Monday, May 14, 2012

Jeffrey Gundlach, Bond Savant

Jeffrey Gundlach, Bond Savant

Can you spot the $34 billion fund manager? Jeffrey Gundlach (third from left), who runs DoubleLine Capital, the fastest-growing mutual fund startup in history. His mid-'80s haircut is only slightly less weird than his rise to the top

DoubleLine Capital’s new office is high up in a downtown Los Angeles skyscraper, with unobstructed views of the famous Hollywood sign. As you walk out of the elevator, a huge canvas with the firm’s logo greets you; DoubleLine founder Jeffrey Gundlach painted it himself. Pass a six-foot-tall faux terra-cotta Chinese warrior and you’ll find a conference office called the Van Gogh Room. The Van Gogh Room has no Van Goghs, though it does display a pair of landscape paintings and looks out to a reception area adorned with other paintings Gundlach won at auction. It also, on this visit, contains Gundlach, sitting at the end of the conference table in a crisp button-down shirt, with a goatee and rust-colored hair, cut short.
The idea was to interview Gundlach, whose company is the fastest-growing mutual fund startup in history, but the conversation quickly turns into a kind of test. Gundlach wants you to know he is a connoisseur of fine art. He also wants you to know you don’t know squat.
Gundlach in his new L.A. officesPhotograph by Todd Weaver for Bloomberg BusinessweekGundlach in his new L.A. offices
“Do you know the total U.S. debt?” he asks.
Around $15 trillion?
“Right,” he says. “Do you know what percentage of national revenue comes from the income tax?”
No idea.
“You’re forgiven for not knowing that,” he says. “It’s not what you do. But if you’re managing bond money, it’s the least you should know. Was it Socrates who said, ‘It’s that I know that I don’t know everything’?” Gundlach is fond of quoting the great and ancient in the service of macro bets: A recent PowerPoint presentation on the future of bond yields started nearly every slide with a quotation from Shakespeare.
He dives into why he alone can trounce the competition in bond funds. “I can still do about 7 percent in a world of 2 percent,” he says. “You stress-test your portfolio constantly. You think about it and analyze it to death. Other people don’t know how. I wish I could teach it to somebody.”
Since DoubleLine first took investor money in April 2010, it has amassed $34 billion in assets. Even as it quadrupled in size last year, DoubleLine’s $22 billion Total Return Bond Fund (DBLTX) outperformed 99 percent of its rivals. The firm takes in $80 million to $100 million in new client dollars every day.
Unlike the reigning bond king, Bill Gross, manager of Pimco’s $259 billion Total Return Fund, DoubleLine Total Return invests primarily in mortgage-backed securities, which Gundlach says he can combine into a portfolio that posts higher returns even during economic downturns. In January, Barry Ritholtz, the New York finance blogger who helps manage $500 million in high-net-worth assets, moved all of his Pimco assets to DoubleLine. Ritholtz says that with the Federal Reserve maintaining its zero-interest rate policy and Treasury bonds yielding so little, Gundlach’s less understood mortgage market expertise was needed to get his clients higher yields without having to make a firmwide bet on interest rates. “It was a straight-up trade for me,” Ritholtz says. “Bill Gross for Jeffrey Gundlach—no player to be named later.”
DoubleLine is not only the fastest-growing mutual fund startup ever, it may also be the fund with the strangest genesis. Two and a half years ago, Gundlach was fired by his old employer, Trust Company of the West, where he and his team managed 70 percent of that firm’s $110 billion in assets. It was a messy departure that involved mass defections, a stash of porn and drug paraphernalia, and an acrimonious trial. The rival firm Gundlach founded may outgrow its ancestor.

