FMD Capital Management

Why DoubleLine Is Right On The Money

Written by Michael Fabian, February 20th, 2014

There is no greater success story in the mutual fund industry than Jeffrey Gundlach’s now infamous breakaway from TCW back in 2010. However, more recently during the 2013 interest rate adjustment, Jeffrey has become somewhat of a polarizing subject and personality amongst individual investors. The media portrays him as a maverick, and from what I can gather, he is, but sometimes investors aren’t always willing to wait for his conversant predictions to become reality.

Although this might have cost him assets under management (AUM) in the short term, as a portfolio manager he’s made the difficult decision to do what he believes will yield the best outcome instead of what contributes to his popularity. I have a high level of respect for that type of commitment, and as I was once a student of Latin It reminds me of the ancient phrase “Aut inveniam viam aut faciam” or “I shall either find a way or make one”. Besides, individual investor’s memories are short, and Jeffrey has one of the longest and most consistent track records for success and expertise in fixed income management. I’m sure the assets that left the firm will be attracted back many times over in the future.

Due to its nimble size and broad investment mandate, one of my favorite funds to watch within the DoubleLine family is the Doubleline Income Solutions Fund (DSL). As Doubleline’s second closed-end fund offering, the fund represents the first real multi-sector fixed income offering in firm’s history, and was developed to include the best ideas from each specialized investment discipline they cover. I like to envision multi sector funds such as DSL as a collaborative effort that is crafted through ongoing deliberation and advocating as to the merits of a single sector or investment theme within an investment committee meeting.

The current best ideas that are being implemented include an uncharacteristically large allocation to emerging market fixed income (45.1%), with smaller albeit adequately sized sleeves of high yield corporate and residential mortgage backed securities (16.9% and 18.1%). Finally, the smallest allocations include positions in senior loans, CMBS, and CLOs (10.2%, 4.4%, and 5.4%).

Interestingly, the reason I believe Doubleline is right on the money with their current sector distribution is their obvious tilt toward relative valuation weighting. EM bonds have languished as of late due to factors surrounding currency and economic instability, but when compared to domestic offerings of similar rating, its clear EM bonds exhibit much better risk to reward attributes. Especially when owned in U.S. dollar denomination, and viewed behind the fund’s primary mandate of income generation. In addition, as the 10-year treasury yield has mostly stabilized under the 3% threshold, and the divergence between U.S. high yield and EM bonds remains stubbornly high, a return to the mean could ultimately ensue. All of these factors contribute to a great investment opportunity for DSL assuming credit conditions remain stable.

The few additional caveats that remain is whether or not you believe DSL’s discount will narrow with time, its cost of borrowing will remain low, and the management team’s expertise in sector selection and rotation will ultimately prevail. Since DSL is a relatively new fund with a limited operating history, and admittedly IPO’ed at the worst possible time, its faith may be slightly more clouded than other multi-sector funds. However, key factors that DSL does have going for it are a reasonable expense ratio, a low effective duration, and a portfolio yield that is very near to covering its distribution policy.

Our trading strategy for clients in our Dynamic CEF Income portfolio revolved around making key purchases when DSL traded at a double digit discount. Although our position is fully sized for existing clients, I’m not hesitating to add to DSL for new entrants to our strategy. Our investment thesis teeters on many of the positive and negative fundamental factors mentioned, but the wild card remains Jeffrey’s larger than life predictions and abilities to manage money and generate high income in a difficult environment.

For this position, ongoing due diligence of holdings and portfolio income will have to prove to me that it deserves a place within our portfolio. Furthermore, I’d prefer to continue to see its discount narrow marginally toward par over the coming two quarters as long EM fixed income performs better than domestic high yield. If these factors are not met, I won’t hesitate to replace it with another multi-sector income fund.

In conclusion, when it comes to investment strategy, maintaining perspective and discipline will go a long way to ensuring positive changes are executed in a timely fashion. To detail the typed of discipline in our CEF income portfolio, I recently wrote a special report expanding on our investment themes in addition to our selection process.