Litman Gregory Alternative Strategies Fund Call

Participant(s): Jeffrey Gundlach, DoubleLine
Litman Gregory Host(s): Jeremy DeGroot, with Katrina Birrell and Mike Pacitto
Date: November 14, 2013

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Litman Gregory Masters' Alternative Strategies Fund Conference Call with DoubleLine's Jeffrey Gundlach and Litman Gregory's chief investment officer, Jeremy DeGroot.

At this time, all participants are in a listen-only mode. During the presentation, please type any questions you have in the text box on your screen. Our host will address questions during the q-and-a portion of the call.

I would now like to turn the call over to Katrina Birrell of Litman Gregory for the reading of compliance disclosures.

Katrina: Thank you, Krista.

The investment objectives, risks, charges and expenses must be considered carefully before investing in the Litman Gregory Masters' Fund. The prospectus contains this and other important information about the Fund, and may be obtained free of charge by calling 1.800.970.0188, or visiting www.MastersFunds.com. Read it carefully before investing.

No opinion expressed herein shall be construed as an offer to sell, or solicitation to buy any security mentioned. The views herein are those of the speakers at the time the comments are made, and are subject to change. Any performance quoted is past performance, and there are no guarantees of future results.

To view the standardized performance of the Litman Gregory Masters' Funds as of the most-recently completed calendar quarter, please visit www.MastersFunds.com, and click on the Funds and Performance tab.

Litman Gregory Fund Advisors LLC has ultimate responsibility for the performance of the Litman Gregory Masters' Funds, due to its responsibility to oversee the Funds' investment managers and recommend their hiring, termination and replacement. Litman Gregory Masters' Funds are distributed by ALPS Distributors, Inc.

Just a couple notes.

If you're having any difficult accessing the presentation, it can also be found at MastersFunds.com/presentation. I'll now hand it over to Mike Pacitto -- our national director of institutional relationships, who is your host for this call.

Mike:   Thanks, Katrina. On behalf of Litman Gregory and DoubleLine Capital, thanks to everyone for joining us on the call today.

Before I hand the floor over to Jeffrey and Jeremy, I would like to provide a quick overview of the Litman Gregory Masters' Alternative Strategies Fund.

The fund is a core-alternatives offering, bringing together four distinctive managers and strategies. Arbitrage, special situations, and event-driven opportunities from John Orrico and his team at Water Island. Contrarian Opportunities from Steve Romick and his team at FPA. Strategic Alpha Fixed-Income from Loomis Sayles. And, of course, from DoubleLine, Jeffrey Gundlach's best ideas and Opportunistic Fixed Income.

These four strategies combine to create a diversified, complementary portfolio that seeks to achieve low-correlation to traditional stocks and bonds, with a focus on absolute-return and risk-management, and low relative-costs when compared to other liquid-alternative investment funds in the mutual fund universe and alternatives.

This portfolio is not a fund of funds. Rather, it's made up of high-conviction investments from each respective manager.

With that, I'd like to hand the call over to Jeremy DeGroot, CIO of Litman Gregory, and Jeffrey Gundlach, CEO and CIO of DoubleLine Capital.

Jeremy: Great. Thanks, Mike. Also, thank you everyone for your time today.

Before I start with our discussion with Jeffrey, I did want to briefly just touch on the Fund's performance since inception, since we recently reached our second anniversary at the end of September.

We're very pleased with the performance, both from a return and a risk-management perspective. I just quickly wanted to share some of the performance here.

This table of risk-return statistics is a table that we publish quarterly, and update on a quarterly basis.

The volatility or standard-deviation on the Fund is 3.56%. Sharpe Ratio is 2.3. And the Fund's beta to the stock market -- the S&P 500 -- is 0.26.

So far in the 2-year period, which we acknowledge is a relatively short time-frame, the Fund has met or exceeded our longer-term absolute-return and risk goals.

Finally, I would just note that the Fund compares very favorably to the Morningstar multi-alternative peer group, which is the last column there on the table.
So, with that brief update out of the way, let me welcome Jeffrey Gundlach to the call. Hi, Jeff!

Jeffrey: Hi, Jeremy. Thanks for having me on.

Jeremy: Sure. Thank you! Certainly your strategy's been an important contributor to the Fund's overall performance, so we thank you for that, as well.

I thought to kick things off, if you could give an overview of the Opportunistic Income Strategy that you're running for our Fund. We talked about this before, but we still get questions from prospects and shareholders about how it also differs from the DoubleLine Total-Return Fund; the core fund that you manage. I think that would be useful, to kick things off.

Jeffrey: Sure. The Opportunistic Income Strategy was really -- it's evolved moderately over time. But it goes all the way back to 1991. When we started it, we [basically thought that] we were using a highly-active management approach and a very non-indexation approach.

We thought that we could reasonably reach an objective of bonds-plus about 6% per-annum using something like the Barclay's Aggregate Bond Index as a proxy. To do that with probably about 150 to 200% of the volatility of a standard bond fund.

We've been investing the portfolio pretty much exclusively in combinations of mortgage-backed securities. To that extent, it sounds something like my total-return strategy. The mortgage-concentration part of it.