Gundlach grew up in Buffalo. His father was a chemist at a company that made wax for bowling alleys, and his mother was a housewife. Although his uncle Robert Gundlach invented the photocopier and his grandfather Emanuel Gundlach formulated a hair tonic popular in the 1950s called Wildroot Cream-Oil, he says his family scraped to get by. “When our drying machine broke, it didn’t get fixed,” he says. “My mother would just run clotheslines all across the backyard.”
What he lacked in privilege, Gundlach says, he made up for with hard work and intelligence. “Look, I’ve never needed to network,” he says. “I was always at the top of my class, always got straight As. I got a near-perfect math SAT.” He went to Dartmouth on financial aid, graduated summa cum laude in math and philosophy in 1981, and entered Yale’s applied mathematics Ph.D. program. Two years later he dropped out and drove to California to become the drummer for a rock band called Radical Flats. He had a Flock of Seagulls pompadour and a day job at insurer Transamerica. A year later, broke and watching Lifestyles of the Rich and Famous on a little black-and-white TV, he resolved to become an investment banker.
He opened a phone book, flipped to “Investment Managers,” and talked his way into a meeting at TCW. He knew nothing about bonds, but the firm was impressed enough by his math skills to offer him a job. By the time he showed up for his first day of work as an analyst on the bond desk, he’d already mastered the math in Sidney Homer and Martin Leibowitz’s Inside the Yield Book, which lays out the field of bond analysis. “Very few people can do that,” he boasts. “Like, very few. I quickly realized I knew more than most people who worked at TCW for years.”
As he immersed himself in the bond market—duration analysis, the yield curve, prepayment risk—Gundlach quickly rose up the firm’s ranks. By 1987, as the savings and loan crisis took hold, the 28-year-old had a reputation as TCW’s mortgage wunderkind. The firm gave him $500 million to manage, and he finally quit his band, which by then was called Thinking Out Loud.

The bond market is a grinder’s playground. A big winner, like Gundlach in 2011, might deliver 9.5 percent. Gross’s Total Return Fund last year, with its more diversified strategy, earned 4.2 percent. A long-term winner might deliver annual returns of 6 percent or 7 percent. Managers can invest in Treasuries, among the safest securities on the planet, but with yields near record lows—a 10-year government bond earns 1.9 percent—it takes other vehicles to deliver a competitive return, especially after fees, taxes, and inflation. (Bond funds are chiefly measured against the Barclays Capital Aggregate Bond Index, just as equity funds aim to beat the Standard & Poor’s 500-stock index.) To increase returns, a manager can buy riskier foreign sovereign and corporate debt, but such an approach can go very wrong. That happened at Pimco last year when it avoided Treasuries just as they staged one of their best rallies in history.
At TCW, his former employer, in 2005Photograph by Cheryl HimmelsteinAt TCW, his former employer, in 2005
Gundlach favors mortgage-backed securities, which are themselves portfolios of home loans. There are two types: guaranteed and non-guaranteed. Guaranteed mortgages are backed by Ginnie Mae, Freddie Mac (FMCC), and Fannie Mae (FNMA), which are sponsored by the government. They’re more secure and thus have lower yields than their non-guaranteed counterparts. These bonds must still yield more than Treasuries to compensate investors for the risk of homeowners prepaying their mortgages. Like Treasuries, they increase in value when the bond market gets anxious about risk. That’s what transpired last year, amid fears of a European meltdown.
Non-guaranteed mortgage securities are directly issued by financial companies and banks not associated with the government, and come with no credit guarantee. The higher risk is reflected in higher yields. If the economy and housing do well, and investors prefer riskier assets to government bonds, non-guaranteed mortgage securities will both pay a nice yield and appreciate in value. The Gundlach theorem: A portfolio with a blend of both kinds of mortgage securities will combine credit risk and interest rate risk in a way that throws off higher returns.
Gundlach has been playing the mortgage market for decades. In 1990 he took home his first million-dollar paycheck. Over the following decade, his pay swelled into the tens of millions. At TCW Total Return, Gundlach rode through the worst of the financial crisis, from 2007 to 2009, to return 9.1 percent a year. By 2009 he was making $40 million a year, and his team was managing most of TCW’s assets.

