What’s Behind DoubleLine’s ‘TOTL’ Success?

The SPDR DoubleLine Total Return Tactical ETF (TOTL), the actively managed ETF that marked Jeffrey Gundlach’s entry into the ETF space, reached its first $1 billion in assets this month, less than six months after its launch.

We caught up with Jeffrey Sherman, co-portfolio manager of TOTL, along with Gundlach and Philip Barach, president of DoubleLine, on what’s behind TOTL’s success, and where Sherman sees opportunities in the market today.

ETF.com: What's behind TOTL's strong performance relative to its peers since launch?

Jeff Sherman: Two things, and one of them lies in the philosophy of the fund: The majority of the assets in TOTL are in the U.S. bond market. It’s U.S.-centric.

We do have an allocation to the emerging market space of approximately 9-10 percent, and that has been a tough area to traffic in, in 2015. But a good contributor to the overall performance of fund is the fact that we've avoided local currency debt in the emerging market space, which has been one of the worst-performing parts of the bond market this year.

We have also avoided sovereign debt almost its entirety in emerging markets. And our bias toward Latin America while avoiding a lot of the Asian economies has worked well, especially now as we see them get hit on the news of the devaluation of the yuan.

So being dollar-denominated has been a very strong boon to performance. But when you compare it to the Barclays Aggregate, the relative performance also comes from TOTL having less interest-rate sensitivity than the index.

When TOTL launched, it was on the lower end of the yield range in the U.S. Treasury market for 2015. And we launched with a duration that's less than the Barclays Agg. One of our objectives is, throughout the full market cycle, to run a duration or interest rate sensitivity of the portfolio, which is less than the index.

We can attribute some of that outperformance to running less interest-rate sensitivity, avoiding some of the missteps and land mines that have been in the emerging market space, although we have an allocation there, and really just overall better quality or higher-quality security selection over that period.

ETF.com: TOTL has a dividend-yield cushion that also addresses the interest-rate sensitivity. How does that protect investors?

Sherman: What it comes down to, to oversimplify it, is looking at the yield of the portfolio from a return expectations perspective. You've got to adjust that yield for what expected losses may be, default cycles if you're credit sensitive and think about how to structure that yield to cushion some of the interest-rate risk. Think of it as comparing the yield of your portfolio to the duration of your portfolio.

The nice thing about that measure—if you take the ratio of those two things—is that it allows you to estimate how much interest rates can move over the course of the next year, all things being equal, before you erode that yield.

For instance, if you have a yield of 3 percent in a portfolio and you have a duration of four years, you divide those two numbers. You get 0.75. That means if interest rates rise 75 basis points over the course of the next year, you lose 3 percent from that interest-rate move, and reprice the bond. But the 3 percent dividend would help offset that.

Now, if you take a ratio of the Barclays Agg, which today has a yield of about 2.1 percent and a duration of around 5 ½ years, you get to a ratio that's more like .35. So if interest rates move 35 basis points over the course of the next year, you're at that zero mark already.

By having a better yield profile and less interest-rate sensitivity, you have more yield cushion if interest rates move adversely against you.

ETF.com: What other metrics are important here when addressing interest-rate sensitivity?

Sherman: This ratio isn’t the only metric we look at. Not all yields are created equal. Some securities have very low interest-rate risk. You don't want to just maximize that ratio.

But when you have a good diversified portfolio, and you could get a very good estimate of what your duration is, you can loss-adjust some of those yields. So you have a good idea about how sensitive you are to swings in the market.

When I say all of that, I'm talking about you never making one change to the portfolio over the course of the next year. Obviously, this is an actively managed fund, so we'll take advantage of opportunities in the market.

One thing we’ve done in the portfolio over the last few months as interest rates have risen is we have added duration to our overall portfolio, because we saw interest-rate risk as a little more attractive.

ETF.com: Where are you seeing the most opportunities today in fixed income?

Sherman: First of all, TOTL has a yield advantage relative to the Barclays Agg, and it has about a year and a half less duration than the overall index, so we think it's positioned well if indeed interest rates are set to rise this year. But we remain in the camp that if the Fed is truly data-dependent, it isn’t going to move in September.

The economic data continue to be choppy at best. Outside of payroll and unemployment numbers going down, the Fed doesn’t have a lot of good data points to work with. When you look at wage inflation, the lack of inflation in the system, it's very difficult for us to believe the Fed has the data to raise rates.

Perhaps they're just tired of being on zero and they want to do it. Remember, the Fed doesn't have to give us a reason; it can just do it. But to us, the Fed should be more in a neutral-to-easing bias versus tightening rates at this stage.

ETF.com: If you’re a bond investor, and rates go up 25 basis points in September, what do you do to your portfolio?

Sherman: You may actually get a bond market rally. If the Fed raises rates on the front end of the curve, say it raises the Fed funds rate 25 basis points, that doesn’t mean that the 10-year yield has to go up 25 basis points. In fact, as the Fed’s been talking about raising rates, the 10-year and the 30-year Treasurys have rallied.

If you look at the 30-year, it’s giving you a completely different signal in the market than any other part of the curve. The back end of the curve is more fixated on the inflation data. The weakening in the overall commodity market, the signaling of a slowdown globally this year—China being the epicenter of that slowdown—all have the market pricing slower growth with low inflation. And that means low bond yields make sense. The bond market has it right.

In general, we don't think the Fed increasing rates will have huge impact in bond portfolios on the short term. Remember, if interest rates go higher and it's a gradual move, what you would find is that you reinvest at a higher rate. So owning a bond fund isn't necessarily bad in a rising-rate environment.

ETF.com: TOTL has a U.S. focus and a lower sensitivity to rates than the Agg. Where could these tilts go wrong?
Sherman: Right now we have less interest-rate risk than the Barclays Agg. So if you have a big deflationary scare—let’s say the Chinese want to devalue more and we find out that they're really growing 3 percent instead of the 6-7 percent and you get the deflationary pressure, and interest rates drop back to the lows again—that's a risk to underperforming the Barclays Agg. If interest rates rally 75 basis points over the course of a month or two, we're going to underperform it.

ETF.com: How is the decision-making process day-to-day for TOTL? Is Jeffrey Gundlach making the calls?

Sherman: TOTL sits in our suite of asset allocation products that we run here at DoubleLine. We run seven different strategies using this top-down macroeconomic landscape.

On the day-to-day, you have individual teams looking at each of the securities and setting the overall mandate. Monthly we have an asset allocation meeting, in which all of the portfolio managers are very heavily involved, when we go to present to the committee, which Jeffrey Gundlach is the head of.

Together with Mr. Gundlach, and upon the recommendation of the committee, we set what we think the sector allocations should be. In TOTL, we're invested in nine sectors of the overall broad-based global fixed-income market.

It's a very team-oriented approach. Mr. Gundlach, being the head of the asset allocation committee and the chief investment officer, dictates the strategy. But there's significant input from both Phil [Barach] and I.

ETF.com: On a final note, TOTL hit $1 billion in just over five months. Are you surprised by the success of your first ETF?

Sherman: T. Boone Pickens said the first billion's the hardest. I think what we found is that we have a good partner with the SPDR family—it has very good distribution. We also found a clientele that exclusively buys ETFs that wants access to DoubleLine, but preferred the ETF vehicle. We’ve been very successful at getting that investor base.

Contact Cinthia Murphy at [email protected].