But it's quite different from our total-return strategy. It's first of all more active. It's less index-aware. It's actually not index-aware at all -- the opportunistic strategy.

The total-return strategy always runs with a duration less-than the intermediate-term bond category like the Barclay's Ag. Whereas the opportunistic strategy has duration that moves all over the place.

It's been at zero. Last summer it was out at a duration of about 10, in 2011. So it moves around as part of the active-management toolbox.

We don't really invest in typically much of anything that is what one might call a standard intermediate-term bond fund security. We've never owned treasuries. We've never owned corporate bonds. In the Opportunistic Strategy, we don't buy garden-variety GNMAs, FMNAs or FMACs.

Whereas, the Total-Return Strategy, in order to risk-manage to a much lower volatility point, we have significant parts of the portfolio in more traditional bonds. So the Opportunistic Strategy, as its name implies, is definitely more active.

Jeremy: Great. Thanks for that elaboration.

Sticking with the broad strategy discussion, can you also now talk about how you incorporate -- broadly speaking, and we'll get into details as we go through this call -- but incorporate top-down macro views. Bottom-up security selection. You're seeing there's a lot of scenario analysis. So just again, generically, how you construct the portfolio -- top-down, bottom-up, and over different scenarios and time horizons.

Jeffrey: Sure. Well part of the important top-down variables are obviously the interest-rate structure and where interest-rates reside, and ideas about the macro-economy.

For example right now, our duration is 3.2 in our sleeve of the Masters' Fund. That's quite low, because we really aren't terribly fond of interest-rate risk.

We don't expect interest rates to rise tremendously, and I really think they're going to remain capped in the low-3s on 10-year treasuries, and now they're about 2.7. But to make profits on investment-grade bonds seems unlikely.

Whenever the 10-year gets down near 2.5 like it did several weeks ago, I'm just not really that interested in thinking about profit-potential.

So we think we have a range-bound interest environment. Some interest-rate risk is fine, but we don't want a lot of it.

Another big variable is the credit cycle, in the top-down. Particularly, we are investing -- the sleeve of this portfolio -- 2/3 of the investments are in credit risk. Not-guaranteed residential mortgage-backed securities, primarily. Where we stand in the fundamental outlook for those assets has a lot to do with why we have such a high weighting of 67%.

Our view, clearly -- everyone knows by now that the housing market is off its lows. The credit market has opened up a little bit, and defaults are a little bit less bad than they used to be two or three years ago in the housing market.

Since prices have been trending higher for the past couple of years, the defaults that we do experience on the underlying loans and non-guaranteed mortgages, the recovery rates have been better.

We really like the fundamentals of the housing market tying into this 2/3 weighting in the portfolio. That has a big deal to do with thinking about the macro and the top-down environment.

We marry that together with a bottom-up analysis. Where, once we decide where we want to be -- thinking of how much credit risk versus government credit in the portfolio -- we then want to, in the credit piece, of course, look very carefully at loan-level detail and geographies and things like that in determining where our exposures would be toward the credit risk.

Then in the government-guaranteed part of the portfolio, we move around in some of the esoteric parts of the agency-guaranteed mortgage market, in order to balance out the total portfolio.

So it's a mixture. It starts with overall positioning that's quite sensitive to top-down variables. Then we fill out the portfolio using a lot of securities selection work by the team.

Jeremy: What about the different time horizons? Your analytical horizon or investment horizon for the different investments? There's kind of a range, depending on what opportunity-to-risk you're seeing. You'll act on a shorter-term basis, and also have longer-term investments in there.

Jeffrey: That's right. That has necessarily evolved over time. Particularly once we got into the world of extraordinary government policies that we continue to firmly reside in. It used to be that we would look most usually and put the most emphasis on about a 3-year horizon for our investments. But these days, you have to be a little bit shorter-horizon, as well. Because of the potential for policy changes.

At the same time, one of the variables that does seem to lend itself to this 3-year horizon we used to use predominantly and historically, is the concept that short-term interest rates are engineered by the Fed down to zero, of course, on Fed funds basically zero -- and T-Bills at zero. And that they're going to stay there.

That's the variable that we think we can rely on.

So we look in terms of short-term interest rates -- we think we have a more-traditional horizon as regards government policy and how it might affect liquidity in the bond market. There, our horizon is really almost 3 months in the way we think about things. Because that seems to be about the life of sentiment toward the Federal Reserve. Even their own rhetoric seems to bounce back-and-forth with about a 3-months' frequency. So we're sort of playing that, as well. We kind of mix these things together.

When it comes to the credit risk, we're using -- again -- probably a longer horizon -- to around 3 years. We really believe that we are in a pretty good spot in the credit cycle, thanks to all of the liquidity in the system and thanks to the fact that things are being supported so mightily with these government policies and zero-interest-rate policy.

In fact, with the housing market clearly trending higher, we think it's very difficult to see the housing market starting to reverse back down. We think we have some clarity on that, for the several-quarter-horizon, anyway.

