Gundlach saga presents a challenge for TCW fund board

Whether the board of directors of the TCW Total Return Bond fund made a wise decision in blessing Jeffrey Gundlach's termination and the acquisition of Metropolitan West Asset Management to replace him ultimately will depend on whether the TCW brand or the Gundlach mystique was the main draw for the fund's investors, observers say.

In a recent interview, Mr. Gundlach said the board can consider tapping his new firm, DoubleLine LLC, as a subadviser if it wants to halt the exodus of more than $5 billion from the fund since he was ousted on Dec. 4.

Investors originally “signed up for” the team he led at TCW, and that team won't be available to them “unless the board of directors assigns the portfolio to my firm,” he said.

Asked about Mr. Gundlach's offer, TCW spokeswoman Erin Freeman said the board already approved the company's Dec. 4 decision to acquire neighboring Los Angeles bond shop Metropolitan West Asset Management to replace Mr. Gundlach and his mortgage-backed securities team. About 40 of the 65 team members have left TCW to join DoubleLine.

Still, with DoubleLine likely to garner the Securities and Exchange Commission's stamp of approval as an investment adviser over the next month or two, the fund's board could have the option of reconnecting Total Return Bond fund investors with Mr. Gundlach's team.

Lawyers say the board is under no obligation to do so. A board of directors has “a fiduciary duty to ask what's in the best interest of a fund's shareholders,” but it's hard to argue that there's a specific legal obligation to consider Mr. Gundlach's new firm, said Thomas S. Harman, an attorney with Washington-based Morgan, Lewis & Bockius LLP, which doesn't represent either firm.

In a situation like the current one, where investment performance has been superior, the board would have to consider how much of that performance was unique to Mr. Gundlach and his team, and whether investors were more attracted by the TCW name or Mr. Gundlach, said Mr. Harman.

Questions like this, involving a board's business judgment, are never black and white, noted Barry P. Barbash, a Washington-based attorney with Willkie Farr & Gallagher LLP. Mr. Barbash said if he were advising a board in a situation that raised TCW-type issues, he'd strongly suggest that they should at least consider arguments of the sort Mr. Gundlach is making.

In most cases, the money management firm, rather than the individual portfolio manager, is considered the main draw for investors, but details — such as the degree to which that portfolio manager was hyped in marketing materials — can also be taken into account.

Even if Mr. