Tag Archives: DoubleLine

Checking Up On Workhorse Bond Funds

At RIA Advisors, we do ongoing research on investments for managing client portfolios, of course. And we recently reassessed some popular bond funds. The results might be interesting for readers.

We looked at a group of bond funds that often make short lists for advisors – DoubleLine Total Return (DBLTX), DoubleLine Core Fixed Income (DBLFX), PIMCO Total Return (PTTRX), Baird Aggregate Bond (BAGIX), Dodge & Cox Income (DODIX), Western Asset Core Bond (WATFX), and Metropolitan West Total Return (MWTIX). We started with five year returns and Sharpe Ratios. That’s not a comprehensive analysis, but it’s where we began. Here’s what we found out.

DoubleLine Total Return’s 3.10% annualized return was the second best over the five years through January 2019, but that fund also had the best Sharpe Ratio of 1.16%. That means the fund delivered the best return per unit of volatility among this group of “usual suspects” on most advisors’ short lists. Lots of people think of the fund’s manager, Jeffrey Gundlach, as a gunslinger, who takes a lot of risks. That may be because of his outspoken and frank webcasts, which many investors, including the group here at RIA Advisors, find informative. But the truth is Gundlach runs risk-averse funds. When he’s done something unusual, such as his buying Alt-A mortgage-backed securities for the Total Return fund after the financial crisis, it’s been justified.

Those Alt-A’s probably delivered a ton of return in the first few years the fund owned them, so the fund’s gaudy post-crisis returns (more than 9% in each of the calendar years 2011 and 2012) might be a thing of the past. But that doesn’t mean the fund is any less attractive or that it can’t continue to beat most of its peers and the Bloomberg Barclays US Aggregate.

Western Asset has the best five-year annualized return at 3.44%. But its Sharpe Ratio of 0.92% shows that investors have to tolerate some volatility to achieve those returns. We also looked at how the funds – or the funds their current managers ran – did in 2008, and Western Asset had a difficult time in that stressful period. The firm went out on a limb at the wrong time.

PIMCO Total Return was the best performer in 2008, but those were the days when Bill Gross was at his peak. For the past five years, the fund looks more like the index in terms of its returns and volatility, but its new management team doesn’t own that entire record. Mark Kiesel, Scott Mather, and Mihir Worah have led the fund for a little more than 4 years, since September 26, 2014, and the fund’s 2.53% annualized return for the three years through January 2019 is better than those of most of its peers and than the index’s 1.95% annualized return.

Dodge and Cox Income was its usual solid self, with a 2.91% annualized return and a 0.90% Sharpe Ratio. During the crisis it lost 29 basis points, much better than the nearly 500 the average intermediate term bond fund lost, though behind the 5.24% return of the index.

Baird Aggregate has been solid as well. It has produced a 2.84% annualized return for the recent five-year period with a 0.76% Sharpe Ratio. In 2008, it dropped a little more than 2%, better than the category average, but worse than the index.

Finally, Metropolitan West has been lackluster. The fund has lagged the index with its 2.44% annualized return for the recent five-year period. However, it has surpassed the 2.25% return for the category average. The fund’s 0.67% Sharpe Ratio has surpassed those of both the index and the category average. So the fund has delivered better volatility adjusted returns than the index and category average. In fact, it’s Sharpe Ratio has also surpassed that of the PIMCO Total Return Fund.

Incidentally, it’s interesting to note how the Morningstar fund category average differed from the index in 2008 (-4.7% for the category average and 5.24% for the index) . That divergence results from the fact that the index is U.S. Treasury-heavy, and Treasuries did well in 2008. The average fund, however, often tries to beat the index by owning lots of corporate bonds or by taking other credit risk. And that was decidedly the wrong move in 2008, when the safest securities were the most loved.

There are other funds we could have included here such as PIMCO Income, Loomis Sayles Bond, Delaware Diversified Income, BlackRock Total Return, Guggenheim Total Return, JPMorgan Core plus Bond, and Lord Abbett Total Return but we had to make the cut somewhere for this article. We monitor those funds and others routinely, and so should other advisors who aren’t fully dedicated to passive funds.

