The best bond fund manager Jeffrey Gundlach's story

TCW Group Inc. decided to oust Jeffrey Gundlach despite being warned that firing the fund manager could trigger redemptions of as much as 70 percent, according to testimony during the six-week trial of the bond- fund manager and his former employer.

Gundlach, who started his own firm within weeks of being ousted and has since attracted $16 billion in assets, yesterday won a $66.7 million jury award against his former employer for unpaid wages, which he has to share with three of his colleagues. He was also found to have breached his fiduciary duty to TCW and misappropriated its trade secrets. The Los Angeles jury awarded the company no damages on the breach claim. A judge will determine damages on the trade-secret claim.

“This trial brought home all of the ugliness and the dirty laundry in the business,” Geoff Bobroff, an independent fund consultant in East Greenwich, Rhode Island, said in an interview. “This would be the most bitter case I’ve seen brought to trial.”

The trial shed light on a decade of tensions between TCW and Gundlach, a former trader who became the company’s star performer over an almost 25-year career there, eventually managing two-thirds of the company’s money. TCW painted him as an arrogant man interested in enriching himself, and a former executive at the firm described him as a “cancer.” Gundlach and his attorneys claimed TCW cheated him out of hundreds of millions of dollars and reneged on a promise not to dilute his stake in the company.

Founder Robert Day at one point contemplated getting rid of Gundlach, 51, then selling the firm to BlackRock Inc. (BLK), according to evidence presented during the trial. His ouster in December 2009 cost the firm $566 million in damages, TCW said in court documents.

TCW, the Los Angeles-based unit of Societe Generale SA, sued Gundlach in January 2010 after more than 40 of its fixed- income professionals joined DoubleLine Capital LP, the asset- management firm Gundlach started after TCW fired him.

The jury found that Gundlach, who countersued, and DoubleLine didn’t act willfully and maliciously in misappropriating trade secrets. Susan Estrich, a lawyer for TCW, said the company will ask the judge to award it $89 million on the trade-secret claim.

“We are very pleased and gratified with the verdict,” Estrich said outside the courtroom. “This was about liability, about standing up for what is right.”

Gundlach said the verdict was “a major win” for DoubleLine.

“In a society governed by lies, truth is considered a cancer,” Gundlach said in a telephone interview.

Gundlach joined TCW in 1985 on a 90-day probation, for about $30,000 a year. TCW needed someone with a “quant” background, which Gundlach had as a Ph.D. candidate in mathematics at Yale University. He didn’t complete his doctoral thesis on the “non-existence of infinity,” which was then considered an unpopular line of thinking among mathematicians, Gundlach said in a 2009 interview.

Gundlach started the TCW Total Return Fund in 1993 and the fund grew as Gundlach’s acumen in picking mortgage-backed securities helped the fund beat peers. By 2001, when Societe Generale acquired TCW, Gundlach had become a substantial shareholder in TCW, with a 4 percent stake.

A consultant who was hired by TCW to advise on options told chief executive officer Marc Sternthat Gundlach’s departure would trigger client redemptions of 60 percent to 70 percent over three years, while keeping 40 percent of clients assets would be a “huge success,” according to court records. The consultant, Woody Bradford, testified that he advised Stern in October 2009 that the best option would be to work out an “arrangement” with Gundlach.

“The case demonstrates the difficulty of running a business when one individual or a group of individuals rise to prominence,” said Bobroff. “That’s a reason why most firms are moving to team management rather than have one or two star managers.”

Public spats are rare in the asset-management industry, where companies typically resolve disputes behind closed doors. In one example that shocked fund managers nearly four decades ago, John Bogle was fired by Boston-based Wellington Management Co. after clashing with the company’s board of directors. He went on to form Vanguard Group Inc. in 1975, which has since become the biggest U.S. mutual fund company.

The relationship between Gundlach and TCW started to sour in 2001, when Societe Generale (GLE) acquired the firm. Gundlach said his stake in TCW fell from 4 percent to the “high 2s,” despite an earlier promise made by Stern that he would “never have the stock taken away” from him, according to court transcripts.

Tensions abated in 2005 after Stern stepped down from active management and the firm created a new leadership team, with Robert Beyer as chief executive officer, William Sonneborn as president and Gundlach as chief investment officer.