Jeremy: One final question, just on the crux of the strategy, overall. You didn't talk much about your ability in terms of the flexibility and the ability to be very active with the strategy in terms of sector-rotating and going for beta.

If, for example, you found high-yield to be compelling undervalued, that is driven on the longer-term horizon.

Jeffrey: That's true. That's absolutely true. We've been really focused in this strategy since the credit crisis really offered this opportunity of mixing together government-guaranteed mortgages and non-agency mortgages. We felt that the most-compelling opportunity has been almost all the time... There have been small, small windows where there have been competing opportunities… But almost all the time, it's been sort of a mix of mortgage-rate securities.

One of these days, on a more-enduring basis, perhaps, it will be overridden by opportunities elsewhere.

When we look at relative value amongst different credit sectors in fixed-income, we are looking at horizons that are about 3-years -- in line with our history. We basically do a rich/cheap analysis on all of the various bond sectors in the US -- using emerging markets and non-US, as well. We try to have a view out at least 18 months to 3 years, where we think we're overvalued or undervalued.

Right now, most credit sectors -- like the high-yield bond market that you just put forward as an example -- the high-yield bond market on a valuation basis, a lot of people think that it's kind of normal. But I think it's very rich.

We compare high-yield corporate bonds to long-term government bonds, because they share similar standard deviation type volatility.
Since the yield curve is somewhat steep today, the long-term treasuries actually, on an historical valuation basis, look quite cheap to high-yield bonds. However, we're not really negative. Although we don't own any high-yield bonds, we're not negative on high-yield bonds. Because we kind of skipped a default cycle, thanks to the very low interest rates that we saw and continue to still see, although not as low.

There was a great deal of refinancing that went on in the high-yield bond market. So the default risk that might be about due to hit the market -- I think -- got postponed for a couple or three years, thanks to the refi.

And with our credit risk, being in non-guaranteed housing, mortgage-related securities, we just think the fundamentals there are just unequivocally positive. So that's why we have the mix we have now.

But you're right. Under certain different outcomes, we would rotate into high-yield bonds. We just haven't done that in recent quarters.

Jeremy: Okay. Great.

Let me just take a second and remind listeners that we are looking to take your questions toward the end of the call, after Jeffrey and I have some more q-and-a here. So please submit questions and comments via the text box on the screen, if you're on the webcast. And we'll try to get to them at the end of the call.

We have a few that came in via email prior to the call that I'll be addressing with Jeffrey. But again, I want to encourage people to write in the questions so that we can cover them as well.

Let's move on to --

You covered some of the macro points, but I wanted to spend some time now on setting the stage for the portfolio-specific discussion. Just getting an update on your broad macro outlook. Again, we've covered some of the fixed-income market views. But let's just start big-picture in terms of where you see the US economy, global economy and in particular, the key variables that really have the most impact on fixed-income markets. Some obvious various there -- inflation -- the Fed and so forth. So we'll just leave it open-ended and let you jump in.

Jeffrey: If you look at basic GDP growth US and globally, it seems to have kind of settled in in the United States at around 2%, minus a little bit. It seems to have a hard time getting much higher than that.

Then we see the global economy as being a little bit weaker. Europe, centered more around the very, very low-positive GDP growth. China with slower GDP growth.

The one thing that's accelerating -- after all these decades of stagnation -- is Japan. But overall, we kind of see as does Janet Yellen, I think -- an underperforming economy. Particularly versus the recovery.

One thing that really affects inflation, as you said, Jeremy, is the outlook for inflation. The only thing that has changed that might support the idea that inflation has a little bit of upward pressure has been a small uptick in average hourly earnings. Average hourly earnings from the employment report -- which are at a very low level, but have ticked up a little bit.

Counterbalancing that very strongly is the message being sent by two important markets. One being the commodities market, which is really at a multi-year low, when you look at the CRB index and when you look at gold or particularly the soft commodities. They're very low. You don't really see any kind of inflation pressure there.

Then the message out of the inflation-protected treasury market -- the TIPS (Treasury Inflation-Protected Securities) market -- which I have been strongly advising investors not to participate in, and it's been good advice because it's done very badly this year --

The message there is also, "No inflation." You see the PCE deflator the Fed likes to look at, down at near an all-time low in the series. It ticked up slightly, but it's very near an all-time low.

So it's hard to see the inflation case right now. A lot of people are absolutely convinced that this quantitative easing will lead to some wild bout of hyperinflation, but they've been waiting a long time for that, and it doesn't seem to be happening.

The outlook for baseline inflation, I think, is rather benign. It seems that the Fed is -- appropriately -- a little bit more worried, and Europe for sure, because they just cut interest rates, making the statement that they're more worried about a deflationary environment. And they should be.

Government debt levels being where they are -- at these very, very cyclically high levels -- the one thing you don't want is a deflationary environment.

I think it's pretty clear from the policymakers that they don't see the inflation case. This kind of means that with short-term rates anchored at zero for what the Fed governors have said are years to come, basically what you have is a yield curve that moves around with long rates fluctuating a lot more than short rates, which are anchored.

