Gundlach Wary About High Yield Bond Market

Apr 21 2015 | 11:34am ET

Jeff Gundlach fears high-yield corporate bonds may be at the root of the next financial crisis. 

The CEO of Doubleline Capital made his remarks on Wall Street Week over the weekend. His main concern is that when interest rates do begin to rise, the higher return available in sovereign and investment-grade credit will quickly dampen the insatiable demand for higher-yield, higher-risk instruments. 

“A lot of investors don’t like Treasurys,” Gundlach said on the show. “They’ve been searching for yield and throwing caution to the wind.” This reach for yield raises the risk of a run on bond funds and ETFs as higher rates diminish investors’ appetite for riskier paper. 

The result could become a self-reinforcing downward push on price. Many individual investors who are invested in bond funds and ETFs have done so under the illusion that these instruments offer high liquidity, when in fact the liquidity of their underlying bond portfolios may actually be rather thin and could evaporate in periods of market stress. Faced with redemptions, managers of these funds may have no choice but to sell under pressure.

Gundlach, however, does not believe this to be an immediate problem. The Fed may delay interest rate hikes until 2016, he says, because U.S. economic data has begun to soften. But a slew of maturation dates in 2018 and 2019 may result in significant widening of high yield spreads at that time, and could catch investors on the wrong foot.

He also warned about high valuations in instruments bearing above-average yield, such as MLPs and REITs. They have been subject to same hunt for yield as speculative-grade bonds but often carry additional leverage, he said.

Gundlach pointed that while the Federal Reserve has been “very well intentioned,” the full impact of its policies over the past few years has yet to be felt. Giving the Fed good marks at this point was “like a man who jumps out of a 20-story building, and after falling 18 stories, says, ‘So far, so good,'” he noted.

Gundlach started Los Angeles-based DoubleLine in 2009 after he was ousted as chief investment officer of TCW Group. The firm’s flagship $46 billion Doubleline Total Return Bond Fund reported its 14th consecutive month of capital inflows in March.

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