Jeffrey Gundlach is always an interesting investor to watch, but recently he has become even more interesting given the news about Bill Gross leaving PIMCO.
It is useful to contrast his style with that of Bill Gross in an attempt to understand how the wheels came off the bus from Gross at PIMCO. Few things result from a single cause, but it Gundlach has been managing far less money than Bill Gross and the bigger a fund gets, the harder it is to outperform a benchmark index.
A bond manager must deal with many types of risk in addition to interest rate risk. For example, there are credit risks and duration risks. Gundlach is focused, as he should be, on mispriced risk. Where that risk may be at any given time will vary. So he or she is an opportunist. And in being an opportunist it is easier to outperform if your fund is not too large. If your funds get too big, the portfolio can suffer. One can argue that Bill Gross suffered much the same fate as Bill Miller did before him in stocks. The fund grew too big and that became a drag on performance. in other words, at some point, being dubbed the bond king can become a ball and chain. I also suspect that changes in monetary policy and in markets generally after the 1987 fiscal crisis have made it even harder for bigger bond firms to outperform smaller competitors. Jeffrey Gundlach faces these same challenges as he grows his assets under management.
Gundlach once said: “When we started the company, our stretch goal was to reach $50 billion of [assets under management] within three years. We do not have a goal of trying to reach $100 billion any time in the foreseeable future. I don’t think we can add another $50 billion to [Total Return Bond] and still manage it the way we want to manage it. What you really don’t want to do is what the young guys do, and that is take every single dollar that is dangling in front of you.” “Closing something is sort of an abstract idea. In the first quarter of 2009, I probably could have invested something close to $1 trillion. [But] those periods like early 2009 don’t happen all that often.” It will be interesting to see if he has the discipline required to close the fund to new money. A recent paper argues that “a doubling in ‘bond king’ assets under management has been associated with a 10-20% decline in achieved alpha. As a result, historically a ‘bond king’ with a smaller asset base has outperformed a ‘bond king’ with a larger asset base.”
1.“The trick is to take risks and be paid for taking those risks, but to take a diversified basket of risks in a portfolio.” Gundlach seems to be communicating the same view that has been also expressed by Bill Gross when it comes to following the advice that Thorp developed to beat the dealer in blackjack. “Mr. Thorp: You have to make sure that you don’t over-bet. Suppose you have a 5% edge over your opponent when tossing a coin. The optimal thing to do, if you want to get rich, is to bet 5% of your wealth on each toss — but never more. If you bet much more you can be ruined, even if you have a favorable situation.” Taking in risk for its own sake is a sucker’s bet. More risk does not necessarily mean more investment return.
What can generate more return is mispriced risk on the part of someone else. As Howard Marks has pointed out, “if riskier investments necessarily delivered higher returns they wouldn’t be risky.”
Businessweek argues that until his recent spell of underperformance Gundlach competitor Bill “Gross did better by investing in riskier bonds…. Estimates from Morningstar suggest that relative to a bond index fund, Gross’s Total Return Fund is twice as likely to move in tandem with the Standard & Poor’s 500-stock index. Since the financial crisis, that spread has only widened—from 2009 to today, Pimco’s fund returns began to more closely resemble the S&P 500. (The opposite happened to the Total Bond Fund offered by Vanguard: It now moves inversely with the broad stock market.)” Now that the “bond king” spell is broken more investors will find their way into indexed funds instead of another actively managed fund. And some will seek the next bond king, follow Gross to Janus or move to Gundlach. It will be interesting to watch.
2. “Avoid investment positions that have poor asymmetrical risk/return trade-offs.” This is straight up advice about the dangers of negative optionality. Investing in situations where there is a big downside and a small upside is a very bad idea. What an investor should seek is the reverse: a big upside and a small downside. Howard Marks puts it this way: “In order to achieve superior results, an investor must be able – with some regularity – to find asymmetries: instances when the upside potential exceeds the downside risk. That’s what successful investing is all about.”
3. “We always try to ensure that we understand the risks we are taking and to avoid the risks for which the potential return is likely to be inadequate. For example, there are times when ideas become too popular and investors don’t understand the risks of an asset.” These statements by Gundlach are consistent with the views of Warren Buffett. To pick just three similarities to Buffett: (1) “I’d be a bum on the street with a tin cup if the markets were always efficient.”; (2) risk comes from not knowing what you are doing and (3) don’t follow the crowd. Investing has universal attributes. Buffett has said, and I doubt Gundlach would disagree: “The very term ‘value investing’ is redundant. What is ‘investing’ if it is not the act of seeking value, at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value — in the hope that it can soon be sold for a still-higher price.”
