach has countered with his own lawsuit. He charges TCW and its owner, the French bank Société Générale, with pushing him out so that they can get their hands on his lucrative fees. In addition to his mutual funds, Gundlach had managed what were effectively two hedge funds for TCW, each of which commanded the amped-up fees typical of those vehicles. Gundlach calculates that he would have personally reaped $600 million to $1.2 billion over the next few years.
What in the name of Peter Lynch is going on here? Sure, we've come to expect shenanigans from Wall Street. But even if the mutual fund world hasn't been exactly pristine (remember the market-timing scandals a few years ago?), more often than not its managers and executives have been well-behaved schoolboys compared with the leather-clad (in spirit, anyway) rock stars among the investment bankers and hedge funders.
But unlike most mutual fund companies, TCW has always aspired to a Wall Street culture. In particular, it cultivated a star system. The company grew by importing ambitious money managers and granting them autonomy. They could invest as they liked; TCW would handle sales and marketing. The two sides would then split the fees, with each manager cutting an individual deal. The result could be huge rewards for managers -- Gundlach made $134 million over the past five years -- but some came to view themselves essentially as sole proprietors.
TCW seemed content with the arrangement and did little to tie its managers' fates to the company as a whole. Few of them, for example, received significant stakes in TCW. That bred frustration in multiple generations of standout performers, who viewed corporate executives (some of whom did receive ownership shares) as getting rich off their toil.
So it went for Gundlach, a bona fide investing star who, by the end, oversaw about 70% of TCW's assets, some $70 billion, putting him in charge of one of the biggest pots of money in the country. Gundlach didn't just generate steady returns; he avoided the blowup of the century. A specialist in mortgage-backed securities, he publicly warned in 2007 that "the subprime mortgage market is a total, unmitigated disaster, and it's going to get worse." He invested accordingly, not only delivering positive returns in the blighted year of 2008 but also earning himself a growing role as a media sage. His ego grew along with it.
There are few people like Jeffrey Gundlach in the mutual fund world -- or in any world. A former rock-and-roll drummer, Gundlach, 50, is a math whiz (but not a quant). He views everything in binary terms: Either you perform to his standards or you don't, and he won't hesitate to let you know which category you fall into. Nor is he shy in articulating his view of himself. "I was by far the biggest revenue generator at TCW, by far the biggest performer," he says. "I created $4 billion in value for clients in '09. If telling you that is self-promotion, so be it. It's just a fact."
With Gundlach, it's hard to tell which is largest: his brain, his self-regard -- or his resentment of TCW. He claims that his recent firing was actually the third time the company tried to get rid of him. "All three of them were an attempt to just steal the economics," Gundlach contends. "And this time they did it. Except they didn't steal the economics. They blew it up. They blew it up. They tried to steal the economics, but they didn't understand. They never understood."
TCW customers, meanwhile, have been watching the blood feud in disbelief. Investors have fled, with assets shrinking $25 billion since Gundlach was fired. For those who have remained, it seems that their patience is limited. "I'm aware of the investment prowess of both [Gundlach and the new TCW team]," says Mansco Perry III, CIO of the Maryland State Retirement and Pension System, which has $50 million invested in TCW. "But right now I don't believe they're acting in the best interest of their clients."
frey Gundlach is the sort of boss who inspires sharply divided opinion. He fostered loyalty among the members of his60-person team at TCW, handing out generous bonuses to his group. He also openly mocked the company's other divisions, especially its stock team.
Many outside Gundlach's orbit viewed him as an ill-tempered bully. He subjected subordinates to withering cross examinations and relished pointing out errors. Some in TCW's New York offices celebrated his dethroning by posting printouts of his scathing e-mails in the halls.
By contrast, loyalists valued his directness. Some would preserve his occasional written compliments as treasured mementos. "You don't have to guess where you stand with him," says Bonnie Baha, a portfolio manager who followed Gundlach to his new firm, called DoubleLine.