It’s Not A Bad Time To Rebalance

Maybe you don’t like a lot of fuss as an investor, and you want to buy-and-hold a simple portfolio for the long term. That’s fine, but you do have to rebalance periodically. And people who favor simplicity may do that rebalancing on a pre-set schedule – quarterly, semi-annually, or annually.

But if you want to be a little more active regarding your rebalancing, now’s not a bad time to consider doing it. Here are some asset class returns for the year through January 30, 2019:

You can see that stocks have done well, with the S&P 500 Index surging by around 8%. Small cap stocks have done even better, with the Russell 2000 Index rising more than 11%. Emerging markets stocks have bounced back too from a poor showing in 2018 with a n 8.67% return for the first month of this year. And finally, with interest rates seemingly under control, REITs have topped the list with a gaudy 11.78% return.

If you started the year with a balanced portfolio of, say, $100,000, the $60,000 you had in stocks could now well be over $63,000. The $40,000 you had in bonds, by contrast, might not even be at $40,500 at this point. It’s not necessary to rebalance, but if you have a tax-advantaged account like a 401(k) or an IRA, and you can switch funds without paying fees or commissions, it’s not a bad idea. If your $100,000 is now close to $104,000 because of the $3000 you’ve made in stocks and a few hundred dollars in bonds, go ahead and move around $1,000 from stocks to bonds. That will get your stock exposure back to 60%.

That’s not a huge move, but the great investor, Benjamin Graham, who understood investor psychology before behavioral finance became an academic discipline, knew that investors get antsy to do something. And if fees, commissions, or taxes aren’t an issue, rebalancing is a good way to satisfy that itch to trade without doing yourself harm.

Besides satisfying the desire for activity, rebalancing can help you in other psychological ways. If you rebalance, and the market drops, you can feel happy that you took at least some money off the table – even if it was only a small amount. If, on the other hand, the market goes up, you can be satisfied that you didn’t alter your target (60/40) allocation; you just returned your portfolio to it after the January gains altered it, booking some profits in the process. You still have 60% of your money working in stocks.

There will always be woulda-coulda-shoulda thoughts when markets move. When stocks go up,  you wonder why you didn’t have more money exposed to them. And when they go down,  you wonder why you didn’t have less. But a balanced portfolio is one that most people can live with psychologically. It provides enough exposure when stock go up to minimize regret. And it provides enough bond exposure when stocks go down to minimize regret.

Investors should understand, however, that a balanced portfolio isn’t perfect. It may well return much less over the next decade than it has over the very long term. That’s because bond yields are so low that it will be virtually impossible for bonds to deliver more than 3.5%-4%, depending on your mix of Treasuries and corporates and your average maturity. Also, stocks are trading at high prices relative to past long-term earnings, which is usually a situation that produces lower-than-average future returns. That’s more incentive to rebalance in accounts that won’t hit you with transaction fees or a tax bill for doing so.

Last, if you think we may get some inflation, you can take that $1,000 away from stocks and put it in gold or leave it in cash. The economy isn’t robust on many indicators, but, according to DoubleLine fund manager Jeffrey Gundlach, inflation can come from all the quantitative easing the Fed has done and the large amount of U.S. debt outstanding. If a balanced portfolio is likely going to deliver subpar returns, and debt turns out to be a problem, holding some alternatives to stocks and bonds is reasonable.

Are Tech Stocks Cheap?

Are technology stocks cheap? It seems like a strange question to ask as the market drops on news that Apple has indicated weaker future sales. I also doubted whether Facebook’s price reflected its business value in the middle of this past summer. I thought fair value for the business was around $140 per share assuming it could grow its free cash flow by a robust 6% annually over the next decade. The stock is now in the $130 range after pushing higher than $200 in the early summer.

But technology isn’t just the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google). And at least two important firms – DoubleLine and GMO – think the sector is at least relatively cheap. Here’s why.

