Bond Guru Gundlach Hoards Cash

(August 29, 2011) — Jeffrey Gundlach’s DoubleLine Capital says it is favoring cash over nearly all investments, foreseeing 10-year Treasuries offering a buying opportunity if yields rise above 3.5%.

“I want fear,” Gundlach, the founder and head of Los Angeles-based DoubleLine, who  previously co-managed the TCW Total Return Bond Fund, said in a recent telephone interview with Bloomberg. “I want to buy things when people are afraid of it, not when they think that it’s a gift being handed to them,” he said of speculative-grade bonds.

He added during the interview: “Something funny is going on in the world of corporate bonds now — something looks broken. It seems there’s less willingness all of a sudden to be lending money to corporations, maybe because the absolute yields are so low. You’re starting to see that saturation point.”

In a previous interview with the news service, Gundlach said: “We are looking for a more severe down move in prices, for a better level to buy…To hold cash you have to have a conviction that prices of something that you’d otherwise own will go down, which is exactly what happened in June.”

According to Bloomberg, DoubleLine has attracted about $14 billion since its December 2009 inception.

Gundlach’s preference for cash echos recent assertions made by James Montier, a London-based portfolio manager with GMO. A flexible allocation allowing timely moves into cash gives an asset owner the best tail-risk protection, he asserted in a July paper. Institutional investors concerned about protection from black swan events often overlook the values of a flexible cash allocation, Montier argued. Other hedges like options/contingent claims and strategies that are negatively correlated with tail-risk simply do not provide the same level of protection.

Cash is “the oldest, easiest, and most underrated source of tail-risk protection,” claimed Montier in the paper, titled “An Ode to the Joy of Cash.” “If one is worried about systemic illiquidity events or drawdown risks, then what better way to help than keeping some dry powder in the form of cash—the most liquid of all assets.”

A flexible cash allocation provides the best tail-risk strategy because it minimizes what Montier called “Valuation Risk” and “Fundamental Risk.” Valuation risk is the risk connected with overvalued assets. According to Montier, cash is a much better investment than sticking with overvalued assets. “In our view it is better to hold cash and deal with the limited real erosion of capital caused by inflation, rather than hold overvalued assets and run the risk of the permanent impairment of capital.” With fundamental risk, or the risk of “write-downs to intrinsic value,” cash is a good hedge because it “is a more robust asset than bonds, inasmuch as it responds better under a wider range of outcomes.” Thus, an allocation to cash can increase a portfolio’s resistance to varied fundamental risks.

Gunchlach’s public affection for cash comes as he has been engaged in a lawsuit for allegedly stealing trade secrets from his former employer, TCW. He has testified that he did not need the company’s data to start his rival firm.