DoubleLine's Gundlach: Buy Closed-End Bond Funds, Indian Stocks

With interest rates at rock-bottom levels, it’s hard to earn a high yield safely. Unfortunately for income seekers, says star bond fund manager Jeffrey Gundlach, rates are likely to remain low for much longer than most people expect. One reason, says Gundlach, who comanages DoubleLine Total Return (symbol DBLTX), is that populations are getting older all over the world. Older people tend to spend less than younger ones, tamping down economic growth and inflation. Moreover, demand from older people for investment income keeps bond prices up and, conversely, yields down.

Most economists and traders expect the Federal Reserve to hike interest rates in December, the first boost since 2006. But Gundlach thinks such a move is not warranted because most economic indicators are weaker today than they were in September 2012, when the central bank launched its third round of quantitative easing (essentially a program of using Fed assets to buy government bonds).Long-term bond yields, which tend to loosely track the growth in gross domestic product, have been creeping up—the benchmark 10-year Treasury closed at 2.32% on November 12, up from 1.99% on October 14. But with the U.S. economy growing at an annual rate of 2.9%, the yield on the 10-year Treasury isn’t likely to exceed that figure by much, if at all, Gundlach says. He thinks the current environment is much like that of the 1950s, when inflation and interest rates rose modestly for the entire decade.

For bond investors, all this means that you’ll need to take risks to obtain high income. Gundlach suggests avoiding high-yield corporate bonds. Energy companies are heavy issuers of junk bonds, and many firms are at risk of defaulting because of low oil prices.

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Gundlach is keen on closed-end bond funds. These funds generally issue a limited number of shares and then trade on exchanges just like stocks. Share prices typically diverge from the value of a fund’s underlying assets, resulting in funds trading at discounts from or premiums to their net asset value, or NAV, per share. For example, if a fund’s underlying assets are worth $10 per share and the fund trades for $9, it is said to be selling at a 10% discount to NAV.

Because many closed-end bond funds borrow to boost their results, they are especially susceptible to rising rates, or even the threat of rising rates. So investors have been dumping these funds lately, pushing down their share prices faster than their NAVs have fallen. As of November 6, the average closed-end bond fund traded at a 8.5% discount to NAV, and most yielded more than 5%; some yielded 10% or more. The funds are likely to remain volatile for some time, but Gundlach thinks when you can buy high-yielding funds at a steep discount to their asset values, the potential returns are likely to outweigh the risks.

Two closed-ends worth considering: Pimco Income Opportunity Fund (PKO, $22.61), which invests in all types of debt, from mortgages to corporate and government bonds, trades at a 6.5% discount to NAV and yields a whopping 9.4%. BlackRock Multi-Sector Income Trust (BIT, $15.75), which invests mostly in corporate bonds and asset-backed securities, sells at a 15.7% discount to NAV and yields 8.9%. Both funds employ leverage. (Share prices, yields and discounts are as of November 12.)

Gundlach, who isn’t afraid to voice opinions in areas beyond his core competence, is also bullish on Indian stocks. India is one of the few countries, he says, where demographic trends portend vibrant economic growth. But investors in India must be both intrepid and ready to stick it out for the long haul. “Buy India, but don’t look at your statement for 25 years,” says Gundlach. “The market may be bad next year and the year after that, but in the long run it’s going to have been a great investment.”