But Morningstar has also maintained it was unsure of the riskiness of Gundlach’s approach, implying that he took more risks at DoubleLine than he ever did at TCW. In fact, Gundlach’s returns in his final three years at TCW varied widely from 6.2% in 2007 to 0.9% in 2008 to 19.5% in 2009. All of these years were abnormal years for the bond market, but defining a normal year for bonds in the last decade is like proving the existence of infinity.

Morningstar acknowledges that DoubleLine’s returns in 2010 and 2011 were outstanding but attributes part of their success to substantial stakes in exotic MBS, including interest-only, inverse-interest and inverse floaters. It argues the positions were large compared to previous positions Gundlach held at TCW Total Return and those held by competitors. Those positions have been reduced in the last two years.

Many other managers, however, also have been using derivatives and exotic securities as they search for yield in the recent low-interest-rate world. In January 2013, Pimco’s Bill Gross was asked in the annual Barron’s Roundtable about his use of derivatives to generate a double-digit return for his recently launched BOND ETF, a real-time proxy for his giant Total Return Bond Fund. Gross candidly responded by challenging anyone to produce similar returns without using derivatives.

Morningstar’s view that it’s difficult to measure the fund’s riskiness is worth closer examination. Through December 31, 2013, DoubleLine Total Return’s institutional investor shares (where the majority of its assets reside) returned 8.38% since its launch in May 2010 while the Barclays U.S. Aggregate Bond Index returned only 3.66%, according to Zephyr StyleADVISOR data. The average intermediate bond fund in Morningstar’s universe returned 4.06%. Comparing the fund to indexes via their Sharpe ratio, a risk-adjusted return measure, the DoubleLine Total Return Fund sports a Sharpe metric of 2.70 compared to 1.27 for the Barclays index and 1.41 for the Morningstar intermediate bond universe.

How valid is Morningstar’s claim that the fund has earned those outsized returns in its first two years by walking a tightrope? The evidence is that the Total Return fund displayed slightly more volatility in 2010, when its standard deviation was 3.04% versus 2.62% for the Barclays Aggregate and 2.53% for the Morningstar universe. In 2011, however, DoubleLine’s standard deviation was virtually identical to the Barclays Aggregate (2.36% versus 2.35%) and slightly less than the Morningstar universe’s at 2.43%.

That is hardly a red flag. In 2012, DoubleLine’s flagship fund returned 9.16% in contrast to 4.21% for the Barclays index and 6.85% for the Morningstar intermediate world. This time, its Sharpe ratio of 5.80 easily topped Barclays’ (2.06) and Morningstar’s universe (3.59). In 2013, DoubleLine Total Return showed it doesn’t walk on water, as it barely eked out a positive 0.02% return, which still placed it in the top 87% of all funds in the category. Barclays’ index fell 2.02%, while Morningstar’s universe was off 1.38%. On the standard deviation and Sharpe ratio risk metrics, DoubleLine’s numbers were slightly better than the averages.

Morningstar continues to voice concern that a sudden interest rate spike could make that tightrope very precarious since instruments like inverse floaters can become vulnerable to illiquidity and the unpredictable behavior of investors in market sell-offs. “These positions were very large compared to both what [Gundlach] had held in the past at TCW Total Return and the size of positions held by competitor portfolios,” says Sarah Bush, a Morningstar analyst. “

Who Changed Their Tune?
Bush’s assessment is contradicted by comments Jacobson made on October 8, 2009 in a Fund Spy column, previewing Gundlach’s nomination as Morningstar’s bond fund manager of the year only two months before TCW fired him. “Gundlach has always stuck almost exclusively with government-backed mortgages, if not the simplest variety, so the fund had some protection from the credit driven bear market,” Jacobson wrote. “What’s arguably even more impressive is how he’s managed to produce a peer-beating 19% rebound thus far in 2009, after pumping the portfolio with nearly 46% in beaten-down non-agency mortgages at one point in 2008.” It is difficult to believe these non-agency mortgages carried less risk when TCW held them in 2008 and 2009 than when DoubleLine did in 2010 and 2011.

Gundlach finds the Morningstar evaluation puzzling. He says the fund “outperformed its benchmark, outperformed its Morningstar intermediate-term bond fund peer group and exhibited lower volatility than its benchmark.”

In a Q&A with Financial Advisor magazine last fall, he says the fund is prepared even if all MBS funds try exiting the cash doors at the same time. Sudden spikes in interest rates represent the greatest threat facing the market, he argues. He questions whether Morningstar officials really understand the DoubleLine MBS portfolio and finds Morningstar’s risk warnings difficult to understand.

“Morningstar.com’s assessment of potential liquidity challenges for DBLTX is perplexing given that cash represents over 10% of the fund’s holdings and very high-liquidity government guaranteed MBS pass-throughs represent another 30%,” Gundlach said last fall. He added that his portfolio is primed for the interest rate and prepayment risks in mortgage-based securities. “Bonds are less risky than they were a few months ago because the yield is now quite a bit higher (thus, more attractive) while inflation does not appear to be worsening,” he says. He maintains his portfolio has sound risk controls.

For instance, Gundlach argues that inverse floaters backed by government guaranteed mortgages have no risk other than interest rate risk and prepayment risk. These risks are shared with all government guaranteed bonds. “Inverse floaters can have a high level of interest rate risk, similar to long-term U.S. Treasurys,” Gundlach says. “A portfolio of nothing but inverse floaters would have high volatility, similar to that of a portfolio of nothing but long-term U.S. Treasurys. A portfolio with a fraction invested in inverse floaters can easily have overall interest and prepayment risk well below that of a Total Bond Market Index fund.”

Gundlach maintains the way the bond market played out last year reveals that Morningstar’s concerns are misplaced. “The open-end mutual fund raters at Morningstar.com framed this ‘concern’ as a forward-looking hypothetical,” he notes. “We now have empirical evidence of the inaccuracy of their assessment. In 2013, we have seen interest rates rise sharply over a relatively short time period and bond funds experience outflows. DBLTX in 2013 has (1) outperformed its benchmark, (2) outperformed its Morningstar intermediate-term bond fund peer group, (3) exhibited lower volatility than its benchmark, (4) exhibited lower volatility than its peer group, (5) exhibited a lower drawdown than its benchmark, (6) exhibited a lower drawdown than most members of the peer group.”

He believes that the Federal Reserve is unlikely to raise rates in the short term. That is a sentiment that was recently confirmed by the Fed’s announcement that it would continue easy money policies—despite other recent hints that it might do the opposite.

In its review last summer, Morningstar conceded that DoubleLine continues to be “tops” in its category and had somewhat reduced its use of “esoteric mortgage-backed securities, including inverse-in-interest-only and inverse floating-rate bonds.” Gundlach himself told clients in a recent Webcast on December 10 that esoteric securities now represent less than 2.5% of his fund’s portfolios.