One of the things that we think is a way of playing the market is to alter portfolio construction moderately, under the concept that the long rates will move around, but ultimately can't move that much higher. Then, as I said, about the low-3s on the 10-year, given that the yield curve becomes too steep then by historical terms, and also that the Fed is pretty much committed to not letting rates rise.

It's a trading-range environment for government bonds that we use a little bit in our portfolio, switching the mix around. But we don't share this viewpoint that so many people are just convinced of. That rates are not only going to rise, but you'd swear that rates were rising every single day, when you listen to commentators that give their investment advice. By, "Since rates are rising all the time," or, "Since we're in a rising-rate environment," --  

It's really not true. We're in a stable-rate environment at this point, and I think that's kind of likely to maintain in this range for a while.

Jeremy: Do you have a sense of what the market is discounting? It did seem to be a view of many. By looking at increasing your duration in your portfolios, as well, that the market had overreacted to the taper-talk, in terms of discounting. A -- the time-frame and the magnitude of the Fed starting raise the federal funds rate. People jumped from, "We're going to start to taper," to, "Uh-oh. That means they're about to start raising the Fed funds rate." That led to a lot of excitement in the markets back in that June/July period.

Jeffrey: That's true.

The idea that the Fed funds rate is about to be raised any time soon, to me, there's really not a very good argument behind that. I just think that you have to get rid of all of the bond-buying. All of the quantitative easing has to stop before you go back to old-school kind of monetary policy. Where you start changing the funds rate around.

That's the way it was sequenced in the first place. First, rates were brought to zero. It was viewed that even that wasn't enough. So, "Let's try lowering interest rates at the long end, and let's try taking the pressure off of the budget-deficit funding by doing quantitative easing." I think you've got to remove that first.

Janet Yellen has stated in a way that's not all that surprising that she's definitely taken away one line of reasoning that you heard in the recent few weeks. Janet Yellen was going to be more hawkish than people think, just to prove that she isn't a pure dove like people think. Kind of a weird circular logic.

But she said in her written statement yesterday, talking today, basically she stayed perfectly true to her past statements. The economy should absolutely positively not be exposed to reduction of stimulus too soon. Using words like, "Fragile," for the state of the economy and the employment market.

The exercise of June and July, I think what really happened was that the Fed was hoping the data would get better through the summer. They were kind of saying if it did, they would reduce bond-buying. When they said that, it created a lot of liquidations in leveraged portfolios.

You saw the asset classes that had benefited by the investments from leveraged portfolios, like GNMAs. Actually, from mortgage REITs. Like high-yield bonds. Like emerging market bonds. They really sold off.

Emerging market bonds dropped 14%, peak-to-trough in the May-to-July period. High-yield bonds dropped about 10%, peak-to-trough over that period. Mortgages… GNMAs, which really underperformed treasuries during that fell because of liquidations from mortgage REITs.

So they managed to unwind some of the leverage in the system, which I guess we would call a good thing. Maybe that was an unintended consequence.

But when the emerging market currencies like the rupee in India and the rupiah in Indonesia started to basically crash as capital was withdrawn from emerging economies, the Fed responding to that and also to the data, that didn't really improve. They changed their minds on taking away or reducing the bond-buying. It seemed that Janet Yellen had made statements that seem like they're pretty committed to staying with the bond-buying. At least in the early part of her tenure.

So the market seems to be thinking consensus-wise that March would be the first possible time period for reducing bond-buying. I completely agree with that. I think that's the first possible time period. This is another reason why we think we're in this range situation.

But we did, as you said, extended the duration a little bit of our portfolio when rates rose so much earlier this year, because we didn't think they would continue to rise. There were some dislocations in the market, so we added to some of the agency-mortgage-backed securities at that time.

Jeremy: Okay. We did get a question that came in that's related to that point. The liquidity currently in the agency-inverse-floater segment.

Jeffrey: Yes.

Jeremy: That's part of the portfolio. So maybe we can talk a bit about that now, broadly speaking.

Jeffrey: Yes. Only 5% of our portfolio in agency inverse floaters. That's actually a fairly low number. In 2011, we had 25% in that category.

They do go from being highly liquid to illiquid. What we try to do is buy them during periods of illiquidity. We did that in the June/July time-frame this year.

Then, basically the thesis -- and it has worked out -- the thesis is that if you buy during periods of illiquidity, you will benefit when the markets normalize or stabilize in a period of more-normal liquidity. Like we're sort of in today. Then you end up with a profit. That has been the case on those purchases from that time period.

Agency-inverse-floaters are probably similar liquidity to lower-rated investment-grade corporate bonds. During bad times, you have a couple of points of illiquidity. During normal times, you have quite-good liquidity. But it does change around.

As I said, we have slightly under 5% of our portfolio in them. We also own other securities that have similar liquidity-variability in the agency thing. One of them is in the IO market. We own about 6% of the portfolio in something that's a little less liquid than the inverse floaters. That's actually IOs. Interest-only securities. Most of them are also inverse-floating and tied to LIBOR. Their liquidity can be about a 5-point or 5-percentage type of problem during bad times.