“I was really happy” after the change, Gundlach said in his testimony. “I thought it was the greatest thing.”

The new leadership team didn’t last long. A month after unauthorized transactions by traderJerome Kerviel spurred losses at the Paris-based Societe Generale in early 2008, Beyer and Sonneborn tried to engineer a management buyout of TCW from the parent, Gundlach testified. The move angered the French bank because of its “timing,” according to Gundlach.

Sonneborn, who described Gundlach as a “cancer” to the company in conversations with Stern, according to court transcripts, left TCW for private-equity firm KKR & Co. in 2008. Beyer retired in 2009, and Stern returned to lead TCW in June 2009 after Beyer’s departure.

DoubleLine’s attorneys said executives at TCW and its parent had already decided at that time to fire Gundlach. He and other senior managers at TCW had opposed Stern’s return out of retirement and wanted the firm to be run by a management committee instead. TCW said Gundlach’s demands to restructure the leadership and compensation intensified in 2009.

TCW, which said that Gundlach made the equivalent of $20,000 an hour, at one point in the trial compared him to Gordon Gekko, the fictional character who gave the “Greed is Good” speech in Oliver Stone’s 1987 film “Wall Street.” TCW also said Gundlach openly disparaged TCW executives, referring to Day and Stern as “Dumb and Dumber.”

Stern testified that he became suspicious of Gundlach after a series of meetings in September 2009 and instructed TCW’s in- house lawyer to start monitoring the e-mail of Gundlach and others in his group. The investigation showed Gundlach’s people were downloading TCW’s proprietary information and looking for office space, Stern said.

While Gundlach was in talks to join rivals such as Western Asset Management Co. and Pacific Investment Management Co., Day contemplated forcing Gundlach out and selling the firm to BlackRock, according to evidence shown at the trial. Executives at Societe Generale thought the idea of selling TCW to BlackRock “is not really feasible at a good price,” according to an e- mail that was made public.

When those plans fizzled, TCW dismissed Gundlach and acquired MetWest, court documents show.

Gundlach went on to form DoubleLine in December 2009. More than 40 people, including Gundlach’s co-manager on the TCW Total Return fund, Philip Barach, joined him at DoubleLine.

Gundlach’s DoubleLine Total Return Bond fund has surged to $11 billion in assets since it was started in April 2010, a record for the fastest growth among startup mutual funds. TCW’s Total Return Fund has dropped to $5.3 billion from a peak of almost $12 billion before Gundlach was ousted. The DoubleLine fund is up 12 percent in the past year, twice the return of the TCW fund and beating 99 percent of rivals, according to data compiled by Bloomberg.

Brad Brian, DoubleLine’s lawyer, said in his closing statements that handwritten notes from an August 2009 meeting of TCW’s senior executives show they had already decided to fire Gundlach before there was evidence of his people copying TCW data or registering a company in Delaware.

It was “telling,” Brian told the jurors, that none of the executives, including Stern, could recall during their trial testimony what was said during that meeting. Brian said TCW executives don’t want to admit they had made up their minds about firing Gundlach months before they did because it would undermine their damage claims in the case.

Gundlach had negotiated for him and his group to receive 60 percent of the performance fees for the distressed-asset funds he set up in 2007 and 2008. The funds invested in mortgage- backed securities that were downgraded and dropped in value with the collapse of the U.S. housing market. When the funds performed better than expected, Societe Generale and TCW wanted to replace Gundlach with a less expensive asset manager, DoubleLine’s lawyers said.

TCW argued that Gundlach wasn’t entitled to management and performance fees from the funds after his firing.

The case is Trust Co. of the West v. Gundlach, BC429385, California Superior Court, Los Angeles County (Los Angeles).

(Source: Bloomberg, September 16, 2011)

Gundlach's `No Normal' pressure cooker

Jeffrey Gundlach, the lone bond manager to beat Bill Gross in the past 5, 10 and 15 years, said there won’t be any “new normal” to guide investors until policy makers repair the damage caused by the financial crisis.

“I think ‘no normal’ is a good phrase, as opposed to ‘new normal,’ ” Gundlach, chief executive officer of DoubleLine Capital LP, said during an interview in his office in Los Angeles. “Some major policy shift has to happen that will turn everything on its ear. So this idea that we’ll go into some quasi-similar paradigm, some sort of new thing -- no way.”

