By Guy Cohen :
Benjamin Graham called discounts on closed-end funds "an expensive monument erected to the inertia and stupidity of stockholders". In an environment sickened by unattractive yields from traditional income investments, Double Line Income Solutions Fund ( DSL ) provides the perfect remedy.
This is Jeff Gundlach's biggest and best ideas without limitation: debt and other income producing securities of any kind, anywhere in the world. Main objective is to produce high current income with a secondary goal of seeking capital appreciation.
If you are not familiar with Jeff Gundlach, and you invest in income producing securities, here is what you need to know about the Buffalo Rock & Roll drummer turned Bond God: In his previous role as CIO and Head of Fixed Income Strategies at TCW he ran 70% of the company's assets ($70 Billion). In 2007 he publicly warned that "the subprime mortgage market is a total, unmitigated disaster, and it's going to get worse." He delivered positive returns in 2008, in case you were wondering. In 2009 he was on track to be awarded Bond Fund Manager of the Decade by Morningstar. This was partly due to averting a monumental collapse, which he attributes to his experience in Mortgage Backed Securities. At this point he was passed up for the CEO position which led to several disagreements with TCW management and parent company Société Générale. Then 'Project G' was initiated - a strategic plan to remove Gundlach from the firm with illogical hopes of retaining his MBS team and the assets they ran.
In late 2009 he was booted from the company for a variety of reasons (not including his marijuana, porn, and sex toy stash kept in his office - these were found after his departure). TCW terribly miscalculated and all his fellow MBS portfolio managers/traders (including EM and Corporate Bond personnel) resigned in short order. Just as getting canned from Apple led Steve Jobs to start NeXT, Gundlach would not be held down for long. He founded DoubleLine almost immediately and brought 60 TCW employees with him. The following year, 2011, Barron's dubbed him "The King of Bonds."
A Rocky Start
DSL began trading on the New York Stock Exchange on April 26th. In the weeks following the Fed taper scare created the perfect storm. This led to a major decline not just in DSL, but bond markets as a whole. Market price for closed end funds is determined by supply and demand, not NAV. In the chart below we see the largest sell off since inception was between May and July, causing a 12% drop in price from $25 down to $22.
Take notice of the steep widening between NAV and market price over the last two months which I will address further down. As an ex-Financial Advisor who personally raised $20 million for this fund, I can tell you first hand this has not been the smoothest ride.
The fund currently manages about $2.3 Billion and, like many other CEFs, employs leverage of roughly 31%. I expect them to delever in the next 12-18 months as interest rates begin to rise. At a current price of $20.04 we are looking at a 10.57% discount to NAV. Below is a sector breakdown of the portfolio.
45% of the fund is currently allocated to Emerging Market Debt and one might think to run for the hills. Fear not; Luz Padilla, who also jumped ship from TCW, is in charge of this portion of the portfolio. Although she is never the center of attention, since Gundlach hogs the spotlight, she is a phenomenal money manager with an excellent track record. Both she and Gundlach are extremely cautious of potential hurdles in India and the rest of the Emerging Market space (I highly recommend reading through his recent presentation on the "End of QE".)
Every income investor should be especially cognizant of portfolio duration. Since inception the plan was to allocate funds to more deeply discounted securities where prices were below par. In recent months prices have moved back toward par increasing the average market price for the portfolio to $99.75. This, coupled with an increasing amount of leverage, has inherently led to a higher current duration (7.41) than they had originally planned for (3.5 - 5).
I have to admit this makes me a little uneasy but something important to note is that leverage increases portfolio duration, not each individual holding's duration. As mentioned above I expect some delevering in 2014 which will help shift towards lower portfolio duration.
The fund is paying out all income earned with monthly distributions of $.15 which translates to an approximate 9% yield.
Most closed ends tend to pay out steady income streams and I expect these PMs to maintain this high yield throughout coming headwinds. Even with the dramatic price decline, the 3-month trailing total return is 4%.
Individual investors rarely think of tax consequences until the end of the year; at which point they start frantically selling poor performing positions, at a loss, to offset any capital gains tax liability.
Fellow contributor Michael Fabian wrote an interesting piece on CEFs and the pressure from tax-loss sell offs. Due to the nature of closed end funds trading at steep discounts, Q4 has historically proven to be their largest sell off period. Michael presents a timely question as to whether sellers will "be persuaded to lower their tax bill in lieu of their income needs?"
The run up in equity markets coupled with the steady decay in closed end prices leads me to believe this time will not be different. In September DSL was trading as high as $22 but has progressively declined to its current level of $20. We can attribute this to a number of factors but two specifically: 1) Investors leaping off side lines to join the equity space ship to infinity and beyond 2) Cutting losses to offset capital gains incurred throughout the year. I expect investors to continue to dump shares through year end which could drag the price below $20.
Purchasing closed end funds solely based on discounts to NAV can be very dangerous. Instead, I urge you to take a holistic approach when conducting research and take into account everything from fund manager to portfolio makeup.
With Yellen set to take over the throne, there is no one better equipped than Gundlach and Co. to navigate through the choppy waters ahead (QE taper, Municipal and Emerging Market distress, rising Interest Rates). DSL had a major sell off weeks after the IPO, right as the Fed Taper talk began, and is trading much lower than its peers in the taxable income multi sector universe.
Jeff Gundlach, monthly distributions, a 10.5% discount to NAV, and a 9% yield - consider this an early Christmas present. I don't recommend diving in just yet. A lot of investors who got in at the IPO are sitting on capital losses nearing 20% and may still be unloading for tax purposes in the coming weeks. Wait until after the New Year to move into a position, but don't wait too long as discounts tend to narrow in January. For those of you who have read Lee, Shleifer, and Thaler's "Anomalies: Closed End Mutual Funds", expect to be rewarded for the noise-trader risk seen here.
Disclosure: I am long [[DSL]]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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