This article was edited on September 9, 2020, to add a link to the slides from the webcast.
Q2 2020 hedge fund letters, conferences and more
Passive bond funds – particular those that track the popular Barclay’s AGG index – offer the worst risk-return profile ever, according to Jeffrey Gundlach’s DoubleLine Capital.
Gundlach spoke to investors via a webcast, which he titled, “Hey Kid, Want Some Candy?” The candy theme was to suggest that what tastes good in the short term is not necessarily good for you in the long term. The focus was on his flagship total-return fund (DBLTX). Slides from the webcast are available here. Gundlach is the founder and chairman of Los Angeles-based DoubleLine Capital.
Gundlach’s co-presenter was Andrew Hsu, a portfolio manager for the total-return fund.
DoubleLine tracks the historical ratio of yield-to-duration on the AGG. This ratio shows the expected return (yield) per unit of risk (duration). Given historically low yields and an increase in the duration of the AGG over the past decade, Hsu said, “this may be the least attractive time ever to be invested in a passive fixed-income fund.”
Gundlach also said that high-yield bonds are the most overvalued in their history.
High-yield spreads are “crazy,” he said, when viewed in the context of the last two recessions. Those spreads typically rise prior to a recession and then continue upward. But in 2020, the front end of the recession saw the peak in spreads, and they subsequently contracted about 50%, due to Fed-injected liquidity.
Many junk bonds are priced in excess of their recovery rate if they were to default, according to Gundlach.
With the high-yield default rate at about 7%, Gundlach said there a solvency problem. “I am quite certain this rate will go higher,” he said.
Loan standards are tightening, he said, which has led to higher default rates in prior recessions. The high-yield default rate could be 10% to 11% a year from now, he said.
But tightening loan standards have not been matched by a rise in high-yield spreads as in prior recessions.
Gundlach provided data illustrating that large bankruptcies are accelerating. Companies with $1 billion of debt are going bankrupt at a faster pace than in prior recessions.
Despite this, flows to the JNK ETF, which tracks the high-yield market, have been strong over the last few months.
Yields on junk bonds are approximately 2.35% and are near historical lows.
Read the full article here by Robert Huebscher, Advisor Perspectives
