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King of Bonds, Jeffrey Gundlach spent time with Bloomberg's Tom Keene this week to discuss his view of the markets and the best place for investor's capital. With over $30 billion of assets under management Gundlach's Doubleline Capital is focused on providing strong risk adjusted returns for shareholders. Gundlach is an astute investor and serious investors should heed his advice.

During his discussion with Tom Keene, Gundlach discussed how investors were not being adequately compensated for short to medium duration bonds. According to Gundlach, investing in short-term bonds is like signing up to get a suitcase full of cash in two to three years. Simply Gundlach would rather have his suitcase full of cash now.

Gundlach's flagship $25 billion DoubleLine Total Return Bond Fund (DBLTX) has returned 4 percent this year, beating about 95 percent of rivals. Gundlach's fund held about 78 percent of assets in mortgage-related securities as of March. During the discussion Gundlach discussed how investors should piece their portfolio together like a puzzle. Each puzzle piece should assess

Gundlach's Total Return Fund buys both agency and non-agency securities as each correlate to market and interest rate risk differently.

Investors looking for exposure to agency and non-agency securities should consider mortgage real estate investment trusts (REITs).

Mortgage REIT Business Model

A mortgage REIT's principal business objective is to generate income for distribution to its stockholders from the spread between the interest income received on its mortgage-backed securities and the cost of borrowing to finance its acquisition of mortgage-backed securities. In addition, most mortgage REITs utilize significant leverage to boost shareholder returns. As opposed to Gundlach's Total Return Fund, mortgage REITs utilize varying levels of leverage to bolster returns.

Agency Securities vs. Non Agency or Hybrid Securities

Mortgage REIT managers typically focus on an agency or hybrid strategies. Agency REITs carry limited credit risk as securities are guaranteed by government sponsored entities. Agency REITs are subject to interest rate and refinance risk. As opposed to agency REITs, hybrid REITs invest in both agency and non-agency securities. Hybrid REIT managers have the flexibility to move between agency and non-agency securities to find the best risk/reward for shareholders. Purchased at the appropriate price, non-agency securities can offer REIT investors attractive risk adjusted returns and lower the volatility in a REIT portfolio. Non-agency mortgages trade more like equity than credit as when the economy heals, recoveries increase. As the economy heals the market drives interest rates up which hurt agency securities.

Fitting Piece of the Puzzle ... A Diversified Approach

Similar to Gundlach's view of making asset allocation decisions like fitting together pieces of a puzzle investors should accumulate a portfolio of M REITs with different strategies. Most mortgage REITs trade around book value. Instead of trying to pick a winner I advise investors to buy a broad, diversified portfolio of agency and hybrid mortgage REITs.

While deploying the same basic borrow short, lend long thesis, M REIT strategies can vary. Annaly and American Capital Agency are agency REITs that are focused on fixed rate securities while MFA and Two Harbors are hybrid REITs that invest in distressed non-agencies and agencies. Below I have outlined by favorite REITs. In my view you are buying managers that deploy a specific strategy. Given that dividend yields are typically low to mid teens I advise a broad and diversified portfolio with your capital allocated to M REITs.

Annaly Capital Management, Inc. (NYSE:NLY) - Fixed Rate Agency Focused REIT

  • Price to Book Value: 1.0x
  • Dividend Yield: 14.0%
  • Market Capitalization: $15.2 billion
  • Leverage: 5.2x

American Capital Agency (NASDAQ:AGNC) - Fixed Rate Agency Focused REIT

  • Price to Book Value: 1.1x
  • Dividend Yield: 16.7%
  • Market Capitalization: $9.0 billion
  • Leverage: 7.7x

MFA Financial (NYSE:MFA) - Hybrid REIT (Agency and Non-Agency)

  • Price to Book Value: 1.0x
  • Dividend Yield: 13.3%
  • Market Capitalization: $2.6 billion
  • Leverage: 3.2x

Two Harbors (NYSE:TWO) - Hybrid REIT (Agency and Non-Agency)

  • Price to Book Value: 1.1x
  • Dividend Yield: 15.9%
  • Market Capitalization: $2.1 billion
  • Leverage: 4.5x

Hatteras Financial (NYSE:HTS) - Floating Rate Agency Focused REIT

  • Price to Book Value: 1.0x
  • Dividend Yield: 12.7%
  • Market Capitalization: $2.7 billion
  • Leverage: 6.7x
Source: Gundlach Bullish On Mortgage Non-Agency Securities