Those are the assets that we buy, really expecting to hold forever. Unless our fundamental outlook really changes.

So we're not really that concerned about liquidity, there. Again, these categories together represent only 10% of our portfolio.

The non-agency mortgages that we own also have variable liquidity. All assets, actually in the world, have variable liquidity.  I have a whole diatribe, but I don't want to waste everyone's time on it -- about liquidity. Really, people think that liquidity is uniquely challenging in various sectors of the fixed-income market. But it's challenging everywhere.

But we think about that, and we try to be liquidity providers and get paid for that. That's one of the things that tend to support outperformance over time -- buying when other people need to sell. That's always been part of our strategy.

Jeremy: Another question that came in is about the probability or the likelihood of rates going down. Then just maybe more specifically, earlier you said you kind of see the trading range, and when it gets down to 2.5%, you don't really want to have much duration exposure. You think on the upside, given that Fed funds rate is anchored basically at zero, the yield curve is only get so steep. So in the low-3s.

But what about on the downside? How do you assess the risk of deflation or a shock to [inaudible]?

Jeffrey: I think that's a great question. It's something I've been thinking about in the recent couple of months. I try to ask myself --

I think we all think we know or should think we know that this quantitative easing program is going to have some fairly substantial consequence somewhere down the line. I think it almost has to. The idea that it would just be a perfect thing would [be a] fly in the face of a lot of economic history.

So, what might be the consequence? A lot of people think it's going to lead to higher interest rates when they withdraw or stop buying or maybe even stop buying, or maybe even cause higher interest rates because it's a fundamental of the inflationary policy.

That might be true.

But I also think you have to think about the opposite being maybe even more likely. One thing that is absolutely undeniable about quantitative easing is, it is reducing the supply or the float to the non-central-bank world. Reducing the float of high-quality assets.

The Fed is buying 70% of all of the net-issuance of mortgage-backed securities, plus treasuries. If you just look at it in terms of treasuries, they're buying 150% of the issuance of treasuries. Now they're doing it via GNMAs and treasuries, so it's probably more important to look at it in the first way I framed it.

But the amount of high-quality securities in the fixed-income market is very small relative to what it used to be. And it continues to shrink because of all this buying by the Central Bank. And other central banks are doing it, too.

One of my favorite slides, and I'm going to use it in my next DoubleLine webcast, is I take a look at the treasury-bond market and I point out who owns it. It's all central banks, basically, that own it. Like 70% of it's owned by central banks.

So what happens is something shocks the economy? If something bad happens or there's some sort of an event somewhere, and you get a stress in the system?

You could actually take out low yield that was set in July of 2012. In July of 2012, I went public saying I think we actually are at "the low," that everyone has been talking about prematurely for two decades. The low in interest rates.

That turned out to be right.

But I'm less-convinced that July of 2012 was "the low," in treasury-bond yields. Less convinced today than I was in July of 2012, when it was down there. Even though the rates are higher -- 5.25% today, or a little more -- I think that this bond-buying program could lead to some sort of a strange melt-up. People like that word, "melt-up," these days, in talking about equities.

So you could get a melt-up in bond prices, that should some scenario like that take place.

In July of 2012, I would've put the odds that that was "the low," in yields at 90%. Today I would put the odds of that at only about 65%.  I do think that this bond-buying could lead to exactly the opposite, thanks to the supply of high-quality bonds.

Jeremy: Interesting.

Okay. Let's just step back again a bit to the macro. You have a team there that invests in emerging market bonds.

Jeffrey: Right.

Jeremy: We briefly touched on Japan. But let's talk about China and the impact or lack thereof of the importance of emerging markets to how you see the world.

Jeffrey: Yes. It just seems like emerging markets have become somewhat addicted to the money flows from the developed world's quantitative easing. It seems a little shaky.

The Chinese situation, nobody really knows what to make of the data that comes out of China. But one thing that seems to be something you can track real-time is the performance of the Chinese stock market.

I've been long in the Chinese stock market from time to time, over the past year. I'm out of it now. It just doesn't seem to perform. Which kind of suggests that the economy there is going to be challenged to put out the kind of growth numbers that it had in the past. That's one of the challenges for the entire global economy.

Then the Indian economy has been another pillar of growth over the last multiple-year time-frame. It's become incredibly reliant on foreign capital inflows. That's really what happened in the May-June period this year. As money was flowing out of India, they have a current-account deficit problem. They don't have any foreign reserves to speak of.

The problem with emerging markets is that if you have a shock from tapering or other shocks to the system -- a good candidate would be a reduction in quantitative easing -- I think those markets really catch a cold pretty quickly. That, I think, is part of the risk-profile that seems to have increased, as witnessed by May and June. Not surprisingly, I think that's why the European market really started to take off right after June 30th. I think money was reluctant to go back to emerging markets, and has moved into Europe and the United States more powerfully.

That has run a long way, recently. It might be reversing. But I just don't see that the emerging markets are going to be quite the engine of growth that they have in the past.

Jeremy: Just quickly on Japan, since you talked about it on some of your other calls, and we didn't get questions to get an update, there -- that's not really directly relevant to what you'd be doing in the Opportunistic Income Strategy.

