Kip 25 Update: DoubleLine Total Return Bond Fund

Quibble all you want about the modest results over the past year of DoubleLine Total Return Bond (symbol DLTNX). But given the whipping many bond funds took in 2013, any fund in the black is entitled to take a bow. Over the past year, Total Return Bond, a member of the Kiplinger 25, beat 89% of all taxable intermediate-term bond funds and outpaced the Barclays Aggregate Bond index (symbol LAG), a proxy for the investment-grade segment of the bond market, by 1.5 percentage points.

What helped? Just the same barbell strategy that lead manager Jeffrey Gundlach has honed for years. He invests in government-backed mortgage bonds, which carry no default risk but are interest-rate sensitive, and balances them with non-agency mortgage bonds, which have higher default risk but are less sensitive to interest-rate moves. The risks offset each other—as does the performance of the bonds themselves, in many instances. When the economy suffers, agency bonds do well; when the economy thrives, non-agency debt does better.

Gundlach beefed up the fund’s holdings of non-agency bonds over the past year to 42% of assets—“our largest exposure ever,” he says. The fund’s holdings in government-backed mortgage securities edged higher, to 51% of assets. Over the past year, cash holdings dropped from 16% of assets to less than 2%. Some of the cash was used to buy ten-year Treasuries, which the fund picked up last year when yields hovered near 3%. Gundlach says he prefers the ten-year Treasury at 3% over a government-backed mortgage bond with a similar yield partly because the Treasuries are less volatile than the mortgage debt.

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The moves have boosted the fund’s yield to 4.8%, up from 3.6% a year ago and 2.7 percentage points higher than the average yield of its peers. That should help offset any drops in bond prices if interest rates rise.

Contrarian bet. But unlike most of the rest of the world, Gundlach isn’t convinced that will happen. In fact, he has made his fund more sensitive to swings in rates. Its duration, a measure of rate sensitivity, has doubled over the past year, to 4 years. That means that for every percentage-point rise in rates, the fund should lose 4%. But for every point rates drop, the fund should gain 4%. “Everybody believes with certitude that rates are going higher,” Gundlach says. “But that doesn’t mean they’re right.”