Just after lunch on Friday, Dec. 4, 2009, Gundlach, then 50 and TCW’s chief investment officer, watched as the bond market closed on the East Coast. It had been a great year: His TCW Total Return Fund had posted more than double the average return of its peers. Morningstar (MORN) had nominated him Fixed Income Manager of the Decade, and he was on track, he says, to collect hundreds of millions in salary and bonuses over the next couple of years.
Gundlach headed upstairs for what he believed was an executive meeting. Instead, in the boardroom, he was met by TCW’s chief counsel and an attorney from Quinn Emanuel Urquhart & Sullivan. They presented him with a document alleging gross misconduct, including an attempt to steal staff and confidential client and trade information to launch his own rival firm. His 24 years with TCW were over, effective immediately. His BlackBerry was already disabled.
Gundlach kept an office on the west side of L.A., where he would work some mornings to avoid rush-hour traffic. Figuring he’d go collect his belongings, he pulled out of TCW’s garage in his Porsche and headed to Santa Monica. At that office, he recalls, he found the door broken and the desk drawers ransacked. TCW would later claim Gundlach kept in his office a stash of porn, sexual devices, and pot-smoking accessories. In a letter to DoubleLine clients, Gundlach called those items “vestiges of closed chapters” of his life. TCW spokesman Peter Viles says the office was company property that security personnel entered with a key.
Back at TCW’s trading floor, Chief Executive Officer Marc Stern informed Gundlach’s team that their boss was gone, and that TCW was acquiring rival Metropolitan West to plug the hole. The following morning, 15 senior members of Gundlach’s team repaired to his house. Gundlach’s then-wife, Nancy, made coffee. (That’s her, second from left, in the band photo at the beginning of this article.) Louis Lucido, a deputy at TCW, brought donuts.
By noon, 14 of the gang of 15 had resigned from TCW. The holdout was Philip Barach, co-manager of the TCW Total Return Fund. Surrounded by a circle of mutineers, Gundlach, who says he got misty-eyed, persuaded Barach to join them. The two men shook hands and hugged, and the reunited team applauded Barach as he thumbed out his own resignation on his BlackBerry. “It was a total leap of faith,” recalls Barach, now DoubleLine’s president. “I wasn’t poor. But this was all or nothing.” That night, he says, TCW CEO Stern drove to his house and offered him a minimum of $10 million a year over six years to stay, with an understanding that the 57-year-old could retire and collect his entire package in just three years. Barach turned down the offer.
“TCW made a multitude of miscalculations,” says Gundlach. “Even if they’d kept most of the team, the clients would have fled. They knew that I ran it.” TCW’s spokesman, Viles, responds that the acquisition of $30 billion MetWest more than made up for the loss of Gundlach.
By the following Wednesday, Gundlach had his 15 colleagues, plus 17 more who had also bolted from TCW, running around town to get the new operation running. Lucido bought 30 laptops with a personal credit card at Best Buy (BBY). Others Googled client names; TCW had seized their computers and Rolodexes. Barach and Gundlach prevailed upon Oaktree Capital, a $67 billion investment firm run by former TCW Chief Investment Officer Howard Marks, to kick in an undisclosed amount. On Dec. 14, five days after Gundlach was fired, DoubleLine put out its first press release.
On Jan. 7, 2010, TCW filed a lawsuit against Gundlach alleging conspiracy, breach of fiduciary duty, and theft of proprietary information. The suit claimed Gundlach had been planning for months to leave TCW and start a rival firm, and that his behavior was “erratic” and “increasingly and openly confrontational.” Forty-five out of 65 of Gundlach’s old TCW team had since decamped for DoubleLine.
“The day we were sued, the phones stopped ringing,” says Bonnie Baha, one of Gundlach’s crew of defectors. “Each of us had families to support. Not one of us was drawing a salary.” On Feb. 10, a month after TCW filed its suit, Gundlach put out a press release announcing a countersuit to recoup $1.25 billion in fees he says TCW owed him and his team. “I believe the facts stack up overwhelmingly on our side,” he said in the statement. “I would be delighted to see this case go to trial tomorrow, if that were feasible.”
DoubleLine in its early days, says Gundlach, faced the chicken-or-egg problem of not yet having nearly enough client assets to prove itself—which, of course, it could hope to do only with enough client assets. He says he realized his last best hope was opening DoubleLine to the masses. “If we were going to make it,” he says, “it would have to come down to mutual funds. It was like putting my record up to a popular vote.”
On April 6, 2010, with staff in and out of depositions related to the trial, DoubleLine launched its own Total Return Fund. A Merrill Lynch brokerage office immediately wired $65 million. By December 2010, the fund had crossed $7 billion in assets under management. One early adopter was broker Kurt Brouwer of the $700 million investment adviser Brouwer & Janachowski in Tiburon, Calif. “We used TCW Total Return, so we were comfortable with him,” he says. “The transition wasn’t traumatic. We just left TCW and moved over to DoubleLine. People are motivated when they start new funds. The messy, sordid details weren’t important to us.”

