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Fixed-Income Strategy: What's Jeffrey Gundlach Doing?

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DoubleLine Capital's Jeffrey Gundlach has $45 billion in AUM. Here's his insight on positioning fixed income in an investor's portfolio.

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Few bond fund managers attract as much attention as DoubleLine Capital's Jeffrey Gundlach. His firm has seen its assets under management grow to more than $45 billion in just over two years since its founding. Although these assets span a multitude of fund vehicles, by far the largest is the DoubleLine Total Return Fund (MUTF:DBLTX), which held almost $35 billion as of 25 October. I am always anxious to see portfolio changes made in this fund, and I recently had the opportunity to take a close look at the fund holdings as of 30 September, which can give some valuable insight into how fixed income investors might consider positioning their portfolios.

He's Made a Bigger Move into CMBS

During the month of September, DBLTX's percentage allocation to commercial mortgage-backed securities ("CMBS") rose to 4.5%, up from 3.6% in August. That means he bought almost $300 million of CMBS.

CMBS are also a favorite in the DoubleLine Low Duration Bond Fund (MUTF:DBLSX); they make up 19.7% of the fund. The rally in CMBS has been strong, particularly since QE3 (the third round of "quantitative easing"). Annaly Capital Management wrote a summary of market action that describes it clearly:
During the quarter ended September 30, 2012, 10-year AAA new issue spreads have rallied from swaps +150/160 basis points (bps) to a level of swaps +85/95 bps. 10-year AAA legacy CMBS have likewise benefited, rallying from approximately swaps +230/235 bps to swaps +155/160 bps. Mezzanine bonds rated BBB and BBB- have seen spread tightening on the magnitude of 125 bps and 200 to 225 bps, respectively. . . . Commercial mortgages, even at current historically low rates, still exhibit good relative value against other fixed income alternatives.
Remember that bond yields move inversely with bond prices, so a fall in yield from a spread of +150/160 bps to +85/95 bps corresponds to a price increase of about 5%.

His Portfolio Is Low Duration with Plenty of Cash

It is no secret that Gundlach believes yields on US Treasury bonds offer a poor risk–return proposition. With a modified duration of 1.59 (i.e., the fund would lose 1.59% in value during an instantaneous 100 bp rise in interest rates), DoubleLine is exposed to much less interest rate risk than its peers.

The PIMCO Total Return Fund, for instance, has a modified duration of 4.02 and would thus likely perform better if Treasury yields were to reach new lows.

Given the significant rally in both agency and non-agency MBS, it appears that Gundlach is keeping a healthy cash allocation (≈16% as of 30 September 2012) to deploy if either U.S. Treasury yields quickly rise or non-agency MBS prices fall. In short, the combination of a high cash balance and low modified duration leaves him both more flexible for future opportunities and less sensitive to changes in rates.

He's Bought Some Long Duration to Hedge

As I mentioned earlier, the aggregate portfolio of DBLTX has a modified duration of only 1.59. However, when Gundlach and his team do buy bonds with high duration, they buy extremely long and less negatively convex MBS.
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