To get the Best of the Bond Market delivered to your email daily click here.
Jeff Gundlach didn’t make his name by following the crowd. So when his contemporaries were abandoning non-agency mortgage-backed securities during the start of the financial crisis in 2007, Gundlach was quietly buying them.
At the time securities backed by mortgage loans not guaranteed by the government, were cheap, and for some, far too risky. But Gundlach focused on how they held up against other bonds, particularly bonds issued by companies.
Fast forward half a decade and the bond market is in transition, from one of falling rates, to one where they’re expected to rise. Yields on the 10-year Treasury traded at 2.70% Monday. Still well below pre-crisis levels of above 5%, but most analysts expect the benchmark yield to rise considerably in the coming years.
That should spell bad news for Gundlach’s long term bet, but he’s holding tight. Safe in the knowledge, that embedded in his investing methodology is a way to manage bond investments in a market that’s afraid of rising rates.
“Today with this universal fear of rising interest rates, most people would conclude that shorter duration would be your friend,” Gundlach said in an interview with MarketWatch.
Gundlach, like PIMCO’s Bill Gross, has shortened duration in DoubleLine’s Total Return Bond Fund. But that’s not the end of it. So what’s Gundlach’s recipe for minimizing interest-rate risk?
“Start with the 12-month dividend yield of the Bond Fund, which is a proxy for the amount of income paid out to investors.” Gundlach told MarketWatch. “Divide the dividend yield by the duration of the fund to get a ratio of how much income is generated for each amount of interest-rate risk taken on.”
“What you’re really plotting is a forward-looking predictive starting point,” said Gundlach. “In an environment today where everyone is so concerned about rising interest rates, this becomes even more important.”
The goal is to generate a ratio that is as high as possible for the fund, which means that ideally the risk from rising rates is kept at bay.
It’s important to note that focusing on this ratio doesn’t protect against other forms of risk, such as currency risk and credit risk that could impede returns. As crisis-scarred investors remember well, non-agency mortgage backed securities dropped precipitously in value at the onset of the financial crisis for reasons wholly unrelated to interest rates.
But at a time when interest rate fear seems to be trumping all else in bond investors’ minds, this is a worthy way of honing in on the amount of exposure to interest rate volatility, Gundlach says.
So what kind of securities best fit this mold? You guessed it, non-agency mortgage-backed securities. Many have minimal duration while paying out relatively higher yields. Gundlach notes that their prices may be susceptible to other risks, such as fund flows and prepayment on mortgages, but that they reliably provide a higher ratio of yield to duration than most other securities.
Todays Other Top Stories
Reuters: – U.S. muni bond sales of $5.4 bln next week include Illinois debt. – U.S. municipal bond sales will rise slightly next week to $5.4 billion, up from a revised $4.5 billion this week, according to Thomson Reuters estimates on Friday.
Bloomberg: – Final four contender UConn to begin $220 million Muni sale today. – The University of Connecticut plans to sell $220 million of municipal bonds starting today as its teams are set to play this weekend in the Final Four of the men’s and women’s national college basketball tournaments.
Kiplinger: – A muni fund that pays more. – It’s been a feeble year for municipal bond funds. But if you’re looking for decent yield and you’re in a high tax bracket, muni bonds, which pay interest that is generally free of federal income taxes, still make sense. A fund worth looking at is USAA Tax Exempt Intermediate-Term (symbol USATX).
LearnBonds: – This homebuilder bond yields well over 6%. – If you are worried about a bubble in junk bonds, you are likely not alone. As the chart below shows, with the “BofA Merrill Lynch US High Yield Master II Effective Yield” hanging out in the sub-6% region, it is not surprising how hard it is to come by good value among non-investment grade bonds.
Los Angeles: – How to evaluate ‘go-anywhere’ mutual funds. – Why bother with a “go-anywhere” mutual fund? For many investors the answer may be that there’s no need. If you have a well-diversified portfolio and a truly long-term focus, your asset mix may suit you just fine.
Business Standard: – Rising bond yields might attract more foreign investors in debt. – Rising government bond yields could attract more flows from foreign institutional investors (FII). The yield on the 10-year benchmark government bond 8.83 per cent 2023 has already breached the nine-per cent mark. The Street believes in the worst-case scenario, it might even touch 9.25 per cent, with investors showing limited appetite for government securities in the Reserve Bank of India (RBI)’s auctions.