In September 2011, after six weeks of trial, an L.A. jury awarded Gundlach and three associates $67 million in unpaid wages. While the jury also found them liable for breaching their fiduciary duty to TCW and misusing company secrets, it didn’t deem the breach important enough to award TCW any damages. In December, before that decision was finalized, Gundlach and TCW agreed to settle their dispute; terms of the deal are confidential. As for that pleasure stash in Gundlach’s office, the presiding judge ruled in July that it was immaterial to the case. The jury never learned about it.
Gundlach says he will consider closing DoubleLine’s mortgage-backed investments to new money when they hit $50 billion in assets. “Do you realize that the week after TCW got rid of me, $30 billion in assets left the firm? That’s $150 million in annual fees,” says Gundlach. (TCW’s Viles calls those numbers “wildly inaccurate.”) Gundlach continues: “They figured that changing fund managers was no different than changing branch managers at the local bank.” He stops to tick off his achievements—a decade at the top of his category, taking DoubleLine’s assets from zero to $34 billion in three years. “Find me anyone else in this industry that did that.”

Tuesday, May 08, 2012

Invest in stocks? FORGET ABOUT IT

Main street hates stocks.
That is according to today’s front page of USA Today: The print edition had a center column, above the fold, screaming green headline “Invest in stocks? FORGET ABOUT IT.” That Cap and Bold headline is as it was in original. (The online version was the tamer Invest in stocks? Small players still smarting [1]).
It may surprise some people to learn this is both an expected and positive development. It implies eventual lower prices (over the intermediate term), but will also help to create that elusive lasting market bottom, as I will explain in a moment.
First, an excerpt:
“On Main Street these days, investing in the stock market is about as popular as watching a scary movie on a 12-inch black-and-white TV.
Wall Street’s long-running story about how stocks are the best way to build wealth seems tired, dated and less believable to many individual investors. Playing the market isn’t as sexy as it used to be. Since the 2008-09 financial crisis, the buy-now mentality has been replaced by a get-me-out, wait-and-see, bonds-are-safer line of thinking.
Stocks remain out of fashion even though the stock market has risen more than 100% since the bear market ended three years ago. It’s up 25% since October and 9% this year.”
This is no surprise — between the run of scandals in the 1990s and 2000s, the dot com implosion, analyst scandal, the 2007-09 crash, housing collapse, the flash crash, and HFT, mom and pop have taken their ball and gone home.
This is how bear markets eventually end.
Most people misunderstand what drives secular bull and bear markets, focusing on prices alone as the defining characteristics. I believe this is in error, or at very least paints an incomplete picture.
Whenever I give a market presentation at a conference, I always use the chart below. It explains in great deal how Main Street investor psychology impacts the long secular cycles of bull (green) and bear (red) markets. Note the metric at bottom, which is P/E ratio.
My definition of a Secular Bull Market: An extended period of time, typically lasting 10-20 years, driven by broad economic shifts that create an environment conducive to increasing corporate revenue and earnings. Its most dominant feature is the increasing willingness of investors to pay more and more for a dollar of earnings.
You can see this in the 1982-2000 secular bull market. Total returns were driven partly by earnings improvements, but far more by multiple expansion. This is essentially a psychological component.
A Secular Bear Market reflects the opposite: Following an extended secular bull, it is a period of time marked by increased volatility, frequent cyclical rallies and corrections, in an economically challenging environment. The dominant feature is that Investors are willing to pay less and less for that same dollar of earnings.
We see that today. Profits going up as volumes go down; investor interest ebbs and fades. Its how markets can go sideways or even rally and still see P/E ratios fall.
Ultimately, when the process generates enough investor disgust, we can form a lasting market low, typically, in the Single digit P/E ratios.
(The caveat is we don’t know how unprecedented Fed printing affects this psychological process).
click for ginormous chart
Original chart, Crestmont Research (annotations added)
Invest in stocks? Small players still smarting [1]
Adam Shell
USAToday, May 8, 2012