Jeffrey: No. Because we're certainly not going to buy any Japanese bonds. That's for sure. I think the yen is going to get weaker. I've been long the Japanese stock market. I actually bought more of it this week, just because it seems to have been a laggard since May, and seems to be relatively very low. That's where they're turbo-charging the quantitative easing program.

We're starting to see growth that's improving there. The yen is weaker and it'll support exports and the like.

The problem with that is, they're really just taking growth from other countries. That's their program. When you're working on a currency devaluation-based economic growth scheme, what you're really trying to do is to increase your exports by taking them from other people. This is another reason why some of the less-developed countries that create these products are going to likely grow slower. Because Japan is taking some of their exports.

Japan's growth -- they're the one country that has a negative real-interest rate, still. They're gunning this pretty hard on the quantitative easing program, and I think they're going to be a challenge for some of the other exporting countries. So I wouldn't invest in Japan's bonds at all, but I think the equities are reasonably attractive, due to how low they are.

You've got to convert them into non-yen, though. If the stock market is going to go up, basically the thesis is that the depreciating yen is going to drive it. So you have to hedge out the yen exposure.

Jeremy: Right.

Okay, stepping back a bit, what are the biggest macro risks that concern you, just looking out over the next 12 months, as you think about it?

Jeffrey: I think there are risks of deflation in the world. Falling commodity prices from here would be somewhat concerning, I think -- as a statement that growth isn't what it might be forecast to be.

As I said earlier, whenever you have a lot of debt, you have to worry about paying it back in a non-inflationary environment, and it becomes really challenging. I also worry about just geopolitical risk, which is always there. We always have to worry about that. It just seems to be kind of grinding higher in terms of the Middle East problems. Syria was an issue in the summer, and Iran and their nuclear program and all of these things. Not much we can do about that. You can't really handicap it or make short-term portfolio decisions based on it. But that's something that I always worry about.

Jeremy: Let's talk a bit more about the portfolio sleeve that you're running here of the fund. You've obviously already touched on some of the positions.

But as you look at this overall, can you just go into a bit more detail about how you see the various risk-integration? That's a term you've used and something we've found to be very compelling in terms of your ability as a portfolio manager.

As positioned now with the inverse-agencies there and compared to non-agency -- walk through some of the scenarios that you're running through on paper and in your head, in terms of how this portfolio could perform in various scenarios.

Jeffrey: Well, one thing -- our agency mortgage portfolio has a lot of interest-rate risk. The duration of our agency portfolio is 13. It's a very high duration.

The reason we run that duration is first of all, we aren't really that afraid of interest-rate risk.  But we have very little other interest-rate risk in the portfolio. To get to a totally comfortable duration of 3.2 on a total portfolio, we tend to take pretty big interest-rate risk in the agency mortgage portfolio. And you get paid for that.

The inverse-floaters that we own have actually the highest yields or higher yields than the credit risk in the portfolio. The yield is about 8% on the inverse floaters, and they're trading at a price of about $0.82 on the dollar. A credit problem, an economic problem. Because they can very, very easily go to 100 cents on the dollar from 82, and that's a pretty big ride.

That's really honest-to-goodness profit potential for a bad-case economic scenario, so we like to have some of them. Plus, they have a high cash flow yield.

In the IO part of the agency portfolio, we have interest-rate risk. But primarily, you have to worry about prepayment risk that somehow you might have everybody refinancing their mortgages. All of that -- 6% of the portfolio -- is theoretically at-risk. If everybody refinanced tomorrow, we'd lose all the money.

So we want to make sure that we have an offset to that.

What's neat about the non-agency mortgages is, they also could be exposed to refinancing. Their average-dollar-price is about $0.82 on the dollar. So under a scenario where we have a huge refinancing wave, we would lose 6% of our portfolio value on the IOs, but we would have about a 20% gain on 2/3 of the portfolio. Or at least part of that 2/3 of the portfolio. Which largely, or maybe even completely offsets it.

So we were able to get the yield of this prepayment risk, which is very high -- it's about 16% or 17% -- without really taking on the total portfolio value that prepayment risk. That's how we think about risk-integration. We take prepayment risk here, but an anti-prepayment risk there. We get paid for taking interest-rate risk here, but taking no interest-rate risk there. Take credit-risk, instead and roll the portfolio together in a way where we can perform pretty well under a pretty wide range of economic and interest-rate outcomes.

We've landed on -- for the current environment -- the structure of the portfolio that you have of the pie chart on the screen, right now.


Jeremy: We have a question, here. It says, "With DoubleLine's broad, flexible investment mandate, how does Litman Gregory manage the fund's diversification? Ie… Correlations -- with such varying tactical portfolio decisions?"

Let me just quickly address that one.

From our seat as the advisor of the fund, I'm not short-term-tactically reallocating assets depending on whether Jeffrey's portfolio all of a sudden has somewhat of a higher duration than it did two months ago.  Our conviction is in each of these managers, and their ability to execute their strategies over multiple cycles.