An interview with Jeffrey Gundlach is less like conversation than like listening to a manic stream-of-consciousness monologue. Consider Gundlach's description of his aborted stint in a math Ph.D. program at Yale (after getting an undergraduate degree in the same subject at Dartmouth): "It was a four-year Ph.D. deal. And they gave me a full scholarship, and it was very hard to get into. There were only seven people accepted, and they had hundreds of applicants. And one of the guys, he was Korean, he had come in via Toronto. I was the only American left. The other American had flunked out. There was a Chinese guy who had polio. That guy was smart. That guy was something else. He had crutches. He had horrible dandruff. He never took a shower, but he was one smart motherf----r, let me tell you. That guy is probably the smartest guy I ever met in my life. And he was my friend. I was the only guy he would be friends with, and there was this other guy, this Korean guy out of Korea, out of Toronto, and I didn't like him very much, and I was walking down the street, and there he was. It was like, 'Hey, Jeff!' They called me Jeff in the day. 'Hey!' You know, good to see you. I was Ike -- I had this really heebie-jeebie feeling, and he goes, 'Let's go to the bookstore and get our books.' And I was like, 'Uh, I don't know.' And he was like, 'What do you mean?' I said, 'Uh, I don't know.' And it hit me right then. I said, 'I'm not going back. I'm not doing it. I can't do it. This is pointless.' "
Gundlach's mind combines that feverish quality with a near-total recall of endless minutiae. But somehow, when it comes to investing, he's able to process huge quantities of details and extract a big-picture message. The result has been superb performance: His flagship $12 billion TCW Total Return Bond Fund returned nearly 8% annually over the past decade. Those results beat 99% of competitors, and his nonpublic funds have done even better.
For all Gundlach's prowess with numbers, it was anything but obvious that he'd go into finance. He grew up outside Buffalo in a family of modest means. Their only savings, he says, consisted of some Xerox stock, courtesy of their uncle, Robert Gundlach, the inventor of the modern photocopier. "We owned Xerox, and it went way, way up, and for the first time it actually felt like we had a little money. And then it crashed," Gundlach says. He was 12 or 13 at the time. "It was my first experience with a bear market, and I remember it really well. The rallies are pennies, and the selloffs are dollars, and that's always the way bear markets behave."
In his mid-twenties Gundlach played drums in a variety of rock bands that performed in L.A. clubs but never made the big time. Meanwhile he was holding down a dreary day job in the actuarial department at Transamerica. One night in 1985 he was watching an episode of "Lifestyles of the Rich and Famous," that described the most lucrative careers. Gundlach decided he would, as he told one interviewer, "figure out my life."
The program identified investment banking as the richest occupation. Gundlach didn't know what investment bankers did, but he contacted 23 firms. Impressed by his math credentials, TCW invited him in and offered him a $30,000-a-year job as a research assistant in the firm's bond department. (This despite the fact that, according to Gundlach, he didn't even know what a bond was at the time.)
Gundlach was thrilled. He loved wearing a suit and tie to TCW's elegant offices. He became fascinated by bonds. "I felt like I was in the middle of something that was important and exciting," he says. "I loved it! When I would walk into a meeting and be able to say, 'I'm from TCW and here's my business card,' I was proud."
As a young analyst, Gundlach zeroed in on the mortgage market. By age 27, he says, he had developed a reputation in his niche as a "young hotshot." After four years at TCW, he was promoted to co-chair of a new division -- mortgage Bonds -- and then made a managing director in 1991. "That doesn't happen," he says. "You don't go from a trainee to managing director in seven years. I was running the most important department at the firm, but the firm didn't like the fact that I was growing so much." Gundlach is getting ahead of the story, but it appears he would later be right.
When Gundlach arrived -- and still to a large extent today -- TCW seemed like a museum version of a Wall Street firm. Even in ultra-casual Southern California, for example, the firm had a suit-and-tie dress code. Gracious meals were served in its white-linen dining room.
TCW was founded in 1971 as Trust Co. of the West by Robert Day, who inherited millions as the heir to the Superior Oil fortune and hobnobbed with the Martha's Vineyard elite. Day was a hard-nosed boss who used to smack errant employees on the head with his cigar, Gundlach says. (Day says he doesn't remember doing so.) In those days 80% of TCW's assets were in stocks, the rest in bonds. By the end of Gundlach's tenure, the ratio would almost flip.
Day built the firm by luring in Wall Street talent. One prominent star, who joined in 1985, was Howard Marks, a junk bond manager who came over from Citicorp. Marks thrived, accumulating $7 billion in assets, about 15% of TCW's total at the time. But he grew increasingly dissatisfied with having to fork over half his fees to TCW. And he resented the fact that TCW would give him no more than a nominal stake in the company. In 1995 he announced that he was leaving and taking his team with him.
Marks' departure was a less lurid, but still bitter, harbinger of what would occur with Gundlach almost 15 years later. Day sent a furious letter to clients blasting Marks' exit as "disloyal at the very least," according to press accounts at the time. TCW then quickly replaced Marks' team by purchasing Crescent Capital, a small high yield bond firm in West Los Angeles.