Gross and Mohamed El-Erian, co-chief investment officers at Pacific Investment Management Co., use “new normal” as shorthand for their forecast that the U.S. will endure below- average economic growth of 2 percent or less for the next three to five years and unemployment peaking at 10.5 percent to 11 percent, from 9.6 percent in August. It’s entered the Wall Street lexicon to describe a post-crisis world in which the U.S. and Europe no longer offer the best investment prospects.

Gundlach, who until December managed the top-ranked TCW Total Return Bond Fund, doesn’t disagree with Pimco’s outlook. His point is that “new normal” fails to recognize that all previous economic and investment assumptions have been permanently altered by the financial crisis.

“Massive” policy changes will be required to bolster the economy and cut the U.S. budget deficit, projected to be at about $1.47 trillion, Gundlach said. The timing and nature of the potential regulatory changes are unpredictable, causing him to shorten the length of time he holds investments.

“You cannot go on with these policies for too very long,” said Gundlach, 50. “The problem is the debt burden is very high to begin with and it’s growing fast.”

The U.S. government will have to increase tax rates, now at historic lows, as it tries to reduce its budget deficit, Gundlach said. It will also have to wean itself from borrowing money to stimulate the economy, he said.

Pimco developed the concept of “new normal” about a year- and-a-half ago as an “attempt to move the general thinking beyond the notion that the crisis was a mere flesh wound, easily healed with time,” El-Erian, 52, said in an interview.

“The crisis cut to the bone, resulting from an extraordinary, multiyear period of debt and credit entitlement which was anything but normal,” he said.

New normal was less about what should happen than “what was likely to happen given our analysis of national and global factors,” El-Erian said.

In an April speech at Princeton University in New Jersey, Christina Romer, then head of the White House Council of Economic Advisers, said she found the fatalism of the new normal distressing. She said that shorter-term cyclical events such as the decline in demand for goods and services were the real drag on job creation.

“Unemployment is high fundamentally because the economy is producing dramatically below its capacity,” Romer said. “That is, far from being the new normal, it is the old cyclical.”

In September, as she exited the Obama administration, Romer said she had underestimated the severity of job cuts and that this “has not been a normal recession.”

Gundlach managed the TCW Total Return Bond Fund until Dec. 4, when he was ousted as chief investment officer of TCW Group Inc. after the company accused him of planning to start his own investment firm. Gundlach said he was fired to reduce expenses.

Co-manager Philip Barach and more than 40 members of Gundlach’s team followed him to DoubleLine, which started three fixed-income mutual funds and plans an exchange-traded fund focusing on emerging-market bonds. Assets in DoubleLine Total Return Bond Fund, run by Gundlach and Barach, have grown to $2.7 billion since its inception on April 6, according to data compiled by Bloomberg.

TCW Total Return under Gundlach averaged gains of 7.5 percent in the five years ended Dec. 4, topping Pimco Total Return Fund, which rose 7 percent in the same period. The TCW fund also beat Gross in the 10- and 15-year periods. He’s the only intermediate-term bond manager to post higher returns than Gross, 66, in each of the three periods, according to Chicago- based Morningstar Inc.

Pimco Total Return is the world’s largest mutual fund, with $252 billion in assets.

DoubleLine Total Return Bond Fund has increased 15 percent from inception through Oct. 4, compared with 7.3 percent by Pimco Total Return, Bloomberg data show.

Gundlach, who is known for his expertise in mortgage-backed securities, was early to spot signs of trouble in the U.S. property market, and by August 2006 he had started a distressed real-estate fund to take advantage of declining prices. He correctly called an end to the five-year property boom and said falling real-estate prices would weaken the U.S. economy.

“He is considered a wunderkind in the bond-fund world,” Jeff Tjornehoj, a senior research analyst at fund researcher Lipper in Denver, said in an interview. “He’s not as well-known as Gross, but he’s well-respected, and part of that reputation comes from being at the right place at the right time.”

Gundlach wasn’t immune to fallout from the subprime- mortgage collapse, investing in securities that lost value during the crisis. Under Gundlach, TCW became the biggest manager of collateralized-debt obligations, with $41.3 billion under management as of Sept. 30, 2007, according to data from Standard & Poor’s. Gundlach has said his CDOs got out of high- risk home loans early in the credit crisis and missed the worst of the losses from those securities.

