Former Drummer Sets Pace at TCW
Longtime shareholders of Jeffrey Gundlach’s bond mutual fund have to be thrilled with his investment performance.
Whether many of them could explain how he does it is another matter.
When your portfolio is stuffed with securities such as Fannie Mae Collateralized Mortgage Obligation 04-68-LC, 5%, due on 09/25/29, the details don’t exactly lend themselves to cocktail party chatter.
Gundlach, 46, has built an enviable record in one of the most complex sectors of fixed-income investing: mortgage securities. His TCW Total Return Bond fund has trounced the average mortgage bond fund over the last 10 years and runs neck-and-neck in that period with the Pimco Total Return fund, considered to be the bond fund industry’s gold standard.
Last September, Gundlach added another role at Los Angeles-based TCW Group Inc., parent of Trust Co. of the West, when the money management firm named him chief investment officer -- giving him oversight of the company’s entire $130-billion asset base.
That requires him to set the tone for TCW’s economic and investment outlook. His view isn’t cheery. He thinks a U.S. recession is likely in 2007, led by a slump in consumer spending.
The stock market is headed for trouble, Gundlach says. He thinks this is a time for investors to limit their risk-taking.
Gundlach’s career path has been an unlikely one. He is a former rock ‘n’ roll drummer whose inspiration to get into the investment business came not from an MBA degree program but from one of Robin Leach’s “Lifestyles of the Rich and Famous” TV shows in the early 1980s.
He also has an eye for art, particularly California landscape paintings. He has a collection of about 40 of them, including eight by early-20th-century master William Wendt.
But it’s Gundlach’s analytical ability that has fueled his rise at TCW.
“He is naturally analytical -- he understands the nuances of the markets,” says Robert Beyer, TCW’s chief executive.
Gundlach’s forte is mortgage-backed securities, an array of IOUs that can make the average person’s head hurt to understand. Gundlach finds them genuinely interesting -- like the Sudoku puzzles he solves.
“If there’s anybody you would want running this kind of thing, it would be him,” says Eric Jacobson, who analyzes bond funds at Morningstar Inc. in Chicago.
For his investors in the $520-million TCW Total Return fund, Gundlach’s prowess with mortgage-backed securities translated into a No. 1 performance rating among mortgage funds for the five years and 10 years ended in 2005, according to fund tracker Lipper Inc.
The TCW fund has earned a 7.1% average annualized total return over the last 10 years, matching the return of the Pimco Total Return fund, which is nearly 200 times the size of Gundlach’s fund and far better known among investors.
Gundlach credits his grasp of the bond market to his grounding in theoretical mathematics, his major at Dartmouth College in the late 1970s.
“Mathematical training is really about taking very complex things and seeing what’s essential and simple in them,” he says. “And there’s a lot of that in the mortgage market and, I think, in investing in general.”
Unlike a stock, a bond’s investment return potential is limited. The main attraction, of course, is the annual interest a bond pays. Beyond that, the market value of a bond may move up, or down, before it matures (and repays the face value) depending on what happens with market interest rates.
For bond portfolio managers, then, there’s limited ability to eke out extra return. And as long-term interest rates have fallen sharply over the last 20 years, the basic interest payoff from bonds has dwindled.
The interest yield on a 10-year Treasury note was 9.2% at the end of 1988. By the end of 1997 it was 5.7%. Now it’s just under 4.8%.
Looking out over the next decade, Gundlach believes that aging baby boomers increasingly will turn to bonds as a way to preserve their nest eggs and earn regular income to support themselves in retirement.
For investors, “need is the most powerful emotion, and particularly in bond investing, because people need a certain income level,” he says.
He believes that mortgage-backed bonds offer the best opportunity for investors to earn a higher yield than on plain vanilla U.S. Treasury securities over time, without taking on extra risk and volatility in sectors such as corporate junk bonds and foreign debt.
The idea behind mortgage bonds is fairly simple: package a bunch of home loans together and issue a bond that’s backed by the loans. The principal and interest payments made by homeowners effectively are passed through to the bond investors.
The mortgage-backed securities market now is valued in the trillions of dollars. Its size and complexity have mushroomed with the U.S. housing boom of the last decade.
One popular security is the CMO, or collateralized mortgage obligation. CMOs carve up the cash flow from mortgages -- the principal and interest payments -- in ways that allow investors to pick and choose theoretical returns and risk levels.
Like any so-called derivative security, “in the wrong hands they could be extremely risky,” says Morningstar’s Jacobson about CMOs and other specialized mortgage IOUs.
CMOs dominate Gundlach’s mutual fund and are a key investment for TCW in its much larger institutional accounts as well.
“What we’ve tried to do is to turn mortgages into Treasuries, but earn the mortgage yield,” Gundlach says.
To put it another way, Gundlach is trying to exploit what he believes are inefficiencies in mortgage securities’ prices caused by other investors’ more limited understanding of the market.
“There are certain characteristics that occur in those markets that investors just seem to never get,” he says.
But Gundlach also says it can still be a struggle to convince some clients of the merits of his mortgage-bond focus, even after more than a decade of strong performance and below-average risk.
“We constantly feel that we’re fighting that battle,” he says.
Gundlach’s mastery of the burgeoning mortgage market in the late 1980s put him on the fast track at TCW, which he joined in 1985.
It’s a safe bet that few kids dream of becoming bond fund managers. It wasn’t Gundlach’s dream, either.
At Dartmouth, he says, “I wasn’t particularly focused on doing anything practical.” With his math degree, he found his options relatively limited after graduation.
His first job was as an actuary with a life insurance company. “I hated it. I was so miserable,” he says. He then went to Yale to study for a graduate degree in math, but soon realized that it wouldn’t make him happy.
His fallback was music: A drummer since fourth grade, Gundlach was playing in a rock band after college. In 1983 he and the band -- first known as the Nuisance, then the Greens, then Radical Flat -- moved to L.A., where they got gigs at such major clubs of that era as Music Machine, Club Lingerie and FM Station.
But that didn’t pay the bills, so Gundlach took a job with another insurance company, Transamerica, doing statistical work such as estimating losses for workers’ compensation insurance.
Then came the epiphany: One day, on his ancient TV set with a broken channel dial (“you needed pliers to change the station”), he watched an episode of “Lifestyles of the Rich and Famous.” The show’s theme was the top 10 highest-paying professions.
“I said, ‘Let’s watch this, we’ll figure out my life,’ ” Gundlach remembers.
The surprise to him was that the No. 1-paying profession was investment banking. Show host Robin Leach said of the career, “you need to have an agile mind, very high analytic skills and work very hard.”
Gundlach says he thought, “I can do that. That’s me.”
Except that he didn’t know what an investment banker did or where to apply. So, he says, he looked in the L.A. Yellow Pages, but couldn’t find a listing for “investment banker.” He did, however, find a listing for “investment management.”
He said he figured “same thing,” and started writing down firm names and addresses.
“So I type out a very aggressive cover letter and send it to everyone who has a bold-faced ad in the L.A. Yellow Pages” under investment management, with his resume, he says.
He got only a handful of responses, one of which was from TCW. Impressed with his analytical mind, the firm hired him for its bond investment unit.
That he may owe his career to Robin Leach fits with one of Gundlach’s investing tenets: Although nuts-and-bolts analysis is the bedrock of his trade, he says he appreciates what a little serendipity can do.
“Nobody,” he says, “is a brilliant investor absent luck.”
Tom Petruno can be reached at tom.petruno@latimes.com.