The equity issue took on new importance when TCW decided to sell itself. In 2001, Société Générale bought 51% of TCW for $880 million. The deal, former employees say, meant lucrative paydays for a cadre of executives, including the founders of Crescent, who had received large chunks of the company. Some longtime TCW employees were embittered by the newcomers' windfall.
Management tried to mend the problems that led to Marks' departure, but the lack of equity for many managers remained a sore point. SocGen announced it would escalate its ownership to 70% and leave 30% for TCW employees. But that 30% turned out to consist of SocGen stock options rather than TCW shares. By 2007 the French bank owned 100% of the company.
Meanwhile Gundlach was accruing more and more influence and renown. In 2005 he was promoted to chief investment officer of TCW. And he was named Morningstar fund manager of the year in 2006. His decision to pull his mutual funds out of riskier debt and his accurate forecast of a looming recession brought him favorable publicity and a steady presence in the press. (Another division of TCW, also under Gundlach's umbrella but not his main focus, was a giant issuer of CDOs, many of which imploded.)
It was Gundlach's time. His reputation was growing, and bonds were beginning to enjoy their moment in the sun. The result: Investments in his funds swelled. So, too, did his ego, according to former co-workers. "He started to think of himself as a god," says one who worked with Gundlach during that period.
Gundlach remained mostly satisfied until January 2009, when SocGen announced that it intended to take TCW public in five years. The uncertainty, he says, made it harder to drum up new business. And he grew even more vexed a few months later when he was passed over for the job of TCW's new CEO. Instead, the position went to the company's former president Marc Stern, who came out of retirement to assume the position.
Gundlach was infuriated by Stern's return. He was offered the job of president but turned it down. Always outspoken, Gundlach grew openly critical of TCW's management, even deriding executives while they sat a few feet away in the company dining room.
Rumors began to circulate that Gundlach would be fired. By the summer of 2009, he says, it had become difficult to work under that stress, as well as to face TCW's uncertain future. In September, Gundlach met with Stern and offered to purchase the firm at a valuation of $700 million. TCW says Stern passed the offer onto SocGen, which rejected it.
TCW and Gundlach disagree about exactly what was said at the meeting. What's clear is that Gundlach at least broached the possibility of taking his team and leaving. TCW interpreted the statement as a threat and prepared for combat: The company hired investigators to look into the affairs of Gundlach and his closest lieutenants, tapping their office phones and monitoring their e-mails. At the same time they initiated clandestine talks with MetWest, the $30 billion bond house that would eventually replace Gundlach's team.
Gundlach was preparing too. He and his "co- conspirators" began e-mailing one another in September about their plot to steal information, according to TCW's complaint. The suit alleges that the group referred to Gundlach as "the Pope" and "the Godfather" and swiped 9 million pages' worth of client contacts, trade tickets, and software routines used to process the complex data that go into analyzing mortgages. They retained a realtor to find an office space with 50 trading desks.
Gundlach acknowledges that his team looked at commercial real estate. It made him feel better, he says, to be making plans when he knew he was going to be fired. "I felt powerless," he says. He insists, however, that he had no knowledge of the downloading, his e-mails prove otherwise. Gundlach says he hired a third party to expunge his employees' computers of TCW data and returned all their hardware to the company.
The crescendo of rumors -- of his ouster, of a sale -- was wearing on Gundlach. Still, he had no inkling of what was in store for him on Dec. 4, 2009. At 1 p.m. that day, when the markets closed on the East Coast, he was summoned to the 17th floor of TCW's headquarters. Michael Cahill, the company's general counsel, was waiting for him in a conference room with John Quinn, one of Los Angeles' top litigators.
Cahill told Gundlach that TCW was putting him on administrative leave. Gundlach argued that the move would cause a disastrous customer exodus unless they negotiated a settlement that resolved various fee and management issues. The lawyers asked him to read a draft of the complaint TCW was planning to file against him. When Quinn tried to place the papers in his hands, Gundlach got angry.
He stormed out of the room and began walking down the stairs. Quinn and Cahill trailed him, thinking he was headed for the trading floor one level down, but Gundlach kept going. It was a surreal procession, says Quinn; they marched down 17 stories in total silence. The lawyers followed Gundlach out of the building and onto the street until Gundlach finally turned around and told them he wasn't planning on stopping anytime soon.