Bloomberg: – Treasuries advance to 1-week high as jobs pace tempers Fed views. – Treasuries rose to the highest level in more than a week as investors bet jobs growth is slow enough to deter the Federal Reserve from accelerating cuts in its bond-purchase program.
IFR Asia: – U.S. market roars in first quarter. – The US investment-grade new issue market wrapped up the busiest quarter ever recorded for corporate bonds on Monday, with US$307.53bn worth of securities priced, according to IFR Markets data.
Financial Post: – Corporate bonds aren’t the next bubble despite low yields. – U.S. corporate bonds are not in a bubble even though the spread over Treasuries fell below the 25-year average this month, says an economist with Capital Economics.
Market Realist: – Why did new high yield bond issuance spike last week? – As the chart below shows, high yield issuance last week rebounded sharply from the past two weeks’ lows. Issuers took advantage of strong market conditions for debt offered at relatively low borrowing costs.
ValueWalk: – Reach for high yield continues: ‘fire and ice’ strategy. – 15 months ago I wrote a piece called Expensive High Yield – II. High yield is still expensive. I won’t post all of the regressions, but I have re-run them. The results are largely the same as before. Yields are low, and spreads are overly tight for everything except CCC bonds.
Financial Express: – Emerging market bounce may disappoint long-term investors. – A tentative recovery in emerging markets may paradoxically disappoint some investors who had hoped a sell-off earlier this year would push governments into making reforms to stimulate longer-term economic growth.
Bloomberg: – Goldman sees chance to cut its China junk debt holdings. – Goldman Sachs Group Inc. (GS) says now may be a good time to cut holdings of Chinese high-yield bonds after the longest winning streak in six weeks.
ETF Daily News: – 5 ETFs for a relaxed retired life. – There are a number of choices available in the ETF world for investors to accelerate their retirement savings by limiting expenses. Below, we have highlighted five ETFs that could prove extremely beneficial and standout in specific categories over the long term.
WSJ: – Closed-end funds look appealing, but weigh the risks. – In many ways, closed-end funds are just like their larger and higher-profile cousins, conventional mutual funds and exchange-traded funds: They all sell shares to investors and use the money to buy securities.
Michael Gayed: – When safety rallies, pay attention. – While strength is real in emerging market equities, the risk is that bonds are signaling that all high beta areas of the market may underperform. Note that I am specifically referencing Treasury strength because of a second award winning white paper which will be released in the weeks ahead which touches on this subject in depth.
MarketWatch: – Don’t dump your bonds when interest rates rise. – It’s a no-brainer, right? Owning bonds is bad when interest rates are on the rise. Not so fast. A review of past rising-rate periods shows that bond investments performed surprisingly well. So don’t be too eager to let the fear of higher rates lead you to sell your bonds and move into assets — such as gold — often billed as providing protection during such times.
Kiplinger: – The great bond shortage. – It gets clearer by the day that your bond principal is safe from the interest-rate termites. If rates advance this year, the climb will be in fits and starts, and it will end with much ado about little.
IFR: – Swaps enable aggregate bond ETF launch. – Deutsche Asset & Wealth Management has launched a new exchange-traded fund that provides the most diverse exposure to the fixed income market to-date.
Barron’s: – The trouble with actively managed ETFs. – It’s the hottest club, so exclusive no one can seem to get in. Asset managers of all stripes are lining up to offer actively managed exchange-traded funds—so long as they can do it on their terms.
Philly.com: – Investors drop, mutual funds rise. – It’s after the crowd thins that the party gets interesting. Such was the case with mutual funds last quarter. The types of funds that did best were often those that investors rushed to exit in 2013.
NY Times: – When bond funds think outside the box. – Unconstrained bond funds can own debt instruments of any type — long- or short-term, high- or low-quality, corporate or government or whatever, in any country and currency — to try to enhance returns. With interest rates near record lows and investors eager to bolster yields, enthusiasm for these portfolios, also known as nontraditional funds, seems boundless too.
Gross: If corporations and the Fed stop their buybacks and QEs, who will be left to buy stocks?
— PIMCO (@PIMCO) April 7, 2014
Kiesel, Dep CIO: Macau remains one of the best ‘pure plays’ to invest in EM & the Asia consumer with > 2x nominal GDP growth in mass market.
— PIMCO (@PIMCO) April 7, 2014
— Cate Long (@cate_long) April 7, 2014