Two Bond Plays for the Year of Stocks

01/26/2011 12:06 pm EST

Focus: BONDS

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

While equities are likely to beat debt, these specialized income plays should more than hold their own, writes Doug Fabian in High Monthly Income.

I recommend the DoubleLine Total Return Bond Fund (DLTNX) and the iShares JPMorgan USD Emerging Markets Bond ETF (EMB) to position your portfolio for higher yields.

This is commensurate with our thesis that equities will continue outperforming bonds, and that specialized short-term bond plays likely will achieve better results than more generic short-term bonds.

EMB seeks investment results that track the JPMorgan EMBI Global Core index. The index, as well as EMB, contains a diverse mix of emerging-market country bonds, including debt from Brazil, Indonesia, Lebanon, Peru, the Philippines, Russia and Turkey. The fund’s top ten holdings include bonds of various ratings and maturities from each of these countries.

The bonds from these robust economies give EMB a yield of 5% (as of Jan. 14). The expense ratio of 0.60% is reasonable. I like EMB as an international play.

The other fund that I want you to buy is not an ETF. Rather, it’s a specialized bond mutual fund. As you know, normally we use ETFs as the superior choice for getting exposure to a given market segment. Yet the DoubleLine Total Return Bond Fund is so unique it really can’t be duplicated by an ETF.

What makes DLTNX so different from other funds is its manager, the highly regarded Jeffrey Gundlach. Mr. Gundlach’s fund invests primarily in short-duration mortgage securities with investment grade or better credit quality. The fund invests at least 80% of net assets in debt securities. It intends to invest more than 50% of net assets in mortgage-backed securities of any maturity or type guaranteed by, or secured by, collateral that is guaranteed by the United States government, its agencies, instrumentalities or sponsored corporations, or in privately issued mortgage-backed securities. The securities are rated, at time of investment, Aa3 or higher by Moody’s or AA- or higher by S&P or the equivalent by any other nationally recognized statistical rating organization.

Though this description tells us the fund holds largely mortgage-backed securities, it doesn’t tell you why we chose this fund. The biggest reason is Mr. Gundlach himself. Since the fund went public on April 6, Mr. Gundlach and his outstanding team of bond researchers have managed to post a total return of 16.4%. That figure crushed the fund’s benchmark, the Barclays US Aggregate Bond Index, which only managed a 12-month gain of 5.25%.

The chart below of DLTNX clearly shows just how outstanding the fund’s performance has been since it began trading in April.

According to the DoubleLine website, the fund has an annual yield of 11.80% as of Dec. 31. This high yield and outstanding capital appreciation also come at a low cost, as this mutual fund has an expense ratio of just 0.74%.

We believe Gundlach and his DoubleLine research team will continue delivering high yields and outstanding capital appreciation, and this is why we’ve departed from our usual ETF-centric offerings and opted for DLTNX.

You should set your EMB stop at $103 and your DLTNX stop at $10.50. [EMB shares closed just above $107 Tuesday; DLTNX finished just above $11—Editor.]

[Last month, Fabian explained why Treasury yield are likely headed higher, and recommended an ETF to profit from that trend. For more on the long-term trend favoring emerging-market bonds, see this interview with fund manager Michael Conelius—Editor.]

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