First, technology is trading cheaply on a Shiller PE basis, shown by the fact that the DoubleLine Shiller Enhanced CAPE Fund (DSEEX) holds the sector. By using a bond portfolio as collateral, this fund gains exposure to an equity derivative that delivers exposure to four of the five cheapest S&P sectors (tossing the one with the worst one-year price momentum) on the basis of their Shiller PE ratios — and technology is one of those sectors currently. The Shiller PE, as a reminder, is the current price of a stock, sector, or index relative to its past decade’s worth of real, average earnings. Right now (and for more than a year) technology has come up as one of the four sectors the fund owns, meaning its Shiller PE is lower relative to its own historical average than other sectors’ Shiller PEs are to theirs. The other sectors the fund owns currently are Healthcare, Consumer Staples, and Communication Services.

This mechanical application of the Shiller PE may not satisfy investors looking for more a more absolute definition of value, but, relative to other sectors, technology is cheap on a serious valuation metric. If you’re going to be allocated to U.S. stocks in some way, shape, or form, this is a reasonable way to achieve that allocation.

Second, GMO, which is also a fan of the Shiller PE metric, and uses it in its asset class valuation work, also likes technology stocks. The Boston-based firm just published a white paper, written by Tom Hancock, the head of the firm’s Focused Equity Team, arguing that technology stocks were attractive. The firm’s “Quality” strategy has 45% of its assets in technology stocks, “including positions in three of the five FAANG stocks.” Alphabet (Google) and Apple are the two largest holdings of the firm’s Quality mutual fund (GQETX), managed by Hancock.

Rather than relying on traditional valuation metrics when picking individual stocks, the firm looks at how Alphabet, for example, invests in R&D, and how that investment can translate into higher future revenues. In other words, R&D isn’t properly counted as an expense that will never yield future revenue and earnings growth. On the basis of accounting adjustments like this, GMO views Alphabet as a cheap stock.

Hancock notes that GMO’s Quality portfolio doesn’t trade at traditional valuation multiples that are different from the broader market. But, “in an expensive market, quality companies typically trade at higher P/E’s than most ‘value’ investors would like.” Higher multiples are justified for companies with resilient margins and strong business models, and Hancock thinks the strategy can produce returns of 5% in excess of inflation.

Quality companies in the U.S. are also cheaper than those outside of the U.S., and Hancock surmises that’s because of a kind of scarcity value. Companies with consistently high margins and returns on invested capital are less prevalent outside of the U.S., so they trade at dearer prices.

Moreover, the U.S. technology sector consists of a diverse group of stocks. Only one of the FAANGs – Apple – is in the top-10 of the S&P 500 Information Technology Sector. Some of the largest constituents of that sector are the darlings from the technology bubble of nearly 20 years ago – Microsoft, Intel, Cisco, and Oracle. They turned out to be good businesses that were just overpriced then. Hancock lists Microsoft’s virtues as being in the cloud growth business and having a lock on the consumer. Qualcomm, by contrast, has a unique position in the smartphone supply chain, while Oracle provides legacy software and benefits from high switching costs. Finally, Visa and Mastercard are “borderline tech” companies, but, nevertheless, find themselves near the top of the S&P 500 Information Technology sector.

So, despite being known for top-down asset class valuation calls, the GMO Quality strategy is bottom-up and fundamentally oriented. And, just like the more mechanical, single-factor approach of the DoubleLine fund, it also finds technology stocks cheap – or cheaper than their brethren in other sectors.

B

Both the DoubleLine Shiller Enhanced CAPE fund and the GMO Quality III fund are worthy of investors’ consideration. Beware that the latter is for institutional investors, given its $10 million minimum. Get in touch with us if you have questions about portfolio construction, asset management, or financial planning.

Gundlach’s Remarks Mean It’s Time To Check Your Allocation

“This is a capital preservation market.” So says Jeffrey Gundlach who can’t argue with anyone who wants to invest in the 2-Year U.S. Treasury, currently yielding around 2.7%. If you choose the 10-year, by contrast, and saddle yourself with 8 more years, you get less than 20 basis points of extra yield.

Gundlach is one of the world’s best investors, especially when it comes to bonds, And that means investors can’t always follow him literally because they’re not paying attention to global markets the way he is and can’t move as adroitly has he can.