While all this was happening, chaos had erupted on TCW's trading floor. CEO Stern sent out a companywide e-mail announcing Gundlach's termination and the acquisition of MetWest. Then Stern appeared to reiterate the news in person. Analysts watched in shock as a team of private detectives and attorneys descended. Gundlach's suspected conspirators were herded into offices and conference rooms, where the investigators interrogated them and seized laptops and records. Some company-owned BlackBerrys went dark without warning. Nervous employees scurried around the floor, trying to figure out who had been terminated. By the end of the day, the tally was five.
TCW proved inept in its efforts to stanch the turmoil caused by Gundlach's departure. On the rainy Monday morning after he was fired, TCW employees gathered in conference rooms for a companywide conference call. CEO Stern told his troops that the downpour was a sign of renewal, and that TCW would emerge as "a firm that has respect for everyone within the firm."
But Day, TCW's founder and chairman, was less temperate in his remarks. He told the employees that he had been through this before -- i.e., with Marks -- and that there was no other choice. "It sort of reminds me a bit of General Washington crossing the Delaware," he said. "The general was in the back of the boat. It would be like a soldier getting up, trying to rock the boat, expecting to sink the boat. His choices are very simple. You shoot the soldier. You throw him off the boat."
After a pause, nervous laughter emanated over the speakers. Some of Gundlach's former colleagues were horrified. A few started crying. Others walked out. "Whatever people may say about [Gundlach], here's a guy that has been working for his company for over 20 years and has made a lot of money for investors," says Luz Padilla, a fund manager at the company. "After that call, I was just incensed."
Padilla hadn't been set on leaving TCW, she says, until she realized the current imbroglio bore an uncanny resemblance to the Howard Marks controversy -- a talented manager leaves after a fight over money, and a new team takes control. "It was a different set of players," she says, "but almost the same movie." There was also the fear that the arrival of the MetWest group would make the current bond team redundant. Dozens more followed Padilla out.
Then came the surge of customer defections. By late February TCW's assets had dropped by some $25 billion. The most prominent deserter was the U.S. Treasury, which pulled out of the $4.1 billion Public Private Investment Fund it had started with Gundlach.
Less than two weeks after he was fired, Gundlach announced that his new firm, DoubleLine, was partnering with a respected L.A. money manager: none other than Howard Marks. The onetime TCW star has thrived on his own, building a firm called Oaktree Capital with $70 billion in assets. Marks is buying 22% of DoubleLine and in exchange will provide the administrative backbone for Gundlach's new operation. Needless to say, an alliance between two of its former stars is also a not-so-subtle poke in the eye to TCW.
After weeks of relative silence, TCW struck back. On Jan. 7 the company filed its explosive complaint. It emphasized the alleged plot to steal information. It also tarred Gundlach personally, referring to the pornography, sexual devices, and marijuana retrieved from his office. TCW justified the inclusion of the prurient material in the suit under the whisper- thin pretext that it constituted a breach of company policy. Asked about the contents of his office, Gundlach offers only the mildest of quibbles: "Not all of the items are mine." In a letter to investors, he noted, "I had every expectation of privacy in these spaces, which stored vestiges of closed chapters of my life."
On a recent Thursday afternoon, Marc Stern sits in one of TCW's dining rooms with Jacques Ripoll, the head of SocGen's asset management division. The two couldn't look more different. Stern, 65, is barrel-chested with white hair and a loud, raspy laugh. Ripoll, 43, has a slick, dark coiffure and a heavy French accent. As Stern talks about growing up on a vegetable farm in New Jersey, one can't help but notice that his story resembles Gundlach's. Both were gifted kids who came from working-class families, and both share a love of art (Gundlach has an extensive collection of contemporary paintings; Stern is the chairman of the L.A. Opera, a passion he developed while riding on his father's tractor and listening to opera on the radio).
Despite the controversy, Stern insists that TCW is better positioned than ever, and its new team, he pointedly adds, is "delighted to be here." Stern predicts that TCW will double its assets in three years. He stresses the importance of having "mechanisms where people share information and are willing to help each other." While not specifically naming Gundlach, the message is clear: The star manager didn't play well with others. TCW's new head of fixed income is MetWest founder Tad Rivelle, a self-effacing, professorial type -- the anti- Gundlach -- and no slouch as a manager. His Total Return bond fund has beaten 94% of its peers over the past decade.
"TCW is ready for growth," Ripoll says. "To be transparent -- this was not possible before." And what of Gundlach's long-desired equity stake? TCW is giving shares to the new team from MetWest (as it did with the Crescent group) but is less definite about handing it to others. "When you have a company like TCW, it is very important that you have equity held by the employees," Ripoll says. "That is what we are putting in place."