Litman Gregory and myself as a portfolio manager at the fund level, are not managing to a specific duration target or a specific credit exposure -- depending on what Loomis Sayles is doing with their sleeve, and so forth.

It's understanding, given the fact that we view it as an advantage… As Jeffrey mentioned, the ability to be very active, very tactical and very flexible and unconstrained in what our subadvisors can do within their portfolios has been a huge advantage for our fund. Then the ability to have multimanagers executing that, we think, should be a diversification benefit.

So the short answer is, and what has happened over the two-year period with these four strategies -- they've not been highly correlated, at all. They've been mostly very low-correlation with each other.

There may be times where there are some similar exposures within parts of the portfolio. But each manager is working in a somewhat different opportunity set. Or very different, in some cases. So we're comfortable with the correlation, if it does occur. But so far, it's been very low.

Jeffrey, you know we're not telling you what some other manager is doing, just for you to kind of keep that in mind in terms of your exposure. But as you said in the past, Loomis Sayles, you always felt was a pretty good complement for a DoubleLine approach, since they're more credit-focused, and you're obviously more of an expertise in the mortgage area.

Jeffrey: That's right. I've been saying that for years and years that Loomis Sayles has long been -- I think -- and continues to be a very good complement in the fixed-income world to what we've been doing with the DoubleLine team for a very long time.

I think a lot of people actually use the two of them together, and I must say I think it's been a very successful combination. Not just for two years, but for a long time.

Jeremy: I'll just throw this one out to you. This is not my question, by the way.

What are you learning from talk radio while driving to work these days? Perhaps in a related vein, where do you see the huge spread in the inequality of income evolving?

I don't know -- do you listen to talk radio?

Jeffrey: Yes, I do. I listen to KNX 1070, which is a news-talk radio show program in Los Angeles.

I basically listen to it to hear how the news is being spun. To kind of hear the way in which the facts are being interpreted.

For example, the first day of the Obamacare thing, it was amazing how the talk radio went on and on about how the website was completely crashed and worthless was definitive proof of the booming success of Obamacare.

This was just all they talked about, all day.

I was just shaking my head saying, "That's just completely nonsensical." I'm kind of interested in seeing how the political winds are being interpreted on talk radio.

Really, this Obamacare thing really is really remarkable. And it ties into the income inequality and the demographic inequality problems that we have in the country.

We continue to see maybe even accelerating polarization of wealth. With stocks booming and contemporary art setting world records this week. Major auctions in New York City.

Yesterday there was the highest price ever paid for a gemstone at auction, for some pink diamond. It was huge -- like 56 carats or something. It went for like $84 million.

This, while we have labor-force participation at the lowest levels in years. We have the duration of unemployment being very high. We have youth unemployment and real problems in the developed world. I mean these things just continue.

Then we ladle on as if the skewed spending toward elderly people in the United States wasn't sufficient enough. We throw Obamacare in, which is really just a tax on young people to pay for the healthcare of sick people who tend to, on average, be older. Certainly older people across the board are going to typically have more healthcare needs.

So what you basically have is you get more through this policy.

I'm with Stanley Druckenmiller, who's taken on this crusade at college campuses of trying to get young people to realize that these policies just seem to be constantly loaded against them, and they're being given a bad deal. That kind of goes along with income inequality, I think. Kind of age-group inequality.

People have been positive on housing, and I'm reasonably copacetic on housing. But one thing that's challenging for the housing market is exactly this problem -- with youth unemployment. Lack of jobs and size of student-loan debt that the college graduates have. It delays or even prevents household formation. There aren't really that many jobs.

This is one of the Achilles heels of the super-bullish case for housing. People don't get married as early, and households aren't formed as early as they were.

Also, there's urbanization that's going on, with younger people in particular moving to cities. I don't remember the exact number, but the percentage of young people that have drivers' licenses is really plummeting, because so many of them live in cities and choose not to have them or don't need them. They don't really have a car, because of the urban lifestyle.

These are all things that argue against this kind of great housing boom concept.  In favor of housing, though, of course is affordability. It's still a somewhat-muted supply, though it's been picking up.

All of these things kind of go together. So yes, I do listen to talk radio. I also read the New York Times from time to time; not every day -- for exactly the same reason. I always find it interesting to see, when the facts don't really change very much, but the way they're being interpreted changes a lot. I can go back to Obamacare, from Day 1 viewed as a booming success, and now everything's being interpreted as yet another setback. I think it's telling, in terms of social mood to see how these facts get reinterpreted over time.

It kind of helps to think about the consumer mood and the economic mood, as well.

Jeremy: Just a different tack, here. What has surprised you the most about this year in the financial markets?

When we talked last fall, you had cash in the portfolio. You were talking about people desperately reaching for yield, and that usually being a precursor to a market shakeout or dislocation.

Jeffrey: Yes. Well, interest rates were going to rise starting from about 1.50 on the 10-year last year. I thought they would go up into the low-2s, and they did. We did some buying when treasuries were in the low-2s. For a while, that was a good idea, because they rarely back down.

Then I kind of thought we'd be playing in an ever-expanding range, but not one that would go all the way to 3% on the 10-year.