Still, his remarks, delivered in a CNBC interview yesterday, are a warning for investors to check their allocations. Most investors shouldn’t try to time stock markets to the extent of being all out of or all in stocks with their long term money. But it’s a good time to check your allocation and see if it lines up with where you decided you wanted it when you started investing.

If you want to alter that allocation, and you watch the markets carefully, you can cheat a little with some extra cash. In fact, I think anyone about to embark on retirement and planning to use something like the “4% rule” (taking 4% of your assets the first year of retirement, and then increasing that initial dollar distribution by 4% every year thereafter) should have around 30% in stocks right now.

That kind of conservative portfolio will be able to withstand stock market declines if they occur while distributions are also depleting a portfolio. At least it has since 2000 when stock markets were wildly overpriced and subsequently delivered a 5.4% annualized return for the next 18 years. Retirees should think hard about revising the “4% rule” to the “3% rule,” however, given how low bond yields are now.

Novice investors should also understand that Gundlach isn’t making a prognostication out of thin air. The U.S. markets have been up for nearly a decade without a meaningful interruption. In 2017, U.S. stocks were up every month, which is the only time in history that has happened. Also, the best valuation indicators such as the Shiller PE and Tobin’s Q are forecasting low returns for the next decade. That doesn’t mean a crash will happen tomorrow; no valuation indicator is any good at predicting that. But it means stocks will have to remain at nosebleed prices relative to earnings, sales, and book value to produce returns that can beat inflation by 4 or 5 percentage points. The S&P 500 Index is now yielding a little less than 2%. Another 4% or 5% earnings per share growth annually for the next decade will produce a 6% or 7% annualized return, which sounds good. But stocks must remain at current prices relative to earnings (currently 30 or so on the Shiller scale) in order to pocket those returns. That’s unlikely. A “valuation reversion” or investors deciding that they should pay less for earnings will detract from that 6% or 7% annualized return — possibly in a significant way.

If you’ve been invested in stocks for the past decade, you’ve been given a gift. But the market can take that gift away if investors decide they want to pay lower prices for earnings than they have over the last decade.

Investors should do three things (at least), and  one of them won’t be possible to accomplish immediately — 1. Study market history and cycles 2. Check your allocation 3. Find an advisor who can help you.

The Tale Of The Two Bond Kings

(This article originally appeared in Citywire.)

Back in September, I examined the records of the managers that Morningstar nominated as candidates for ‘domestic equity Manager of the Decade’ in 2009. The results were not hugely encouraging. After making that illustrious shortlist, not one manager went on to beat their best-fit index. The Yacktman fund came closest, gliding so smoothly to its 11.43% annualized return from 2010 through August 2018 that it nearly produced the same Sharpe ratio as the S&P 500 index (1.14 versus 1.15 over the past decade). However, it still trailed the index’s return by more than 2.5 percentage points annualized.

Now, though, it’s time to focus on the nominees for the fixed income ‘Manager of the Decade’ award. The results are decidedly better. In 2009, Morningstar shortlisted Dan FussJeffrey GundlachBill Gross, Christine Thompson of Fidelity’s municipal bond funds, and the team on the Dodge & Cox Income fund. The award ultimately went to Gross, but it turns out that he is the only one to have subsequently posted a poor set of results.

It is unclear why Morningstar’s fixed income nominees have fared better than its equity picks. Perhaps, given the relative illiquidity of the bond market, it’s simply easier for fixed income managers to beat their indices than it is for their equity counterparts. Or maybe manager selectors and consultants have an easier job when it comes to identifying talented bond managers. Whatever the explanation, the fund analysts at Morningstar (including me, at the time) certainly seem to have been more successful in having their bond ‘Manager of the Decade’ nominees go on to post good returns in the future.

Masters of their domains

First up is Christine Thompson, who headed Fidelity’s municipal bond operation at the time of the nominations. She is no longer listed as a manager of Fidelity’s funds, but it was obvious that Fidelity’s municipal bond operation had depth and that this was a team nomination. For the period from 2010 through the end of September 2018, the Fidelity Municipal Income fund has posted a 43.7% cumulative return, while the Bloomberg Barclays Municipal Bond index has delivered 39.9% (see Figure 1). Over the past decade, the fund’s 1.09 Sharpe ratio has trailed that of the index (1.13), meaning that it has incurred more volatility to achieve its outperformance. Even so, it would be difficult to say that the fund has carried an unjustifiably high level of volatility.