TCW's basic business model -- a collection of autonomous managers -- seems unlikely to change. In a separate interview, the founder and chairman defends the approach. "I started the company with $2 million, and it has $115 billion today," says Day. "The formula that has worked for 40 years is going to continue to work." (Day also insists Gundlach really didn't care about an equity stake; when given the choice, he always opted for more fees.)
Gundlach, meanwhile, is still setting up shop. He has been through a lot of late. He showed up at meetings in January with a black eye and cuts on his face, which he says came from tripping and colliding with his desk at home. On Feb. 1, his wife of more than 20 years, Nancy, filed for divorce. And Bill Gross was named fixed-income fund manager of the decade; Gundlach thinks he would have taken the prize if he hadn't been fired. That said, Morningstar clearly still views him as legitimate: The organization invited Gundlach to deliver the keynote address at its annual investors conference this summer.
DoubleLine has registered three mutual funds with the SEC, and it expects $10 billion in new accounts this spring. Gundlach says the most gratifying thing about the firing and its aftermath is that 45 people followed him from TCW -- proof, he says, that he isn't such a difficult guy to work with. As Gundlach walks through his new firm's offices, he looks happy. To reign there, it seems, is better than to serve at TCW. 
Now let's create our two hypothetical portfolios with an initial investment in 1988 spread equally among these four indexes. A properly balanced portfolio wouldn't blindly divide equally among these four asset classes, especially as it produces an aggressive, stock-heavy portfolio with large emerging-markets exposure, but for illustrative purposes, this hypothetical portfolio will work beautifully. After investing two portfolios equally in each of the four indexes, we will have the first portfolio be strictly buy-and-hold, while the second one will annually rebalance to return the portfolio to its initial mix.After 22 years have passed, the buy-and-hold portfolio would have increased an investor's wealth by 10.4% annually, a better result than three out of the four indexes. While there was little to gain by rebalancing through the 1990s, eventually it proved to be a wise move as the second portfolio ended up with an annualized return of 11.1%. While this doesn't sound like a large difference, keep in mind that the extra 70 basis points of performance compounded over 22 years increased our hypothetical portfolio by more than 100% of the initial investment! When you're compounding returns, every extra little bit counts.
While a straight investment in the MSCI Emerging Market Index would have provided a greater return than either of our diversified portfolios, an investor shouldn't ignore risk in evaluating investment opportunities. Using standard deviation of returns as a proxy for risk, our buy-and-hold portfolio was much less volatile than the MSCI Emerging Markets Index, and our rebalanced portfolio was a steadier ride than any of the three all-stock indexes or our pure buy-and-hold portfolio. On a risk-adjusted basis, a strict asset-allocation strategy with regular rebalancing is hard to beat.Of course, not many people invest a large chunk of cash at one time without ever adding to it. To reflect additional savings as people add to their portfolio, we created two more hypothetical portfolios, which included monthly contributions of 1% of the initial investment. Once again, we created a buy-and-hold portfolio, as well as a portfolio that annually reallocated equally among our four indexes. Just as in our last example, investors who rebalanced regularly would have been pleased with that decision, as both returns and risk were superior to the buy-and-hold strategy.
Obviously, both of our examples were simplified; we ignored the effects of transaction costs, taxes, and other important considerations. Counting the costs of buying new ETF stakes would not have weighed on the rebalancing strategy sufficiently to make the pure buy-and-hold portfolio superior but would have substantial effects on the cost efficiency of monthly new investments. Still, we believe the evidence is clear that over a long-term horizon, asset allocation, including a regular rebalancing program, is a powerful tactic for investors.So if you've accepted the arguments in favor of asset allocation, how do you go about optimizing your portfolio? Morningstar has several tools available to help in making asset-allocation decisions, ranging from Morningstar.com's Instant X-Ray tool to Morningstar EnCorr for institutional users. In addition, consider using ETFs in forming your portfolio as there are multiple options available for all of the major asset classes, including fixed income, equities, cash, commodities, real estate, and foreign currencies.There is no "right" answer when it comes to asset allocation, as it can vary greatly depending on an investor's own circumstances. Age, risk tolerance, other sources of income, and other factors need to be accounted for. The most important point to keep in mind is that investors need to set realistic financial goals, create a plan to meet them, and then stick to that plan through the ups and downs of the market.
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