April 2011 IssueLong scroll reading

RiverNorth DoubleLine Strategic Income (RNDLX)

By Editor

Objective

To provide both current income and total return. The fund has three distinct strategies, two overseen by DoubleLine, among which it allocates assets based on the advisor’s tactical judgment. The fund aims to be less volatile than the broad fixed-income market.

Adviser

RiverNorth Capital Management, LLC. RiverNorth, founded in 2000, specializes in quantitative and qualitative closed-end fund trading strategies and advises the RiverNorth Core Opportunity Fund (RNCOX) and a several hedge funds. They manage nearly $700 million for individuals and institutions, including employee benefit plans.

Manager

Patrick W. Galley and Stephen A. O’Neill, both of RiverNorth Capital and co-managers of the five-star RiverNorth Core Opportunity fund (RNCOX), and Jeffrey E. Gundlach. Mr. Gundlach ran TCW Total Return (TGLMX) from 1993 through 2009. For most trailing periods at the time of his departure, his fund had returns in the top 1% of its peer group. He was Morningstar’s fixed-income manager of the year in 2006 and a nominee for fixed income manager of the decade in 2009. Most of the investment staff from TCW moved to DoubleLine with him.

Management’s Stake in the Fund

None yet reported since the latest Statement of Additional Information precedes the fund’s launch. Mr. Galley owns more than 25% of the adviser and has between $100,000 and $500,000 in his Core Opportunity fund. Mr. Galley reports that “100% of our employees’ 401k assets [and] over 85% of the portfolio managers’ liquid net worth [is] invested in our own products.”

Opening date

December 30, 2010.

Minimum investment

$5000, reduced to $1000 for IRAs.

Expense ratio

Capped at 1.2% on assets of $29 million

Comments

Many serious analysts expect a period of low returns across a whole variety of asset classes. GMO, for example, forecasts real returns of nearly zero on a variety of bond classes over the next five years. Forecasts for equity returns seem to range from “restrained” to “disastrous.”

If true, the received wisdom — invest in low cost, broadly diversified index funds or ETFs — will produce reasonable relative returns and unreasonable absolute ones. A popular alternative — be bold, make a few big bets — might produce better returns, but will certainly produce gut-wrenching periods. And, in truth, we’re not wired to embrace volatility.

The folks at RiverNorth propose an alternative of a sort of “core and explore” variety. RiverNorth DoubleLine Strategic Income has three “sleeves,” or distinct components in its portfolio:

  • Core Fixed Income, run by fixed-income superstar Jeff Gundlach & co., will follow the same strategy as the DoubleLine Core Fixed Income (DLFNX) fund though it won’t be a clone of the fund. As the name implies, this strategy will be the core of the portfolio. With it, Gundlach is authorized to invest globally in a wide variety of fixed-income assets. The asset allocation within this sleeve varies, based on Mr. G’s judgment.
  • Opportunistic Income, also run by Mr. G., will specialize in mortgage-backed securities. Most analysts argue that this is DoubleLine’s area of core competence, and that it’s contributed much of the alpha to his earlier TCW funds.
  • Tactical Closed-end Fund Income, run by Patrick Galley and the team at RiverNorth, invests in closed-end income funds when (1) they fit into the team’s tactical asset allocation model and (2) they are selling at an unsustainable discount. As investors in the (five-star) RiverNorth Core Opportunity (RNCOX) fund know, CEFs often sell at irrational discounts to their net asset value; that is, you might briefly be able to buy $100 worth of bonds for $80 or less. RiverNorth monitors both sectors and individual fund discounts. It buys funds when the discount is irrational and sells as soon as it returns to a rational level, looking in an arbitrage gain which is largely independent of the overall moves in the market. Ideally, the combination of opportunism and cognizance of volatility and concentration risk will allow the managers to produce a better risk adjusted return (i.e., a higher Sharpe ratio) than the Barclays Aggregate.

The fund’s logic is this: Gundlach’s Core Fixed Income sleeve is going to be rock-solid. If either Gundlach or Galley sees a high-probability, high-alpha opportunity in their respective areas of expertise, they’ll devote a portion of the portfolio to locking in those gains. If they see nothing special, a larger fraction of the fund will remain in the core portfolio. While most of us detest market volatility, Galley and Gundlach seem to be waiting anxiously for it since it gives them an opportunity to reap exceptional profits from the irrationality of other investors. The managers report that their favorite time to buy is “when your hand is shaking [as] you are going to write the check.” The ability to move assets out of Core and into one of the other sleeves means the managers will have the money available to exploit market panics, even if investor panic means the fund isn’t receiving new cash.

The CEF strategy is distinguished from the RNCOX version, which slides between CEFs (when pricing is irrational) and ETFs (when pricing is rational). Based on the managers’ judgment that Mr. Gundlach can consistently add alpha over what comparable ETFs might offer (both in sector and security selection), Mr. Galley will slide his resources between CEFs (when pricing is irrational) and Core Fixed Income (when pricing isn’t).

While there’s no formal “neutral allocation” for the fund, the managers can imagine a world in which about half of the fund is usually in Core Fixed Income and the remainder split between the two alpha-generating strategies. Since the three strategies are uncorrelated, they offer a real prospect of damping the portfolio’s overall volatility while adding alpha. How much alpha? In early February, the managers estimated that their strategies were yielding between the mid single digits (in two sleeves) and low double-digits (in the other).

Bottom Line

In reviewing RiverNorth Core in 2009, I described the case for the fund as “compelling.” Absent a crushing legal defeat for Mr. Gundlach in his ongoing fight with former employer TCW, the same term seems to fit here as well.

I’ve been pondering a question, posed on the board, about a three fund portfolio; that is, if you could own three and only three funds over the long haul, which would they be? Given its reasonable expenses, the managers’ sustained successes, innovative design and risk-consciousness, this might well be one of the three on my list anyway.

Fund website

RiverNorth Funds

RiverNorth/DoubleLine Strategic Income

Fact Sheet

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact [email protected].