Next, we have the ‘bond kings,’ Bill Gross and Jeffrey Gundlach, and the Dodge & Cox Income fund. All three deserve to be judged against the Bloomberg Barclays US Aggregate Bond index. There are two caveats with our data here. Gundlach left the TCW Total Return fund in December 2009 and began managing the DoubleLine Total Return fund the following April. Here, I have taken the TCW fund’s 2010 data through April and then hooked it up to DoubleLine’s data starting on May 1 that year. Similarly, for Bill Gross, I took the Pimco Total Return fund’s data from 2010 through October 2014 and then picked up with Gross’s new charge, the Janus Global Unconstrained fund, in November 2014. Gross began his tenure at Janus on October 6, 2014.

No Undue Risk

Realistically, Gundlach has dominated the period since the ‘Manager of the Decade’ nominations. According to the spliced data, he posted a 58.9% cumulative return from 2010 through the end of September 2018. His combination of safe Ginnie Mae bonds and beaten-up, high-yielding Alt-A private label mortgage-backed bonds has worked splendidly.

The team of managers that runs the Dodge & Cox Income fund has acquitted itself well too, delivering a cumulative return of 39.6% versus the index’s 30.7%. Gross, by contrast, has returned just 29.4% over that period (see Figure 2).

And lest anyone suppose that it was reckless portfolio positioning that accidentally produced Gundlach’s heady post-crisis returns, let the record show that he hunkered down with higher quality securities exactly when he should have done in 2008. That year, he piloted the TCW Total Return fund to a top-decile performance in the Morningstar intermediate-term bond fund category, with a 1.09% return.

Finally, the Loomis Sayles Bond fund, led by Dan Fuss, has outpaced the index with a cumulative return of 65.1% versus the Agg’s 30.7% (see Figure 3). However, investors should take this with a pinch of salt. The fund routinely invests in junk bonds and emerging market debt, along with a slug in safer sovereign debt. That makes it more volatile. Indeed, its Sharpe ratio over the past decade through September 2018 is 0.84. Compared with the Agg’s 1.04 Sharpe ratio over the same period, the Loomis Sayles Bond fund arguably hasn’t achieved as attractive a volatility-adjusted return.

Overall, the Morningstar ‘Manager of the Decade’ nominees in fixed income have produced solid results since 2009. Consultants often think small-cap stocks and international markets afford greater opportunities for active management to shine. Perhaps the ability fixed income provides has been under-appreciated.

The Worst Place To Be For Bond Investors

Last week, Jeffrey Gundlach of DoubleLine Funds noted in a webcast that investment grade corporate bonds are terrible. There is no way to win with them, he said. As much as half the investment grade universe could be downgraded to junk, and that will take buyers out of the market who can’t buy junk bonds. On some basic ratios, Gundlach argued, a lot of investment grade debt should already be rated junk.

Yesterday, DoubleLine Capital Portfolio Manager Monica Erickson was quoted in a Reuters piece arguing similarly that the investment grade corporate bond market is the worst place to be for bond investors. That part of the market has delivered negative returns this year. For example, the iShares Investment Grade Corporate Bond ETF (LQD) is down 5.50% for the year through November 15. The main investment grade bond index, the Bloomberg Barclay’s US Aggregate Bond Index, is down 2.23% over the same period. This year, investment grade corporates have underperformed lower quality junk bonds.

Interestingly, it’s not that investment grade companies are ready to default, noted Erickson. It’s that the starting yield on investment grade corporates is so low that there is a lot of duration risk in them. That risk reflects how soon or long it takes for an investor to receive their money back in interest and principal payments. If interest rates increase, bonds with higher durations (fewer payments coming back to the investor sooner) suffer more because it takes an investor longer to receive their money back and invest in new prevailing higher rates.

