DoubleLine’s Approach to Unconstrained Fixed Income
At Doubleline, we believe investors should proceed cautiously when considering an investment in unconstrained bond strategies. That does not mean these strategies should be avoided entirely. Some of the benefits of these products may include better relative performance over a gradually rising interest rate environment, reduced correlation to existing fixed income holdings, and an ability to derive return from credit premiums. When we launched the DoubleLine Flexible Income Strategy (the “Strategy”), we deliberately avoided using the unconstrained terminology. We believe that the Strategy can be utilized in a welldiversified portfolio to compliment traditional core bond strategies benchmarked against the Bloomberg Barclays U.S. Aggregate Bond Index, potentially providing a higher level of income and taking advantage of further opportunities with its flexible mandate. The Strategy seeks longterm total return through current income and capital appreciation. The Strategy is built upon four main principles: the stability of our team, active management, a longer-term investment horizon and avoidance of unnecessary risks.
Stability of Our Team
Asset allocation decisions within the Strategy are made by DoubleLine’s Fixed Income Asset Allocation Committee (the “FIAA Committee”), which is led by Jeffrey Gundlach and includes senior portfolio managers from each asset class. The FIAA Committee meets monthly and has worked together for over 16 years on average. The goal is to provide better risk-adjusted returns over a variety of different interest-rate environments.
Active Management: Relative Valuation Analysis
The global fixed income markets offer a very diverse set of risk factors. Thus, one of the key benefits of a more flexible approach is the ability to allocate capital to sectors of fixed income with the most attractive riskadjusted return potential. We offer a unique solution through our top-down macro asset allocation framework in differentiating between fixed income subsectors to take advantage of developing secular themes while mitigating unnecessary risk taking. This analysis is applied when evaluating the diverse range of risk factors, including market directional risk in rates, sector spreads, relative value risk and idiosyncratic (i.e. issuer or bond specific) risk. The integration of these risk factors offers greater diversification benefits beyond individual underlying allocations and alleviates the duration risk factor that is most prevalent in traditional core bond strategies.
Benchmarking a portfolio to 3-month LIBOR, which has a duration of about 0.25 years, rather than a traditional fixed income index with a duration of about five years, has the effect of reducing the baseline for duration exposure. Duration then becomes one risk factor that can be employed to generate returns, rather than the dominant risk factor that drives returns and limits diversification potential. With the yield on government bonds and other core bond sectors at record low levels, the Strategy seeks to utilize a variety of credit sectors to achieve its long run goal. As such, cross-sector spread analysis and deducing risk premia to compare levels of volatility are ways the team seek to evaluate risk factors and time tactical shifts in the portfolio’s risk exposures. Also, this will allow the team to reduce the concentration risks of unidirectional sector or credit bets. This approach is paramount, given credit sectors themselves are less homogenous and dispersion of credit value across the sectors will present opportunities the team can take advantage of.
Longer-Term Investment Horizon
The FIAA Committee uses a longer time horizon when making investment decisions, typically between 18 and 24 months. We believe a longer-term horizon can increase the chance of success within the Strategy and differentiates DoubleLine from competing firms that have become increasingly near sighted leading to high portfolio turnover. We historically will ease into and out of the various sectors of fixed income, making gradual portfolio shifts, as illustrated by the soil chart (Figure 2). This ultimately helps reduces portfolio turnover which helps to manage potential liquidity risks.
Flexible Income
No Unnecessary Risk Taking
Generally speaking the Strategy does not use derivatives, including futures and swaps. Unlike many of the Strategy’s competitors in the Nontraditional Bond Category who use derivatives to make interest rate bets and leverage in order to increase exposure to certain areas of fixed income, DoubleLine prefers investing using CUSIP cash bonds.
Final Thoughts
At DoubleLine, we believe investors should continue to use actively managed intermediate-term bond strategies as their core fixed income holding and look to complement those strategies with more flexible solutions. In the past investors believed these flexible income solutions were unconstrained bond strategies, but they have largely been a failed experiment. The mangers of unconstrained strategies have traded one risk for another, increasing the equity-like risk and reducing the historical diversification benefits of owning fixed income. However, we believe some investors may benefit from a strategy that utilizes active management for top-down macro asset allocation and bottom-up security selection to manage duration within a wide range, opportunistically provide yield and truly complement your core fixed income holding. Even in a prolonged period of stable or rising interest rates, we believe a flexible portfolio can offer attractive risk-adjusted return potential, exposure to developing secular and global macro themes and generate a low correlation to the direction of major rate markets.
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