Fixed-income closed-end funds (CEFs) should perform poorly when the yield curve flattens, according to Jeffrey Gundlach, because those funds borrow short and lend long. But DoubleLine’s CEFs have more than withstood the flattening of the yield curve over the last six years.
Jeffrey Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital. He spoke to investors via a conference call at 4:15pm on May 2. The focus of his talk was DoubleLine’s fixed-income CEFs, DBL and DSL. There were no slides accompanying his presentation.
According to Gundlach the yield curve, as measured by the spread between the 2-year and 30-year bond, has flattened by approximately 200 basis points over the last six years. But DBL and DSL have done exceptionally well, he said. DBL outperformed its benchmark by approximately 600 basis points over the last year.
”We are not going to see a flatter yield curve in the near term,” Gundlach said. “The long end will back up [and increase in yield] along with the short end, if the Fed raise rates.”
The yields on DoubleLine’s funds are attractive; DBL yields 8.2% (which includes some special dividends) and DSL yields 8.2%.
Those funds employ leverage – 21% for DBL and 41% for DSL. Their borrowing costs are tied to LIBOR rates, Gundlach said, and have gone up approximately 75 basis points following the last three Federal Reserve rate hikes.
DBL has traded at an average premium to its NAV of 7.73% this year according to Morningstar data, and according to Gundlach it is now at approximately 3.5%. DSL has historically traded at a discount (this year averaging 5.12%).
Gundlach said the only reasons to buy a CEF at a premium are that the underlying assets cannot be purchased any other way, or that they are no longer available. But, he said, “DBL is still attractive at a premium.”
When rates rise, fixed-income CEFs generally trade at a discount, Gundlach said. Their NAVs drop and the discounts widen, putting further pressure on prices and creating an unfavorable cycle for investors. But he added that such a cycle is a function of “supply and demand” in the markets where the funds trade and does not reflect the underlying investments in the portfolio.
Gundlach said that rates are “near bottoming out.” One might infer that fears of a rate-driven cycle are warranted for fixed-income CEFs. But Gundlach also said that the reason for his outperformance during the past six years was due to skillful active management, particularly by positioning assets in high-performing sectors of the bond market, such as emerging markets.
Musings on the markets
Aside from his comments on CEFs, Gundlach offered a number of thoughts on other aspects of the markets.
He said he is “not a fan of long duration.” He noted that the benchmark 10-year Treasury bond has already made it to within one basis point of the target yield (2.18%) he set early this year.
The rally in the 10-year this year (its yield is down 15 basis points) has not been big enough to signify a flight to safety, Gundlach said. He reminded the audience that its yield is still 100 basis points higher than its low in July of last year. “Let’s not get too excited,” he said.
By Robert Huebscher, read the full article here.