Mutual fund managers struggle to beat their benchmarks in any given year, and if they do, their hot hands eventually turn cold. Hence, the rise of passive investing.
But, occasionally, a fund firm or smart investor will devise a strategy that works for years at a time. That might be the case with the DoubleLine Shiller Enhanced CAPE Fund DSEEX, -0.12% DSENX, -0.12% managed by DoubleLine CEO Jeffrey Gundlach and Jeffrey Sherman, the firm’s deputy chief investment officer.
The $4.7 billion fund has outperformed the benchmark S&P 500 Index SPX, +0.82% every year since its inception Oct. 31, 2013. This year it’s only marginally better, but the average three-year return is 13.9% versus 10.2% for the S&P 500 and 7.1% for the Morningstar large-value fund category. It has ranked in the top 1% of value funds over the past three years, according to fund-research firm Morningstar.
Managers of the DoubleLine Shiller Enhanced CAPE Fund DSEEX, -0.12% follow an “index overlay” strategy that’s completely different from the way a typical index fund operates. Curiously, the mutual fund doesn’t directly own stocks; it’s fully invested in fixed-income securities and bank loans.
That actively managed portfolio — fixed-income securities and bank loans — serves as collateral for swap investments in the Shiller Barclays CAPE U.S. Index. The fixed-income portfolio had a weighted average life of about three years, with 75.8% of assets invested in investment-grade paper, government bonds or cash, as of Oct. 31.
The CAPE ratio (cyclically adjusted P/E ratio) was developed by Robert Shiller, the Nobel Prize-winning Yale University economics professor who is also a co-creator of the Shiller Barclays CAPE U.S. Sector Index. The price-to-earnings ratio for a company, sector or index is price divided by earnings. The CAPE ratio is price divided by average earnings over the past 10 years, adjusted for inflation.
According to Sherman, DoubleLine was “approached by Professor Shiller and Barclays with the idea” for a new fund tracking the Shiller Barclays CAPE U.S. Index in 2012.
“We were not looking to get into this business,” he said in an interview Nov. 28, “but we are entrepreneurial enough that when we see [good] ideas, we want to do something with them.”
The Shiller Barclays CAPE U.S. Sector Index is updated monthly. It selects the five cheapest S&P 500 sectors, out of 10, based on their relative CAPE ratios. A sector’s relative CAPE ratio is its current CAPE ratio divided by its 20-year rolling average CAPE ratio. This approach is taken to identify which sectors are cheaply valued relative to their typical CAPE ratios. Otherwise, the rapidly growing information-technology sector would always appear expensive, while utility stocks would always appear inexpensive.
Once the five cheapest sectors are selected, the one that has had the worst performance over the past year is thrown out to avoid a possible “value trap.” An example of a value trap was observed during the credit crisis of 2008. Long before shares of banks and home builders bottomed, their stocks appeared to be good values. A more recent example is oil stocks.
So with the DoubleLine Shiller Enhanced CAPE Fund, you have continuous exposure to a rotating (and value-trap filtered) group of the four cheapest S&P 500 sectors, according to the index’s methodology, along with a respectable dividend yield, to enhance returns.
The fund has two share classes: Class I (institutional) DSEEX, -0.12% with an annual expense ratio of 0.58% and a 30-day yield of 2.47%; and Class N (retail) DSENX, -0.12% with an annual expense ratio of 0.83% and a 30-day yield of 2.22%, as of Nov. 27, according to Morningstar.
Seeking value when the market is expensive
You can see at Schiller’s website that the CAPE ratio for the S&P 500 is about 31 today, which is higher than it has been since 2001. The ratio peaked at 44 in late 1999 as the dot-com bubble was about to burst.
The fund is not specifically defensive in nature, Sherman explained, because it is not designed to outperform during a market pullback. Instead, it seeks to outperform the S&P 500 over the long term through the sector-rotation of the Shiller Barclays CAPE U.S. Sector Index, augmented by the returns on the fixed-income portfolio.
“Even though the overall market has a value that is higher than the historical value, there are still sectors with valuations below their average CAPE ratios,” Sherman said. Currently, the four sectors represented by the Shiller Barclays CAPE U.S. Sector Index are industrials, health care, information technology and consumer discretionary.
Here’s how the fund’s two share classes have performed against the S&P 500 over the past three years:
Here are average total returns for the fund’s two classes, compared with those of the Morningstar large value fund category, and to the S&P 500, through Nov. 27:
|Total return – 2017||Total return – 2016||Total return – 2015||Total return – 2014||Average return – three years|
|DoubleLine Shiller Enhanced CAPE Fund – Class I||19.0%||20.3%||4.7%||17.9%||13.9%|
|DoubleLine Shiller Enhanced CAPE Fund – Class N||18.7%||20.0%||4.3%||17.7%||13.7%|
|Morningstar large-value fund category||11.3%||14.8%||-4.1%||10.2%||7.1%|
|S&P 500 Index||18.3%||12.0%||1.4%||13.7%||10.2%|
Three years is not a long track record. However, the fund’s management style mitigates the danger of chasing performance, because the index it invests in can change its sector focus each month.
It’s also interesting to note that during 2015, when large-value strategies fared poorly against the S&P 500, the fund outperformed both. And when the large-value category beat the S&P 500 in 2016, the fund again outperformed both.