Article printed from The Big Picture:
URL to article:

Benchmark obsession undermines investor returns

Sir John Templeton, the pioneering global investor, argued that the aim of investing was quite simply “maximum real returns”. Over time this simple but powerful objective has been lost. This is all the more surprising because, clearly, real returns matter to the end investor, particularly in current markets. Pensions are paid from real returns not relative ones.

So where did the concept of relative performance originate? It probably stemmed from good intentions (as do most bad ideas). Why pay active fees if the managers don’t deliver returns above a passive benchmark? However, this idea has morphed into an unhealthy obsession with pigeon-holing managers into niche buckets.

The late great value investor Bob Kirby opined: “Performance measurement is one of those basically good ideas that somehow got totally out of control. In many cases, the intense application of performance measurement techniques has actually served to impede the purpose it is supposed to serve”.
Investment committees spend an inordinate amount of time discussing decisions such as which small-cap growth manager to hire.
Yet often they fail to devote the same energy to discussing the asset classes to choose. They should spend more time selecting the asset classes. After all, the extra performance from a good manager over an asset class is unlikely to be much more than the icing on the cake.
Perhaps this neglect of the importance of asset class decisions stems from the fact that such discussions are inevitably harder than discussing the relative merits of a beauty parade of managers. Often discussions on asset classes degenerate into debates over the economic outlook.
Sadly this is largely an investment dead end. There is no evidence that anyone can read the economic tea leaves consistently well. As if that wasn’t difficult enough, even if you got the economics right, you still have to work out how the markets will react, and which assets will benefit.
Many institutional investors have their asset allocation dictated to them from asset liability studies, or simply implement a fixed ‘strategic’ asset allocation, thus abdicating responsibility for any discussion on asset classes. There is also a tendency to view ‘strategic’ as meaning static. This assumption needs challenging.
When a pensions plan appoints a manager with an investable benchmark they inadvertently create incentives to alter the manager’s behaviour.
Suddenly everything becomes relative, so the manager starts to think about relative valuation (ie is the asset I’m buying cheap relative to the benchmark?), relative risk (ie. I mustn’t deviate too far from my benchmark as I will be taking on ‘tracking error’), and, worst of all, relative return (ie. I did a good job because I only lost 30 per cent of your investment, and the benchmark was down 50 per cent). So while an investable benchmark makes measuring performance an easy task, it isn’t necessarily good for focusing the manager’s mind on generating real returns. Relative benchmarks are often employed to the detriment of real returns and the preservation of capital.
Thankfully, there is a simple, although not easy (to borrow Warren Buffett’s phrase), alternative – to use a value approach across a wide range of assets. Buy when an asset is cheap, and sell when an asset gets expensive – buy low and sell high, a sensible approach to both the preservation and growth of capital.
Valuation is the primary determinant of long-term returns, and the closest thing we have to a law of gravity in finance. For instance, buying assets when they are expensive (high price/earnings ratios in the equity space and low yields in the bond space) tends to result in low returns. In contrast, buying cheap assets generally leads to high long-term returns. So moving your assets in response to valuation signals makes sense.
Of course, there is a downside to this style of investing. In order to pursue a value-driven approach you need two key traits – patience and a willingness to be contrarian. Unfortunately these traits are in rare supply, and become almost extinct when people act in groups (such as committees).
Let’s end as we began with a quotation from Sir John Templeton: “If you buy the same securities as other people, you will have the same results as other people. It is impossible to produce a superior performance unless you do something different from the majority. To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward”.
James Montier is a member of GMO’s asset allocation team and the author of several books including Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.