Updated Saturday, July 12, 2014 as of 7:41 AM ET
Portfolio - Fixed Income
Gundlach Expecting Kaboom of Defaults
by: Seth Lubove and Alexis Leondis
Friday, November 30, 2012
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It’s mid-October, and Jeffrey Gundlach is giving a stump speech to a luncheon crowd of about 200 financial advisers and investors at Los Angeles’s City Club. The renowned money manager’s theme: the financial catastrophe on the horizon.

The co-founder and chief executive officer of DoubleLine Capital LP explains that the first phase of the coming debacle consisted of a 27-year buildup of corporate, personal and sovereign debt. That lasted until 2008, when unfettered lending finally toppled banks and pushed the global economy into a recession, spurring governments and central banks to spend trillions of dollars to stimulate growth, Bloomberg Markets reports in its January issue.

In the ominous third phase, he predicts another crisis: Deeply indebted countries and companies, which Gundlach doesn’t name, will default sometime after 2013. Central banks may forestall these defaults by pumping even more money into the economy -- at the risk of higher inflation in coming years.

Gundlach, 53, doesn’t know when the third phase will get here, but he tells his audience they need to gradually get ready for it.

“I don’t believe you’re going to get some sort of an early warning,” Gundlach, who’s also chief investment officer at Los Angeles-based DoubleLine, tells his listeners. “You should be moving now.”

Gemstones, Art

He recommends buying hard assets: Gemstones, art and commercial real estate are high on his list. And DoubleLine has been buying the stocks of Chinese companies, U.S. natural gas producers and gold-mining firms because it considers them to be bargains.

Gundlach himself has amassed a contemporary art collection of about 100 pieces, with works by Jasper Johns and Franz Kline. The money manager drew on abstract painter Piet Mondrian’s double-line style for the name of his firm and its geometrical, crosshatched logo.

Gundlach, who correctly predicted the subprime mortgage disaster, has a proven record as a prognosticator -- and the performance numbers to go with it. At his former firm, TCW Group Inc., his Total Return Bond Fund earned an annual average of 7.9 percent in the decade ended in November 2009, according to data compiled by Bloomberg.

His flagship $35.8 billion DoubleLine Total Return Bond Fund gained an annual average of 13.2 percent from its inception in April 2010 through Nov. 28, topping the performance of Gundlach’s more famous neighbor to the south, Bill Gross.

Topping Gross

The co-chief investment officer at Newport Beach, California-based Pacific Investment Management Co. earned an average of 7.6 percent during the same period in his much larger, $281 billion Pimco Total Return Fund.

Gundlach’s performance convinced Andreas Lehmann, chairman of Luxembourg-based Alma Capital Investment Funds, to hire him to manage a fund for European investors. “Ultimately, what matters are the returns over time, and on that count, Jeffrey stands out,” Lehmann says.

If Gundlach’s outlook for the possibility of higher inflation comes true, his bond funds could suffer like most fixed-income investments. Since he opened DoubleLine in December 2009, it had gathered about $50 billion in assets as of mid- November, and it was the fastest-growing mutual fund firm ever in its first year, according to Strategic Insight, a New York- based research firm.

Mortgage Holdings

Most of DoubleLine’s assets are in the Total Return Bond Fund, which has 78 percent of its holdings in residential mortgage-backed securities -- both those guaranteed by the U.S. government and those that are not and have discounted prices.

The mix should help the fund weather either inflation or deflation because the securities should move in opposite directions if interest rates go up or down. Because higher rates could mean the economy is improving and housing prices are recovering, there would be fewer defaults on the riskier nonguaranteed bonds, and prices would rise, says Philip Barach, DoubleLine’s co-founder and president.

And he says the fund’s duration, a measure of how much bond prices will change when yields rise or fall, is low, making it less sensitive to shifts in interest rates.

“Jeffrey and I are more risk averse than you might imagine,” Barach says.

Gundlach is so confident that phase three is coming that he’s planning to start an equities fund and a long-short hedge fund in early 2013 to offer investors additional protection from inflation. Gundlach, who says he buys assets only on the cheap, is also sitting on cash in anticipation of scooping up securities at fire-sale prices. Cash makes up 17 percent of his Total Return fund.

Kaboom

He says the amount of money investors can make in phase three will dwarf what they can earn now.

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