What happened was, I was surprised when Ben Bernanke chose to throw out that trial balloon that maybe they were going to stop quantitative easing. I really didn't think they were going to do that. Looking back at it, they shouldn't have done that. Because obviously, all it did was cause a lot of anxiety.

I didn't think he was going to say that. So I didn't think the 10-year treasury was going to go above 2.35 -- really, this year. But the second that it did go above 2.35, that was a major-major event for us. We completely scuttled the idea that that would be the peak in rates. Suddenly it seemed quite clear that rates would be headed toward at least 2.75 to 3.

Now they've kind of settled in there I think because of that exercise. I think interest rates would be at 2.25 today on 10-year treasuries or 2% even, if Ben Bernanke hadn't pulled that rhetorical stunt in the summer.
When I was talking about "reaching for yield can be dangerous," that was certainly true.

When the May-June period came about, there was a big -- as I talked about earlier -- huge selloff in the asset classes that people had run into for this sort of income-starvation concept.

One of the things we really saw and continue to see is a lot of closed-end funds had been trading at premiums to NAV. Now on average, they trade at 5% to 10% discount.  So there's been a huge loss by people that were buying things like that -- leveraged funds.

Look at mortgage REITs. Another example. Mortgage REITs are down on a total-return basis over 20%, this year. Another category where people were reaching for yield.

I really think that that pretty much played out. But I didn't expect that we would see the liquidation cycle that we saw [tick up] by Ben Bernanke's rhetorical stunt there in the May-June time-frame.

Jeremy: We had a question if you had any thoughts on the recent news of hedge fund's proposal to buy Fannie and Freddie's insurance business -- to privatize them. It's a somewhat random question, but have you -- ?

Jeffrey: I don't really have much of an insight on that. You know, Freddie and Fannie seem to be stumbling slowly in the right direction of trying to get into a world where they're sharing risk.

They've issued a few securities that are second- and third- loss pieces. Fannie Mae has a very, very small first-loss piece, and then investors buy bonds that are the second and third little slivers of losses. I find those securities to be horribly overvalued versus just government-guaranteed pass-throughs. So we've looked at them and rejected them very quickly.

Hedge funds buying Fannies' and Freddies' business just seems to me to be very unlikely to really be allowed to happen, based upon the volatility of hedge funds, in terms of their propensity to come and go with market volatility.

Jeremy: A couple more quick ones.

Someone asked about how the Opportunistic Income Strategy is similar to that in your closed-end DBL and DSL funds.

Jeffrey: It's utterly different from DSL. DSL is a diversified portfolio with international exposure and diversified exposure all the time. It is somewhat similar to DBL.

The differences between the sleeve and DBL - DBL is limited to 50% maximum of below-investment-grade. That, as a practical matter, means it has a 50% maximum in non-guaranteed mortgages. Not surprisingly, we're at or very near the 50% number in DBL.

Obviously in a more unconstrained strategy like the Opportunistic Income, we have more like 2/3. So we're basically using the entire risk-budget there. As a consequence, we have a longer duration in DBL, because there are more agency securities.

So those are the primary differences.

But this concept of matching up various mortgage-security classes is a common thread between the two.

Jeremy: We just got a question asking about what the assets are in this sleeve that you're running in our fund. You're 1/4 of the fund -- roughly $170 million in this sleeve. $680 million roughly in the fund, overall.

One question, just before we wrap up, here. Your Opportunistic Income Strategy does have the ability to use some moderate prudent leverage. We have a line of credit on the fund. You haven't taken advantage of that, yet. Any update on your thinking or what would lead you to implement some leverage, potentially, in the strategy?

Jeffrey: We're not even fully-invested. On the pie-chart, you see 8% cash.

I don't know. I suppose I would need to see more of a real market shakeup to reduce what would be the risk of owning some fixed-income, incrementally -- and therefore feel more comfortable that leverage was a good idea.

Also, I don't really want to increase the duration, at this juncture in the portfolio, either. Leverage is very, very likely to do that.

So that's pretty much the reason. It's just basic, prudent risk-management. We're not a big-leverage investor, typically. We tend to stay sometimes with a little bit of cash -- fully-invested. If there's something that's one of those 20% moments that happens once every who knows -- 5 years or so -- that's probably when we would want to jump on the leverage.

Jeremy: Okay. Looks like we're coming up on the hour. So sorry if there were a few more questions that I didn't get to ask Jeffrey. We can answer them or try to answer them offline and get back to people that we know that asked the questions.

I want to thank you, Jeffrey, for your time on the call. I'm going to hand it back over to Mike Pacitto just to wrap up. Thank you again.

Jeffrey: Thank you, Jeremy.

Mike:   Thanks, Jeremy. Thanks, Jeffrey. Both of you, for your time. Thanks, everyone for dialing in today. We appreciate it.

To get more information on the Litman Gregory Alternative Strategies Fund or any of the Litman Gregory Masters' Funds, please visit our website -- www.MastersFunds.com. And for a copy of today's presentation, please feel free to e-mail us. LG-FA@LGAM.com.

Thanks, everyone.