Confidence in financial markets collapsed in 2008 after the debt securities derived from defaulted properties -- many of which were purchased with subprime loans -- became so toxic that credit dried up for companies and individuals. The bankruptcy of Lehman Brothers Holdings Inc. and ensuing panic-selling of all but the safest government bills and bonds prompted an unprecedented $1.49 trillion rescue of banks and the economy, now recovering from the worst recession since the Great Depression.

The economy grew at a 1.7 percent annual rate during the second quarter, compared with 3.7 percent in the first three months of the year, according to government data.

“The GDP isn’t really growing now, counting all this debt that is being used to prop up consumption over the short term,” Gundlach said.

That the stock market hasn’t declined this year amid predictions of a global economic slowdown and the debt crisis in Europe is “impressive” and signals demand from investors looking for higher returns as interest rates have hovered near zero for the last two years, Gundlach said.

The MSCI AC World Index has climbed 1.8 percent this year, while the Standard & Poor’s 500 Index has advanced 2 percent.

Gundlach said he is less bearish on the market than he was in 2006 and 2007, largely because he was worried about the solvency of the nation’s banks and because securities were “egregiously overvalued.” The S&P 500 peaked at 1,565.15 in October 2007, falling to a low of 676.53 in March 2009.

Investor demand for dividend-paying stocks bears the hallmarks of the next investment “disaster,” he said.

“People that think dividend-paying stocks are a good bond surrogate are greatly mismatching the risk,” he said. “This has the characteristics of something that could potentially be a debacle.”

Gundlach said equities haven’t declined enough to be attractive investments, especially shares of investment banks such as Goldman Sachs Group Inc. He compared bank stocks to those of airlines, as they haven’t made money for investors over the long term. In the past five years,airline stocks fell at an annual rate of 4.9 percent, compared with a decline of 11 percent for financial stocks.

“Banks and investment banks are horrible investments at the top of a debt cycle,” Gundlach said.

As concerns over regulation and the economy have increased, Gundlach said he’s investing in government bonds as well as mortgage-backed securities that will do well as they rebound from deeply discounted values. DoubleLine’s funds, including the Core Fixed Income Fund, haven’t completely sold holdings in 10- year Treasuries, which have the potential to do “reasonably well” in a weak economy where interest rates are low, Gundlach said. The securities can hold up in the event of deflation, which Gundlach said is a possibility.

The funds are also invested in non-guaranteed mortgage securities that Gundlach and his team believe are trading below what they are worth. These bonds, if purchased at the correct valuation, aren’t sensitive to interest-rate increases and inflation, or rising prices.

“It’s the ultimate inflation hedge,” Gundlach said.

In the past couple of months, DoubleLine also bought below investment-grade corporate bonds because they will be in favor for at least a year and yields are 7 percent to 8 percent. Gundlach doesn’t like junk bonds in the long term because there is risk of default, he said.

Gundlach, who joined TCW in 1985 as a quantitative analyst, later became a fund manager and was named chief investment officer of the Los Angeles-based company in 2005. TCW fired him last year, saying that Gundlach had threatened to leave and take key employees with him. Gundlach said he was dismissed so the company could cut costs.

TCW sued Gundlach and three other former employees in January, alleging they secretly downloaded proprietary information that was used to form DoubleLine. Gundlach has sued TCW, claiming he is owed as much as $1.25 billion in anticipated fee income, and said the allegations that he used information from TCW are untrue.

Assets in TCW Total Return, now managed by a team overseen by Tad Rivelle, have fallen by more than half to $5.3 billion since Gundlach’s departure. It has returned an average of 8.7 percent over the past five years.

DoubleLine started with backing from Howard Marks’s Oaktree Capital Management LP, a Los Angeles-based firm that focuses on high-yield and distressed debt. DoubleLine Total Return Fund had the fastest start for a mutual fund, according to Morningstar. It took 16 years for the TCW Total Return Bond Fund to reach $2 billion in assets under management, Gundlach said.

DoubleLine’s assets under management have risen to $5.5 billion, helping the firm turn profitable, according to Gundlach.

(Bloomberg, October 5, 2010)