In addition to the higher-than-usual duration risk, investment grade corporates are yielding less over comparable Treasuries than they have previously. Echoing Gundlach’s point, Erickson said BBB-rated (the lowest rung of investment grade) bonds had increased from 20% of the investment grade universe in 2008 to 50% of the universe today. In a downturn, bonds moving from BBB to BB may not find buyers easily since many institutions have prohibitions against owning junk bonds. The BBB-rated universe is around $3 trillion, while the entire junk bond universe is a little over $1 trillion.

The Reuters article said that Erickson favored bank loans over investment grade corporates, since bank loans have a floating rate feature. But they aren’t foolproof either because of their extra dollop of credit risk.

Investors should have a handle on their bond allocations. It may not be a bad time to overweight Treasuries.

Please click here if you have questions about how we manage bond portfolios.

How’s Your Bond Fund Doing?

It’s been a tough year for bonds so far. Of course, a tough year for bonds can be a tough day for stocks. But investors seem equally disturbed by a 2% loss in bonds as by a 10% or more loss in stocks, so it’s worth looking at how bond funds have weathered the most recent storm. We looked at some of the most popular funds that reside in Morningstar’s intermediate term bond fund category. That category contains funds whose duration is moderate and whose holdings tend to be almost all investment grade, and so those funds tend to be the workhorses of most investors’ portfolios.

Through May 1, the BloombergBarclays US Aggregate is down 2.42%. That’s a total return number, so it includes the difference in price plus interest payments. The Morningstar intermediate term bond fund category average is down 2.11%, a slightly better showing likely owing to the higher corporate bond exposure and slightly lower duration of many funds compared to the Treasury -heavy index.

Duration Hurts

First, all of our selected funds have beaten the index so far this year except for the Western Asset Core Bond fund. The fund’s portfolio doesn’t appear unusual, although it has more of its assets in Agency Pass-Throughs than its peers (35% versus 21%), according to Morningstar. It has nearly 22% of its portfolio in Government bonds, according to Morningstar. Almost all of that is in U.S. Treasuries with a small part scattered in U.S. Agencies and Non-U.S. government debt. Nearly 8% of the fund’s portfolio is in emerging markets debt.

However, the fund’s average effective duration, a measure of interest rate risk, is nearly seven years, and that has likely contributed to its underperformance. No other fund’s duration is over seven, and the next highest three are barely over six. Five of the funds have durations around 4 years, and they’ve tended to hold up better this year.

Things Besides Duration Matter Too

Two funds stand out for bucking the trend of duration dictating performance. First, the Delaware Diversified Income Fund clocks in with a duration of 6.09, but the fund has still been able to eke out a gain over the Morningstar intermediate term category average and the Bloomberg Barclays U.S. Aggregate. This fund has traditionally held a lot of corporate bonds, including more high yield bonds than its peers. Currently the fund has 13% of its portfolio in BB-rated bonds (the highest level of junk or high yield), and those have held up better than more highly rated bonds this year. So the fund’s credit risk has likely helped it in an environment when interest rate risk has inflicted more pain.

Second, PIMCO Total Return has the lowest duration of the group at 3.99 years, but has lost more than the category average. The fund has been lighter in corporates than its peers – 19% versus 30%, according to Morningstar. It also has a significant allocation to what it classifies as “US Government Related,” which, according to PIMCO’s website, could include “nominal and inflation-protected Treasuries, Treasury futures and options, agencies, FDIC-guaranteed and government-guaranteed corporate securities, and interest-rate swaps.” Morningstar has its Agency MBS Pass-Through allocation at 39%, relative to 22% for its peer average. The fund’s most recent quarterly commentary mentions that positions in Agency MBS along with short exposure to the Japanese Yen, short exposure to duration in Japan and Canada, and exposure to high yield corporates” detracted from performance. The fund’s most recent monthly commentary lists non-U.S. rate strategies, positions in non-Agency MBS, and high yield corporates as the largest detractors.

It should be said that the new managers of PIMCO Total Return have done quite well since taking over in the fall of 2014. The new management team has been running the fund for a little over three years now, and, after a choppy start, the fund ranks in the 28th percentile of Morningstar’s intermediate term category for the three-year period ending in April 2018. A quarter’s worth of underperformance shouldn’t discourage any investor from choosing a particular fund or manager, though it’s useful to check in on asset classes and particular funds from time to time.