4. “People love junk bonds because for some weird reason they feel [junk bonds] don’t have interest rate risk.” This is another example statement of Jeffrey Gundlach’s views that markets are not always efficient. People who do not think rationally about a risk create opportunity for the investor. There are many heuristics that as a whole have been helpful to humans in evolution but which can be very dysfunctional in investing. People are “weird” about some things and that can be arbitraged.
5. “We try to be liquidity providers and get paid for that. That’s one of the things that tend to support outperformance over time — buying when other people need to sell. That’s always been part of our strategy.” Having cash when others need it can be a huge source of investment out-performance. People for some reason get easily confused about the difference between cash and wealth. The reality of life is that sometimes people with a lot of wealth are unable to get their hands on cash. Predicting when those times will happen is impossible. When it comes to ash especially, it is better to prepare than predict.
The only unforgivable sin in business is to run out of cash. If you have cash at the right times and can be aggressive at those times in buying assets at a bargain, you can do well as an investor. This will not be easy, especially today, since these are times of great uncertainty (e.g., we are increasingly living in Extremistan).
6. “I want fear. I want to buy things when people are afraid of it, not when they think it’s a gift being handed down to them.” Be greedy when others are fearful and fearful when others are greedy. One of the best times to invest is when uncertainty is the greatest and fear is the highest. Gundlach is channeling Howard Marks and other contrarians. You can’t beat the market if you are the market. Sometimes you must be contrarian if you want to outperform a market and you must be right enough of those times to succeed. This is also consistent with the Mr. Market metaphor. Make the market your servant and not your master.
7. “There is one thing about being an asset manager. Timing is everything. The synonym for “early” in the investment business – is ‘wrong’.” Being a contrarian is not enough if you are wrong. You must be contrarian and right enough to beat a market index. Of course, it is magnitude of correctness that matters and not frequency.
8. “People always want investments to go up like a line.…That’s just not reality. You make 80% of your money in 20% of the time in investing and you have to be patient.” Success in investing and in life will be lumpy. Accepting that fact is a significant part of not only financial and career success, but happiness in life.
9. “To hold cash you have to have a conviction that prices of something that you’d otherwise own will go down.” Cash has optionality. That optionality has a cost that may or may not be worth paying. Whether this is worth paying depends on the circumstances and the time. I would rather have cash and not need it, than need it and not have it. As always, a margin of safety is wise and that statement applies to cash.
10. “One way you get high yields is taking interest-rate risk, but you don’t want a lot of interest-rate risk because interest rates are low and they could rise from time to time during the course of this year or could even break out to the upside ultimately in the future. In the nonguaranteed mortgage market, there is still a market that’s plagued with defaults. And the way to think about it is if those defaults get better, that would be the sort of scenario of higher interest rates and a better economy if the defaults slow down.
So actually those securities don’t have interest-rate risk, and yet you get paid for taking the default risk. So the secret is to marry together opposite moving investments relative to interest rates while getting paid on both sides of the trade, and that’s why we’ve been so successful with the DoubleLine Total Return earning those yields.” This is an interesting statement but it only works if the two bets are mispriced. If this trade or any other trade gets “crowded” it won’t work. Are there situations where there are two risk premiums to be earned? Yes. But that depends on price.
11. “The fundamentals are always important but it does get trumped by policy decisions when policy decisions are so radical as has been the case in recent years.” “One thing that is absolutely undeniable about quantitative easing is, it is reducing the supply or the float to the non-central-bank world. Reducing the float of high-quality assets.” The period since the financial crisis has not been a normal time for most markets, including the bond markets. How is that for an understatement? What may have tripped up Bill Gross: the penalty for having massive assets under management (AUM) may have grown significantly due to changes in factors like liquidity and volatility. Changes caused by (1) new and extraordinary monetary policy (2) changes in the markets as a result of changes in policy, have interfered with his long held theses regarding interest rate, duration, credit and other risks. It is now “the new abnormal”.
12. “I don’t often know where my ideas come from. Maybe it’s the fact that I’m obsessively regimented in my analysis, borderline autistic.” It has been my experience that some people who are borderline autistic can have a gift for rationality that can be very helpful in investing. This is not always true but I have seen it happen enough that I think what Gundlach says about himself is not a one-off case.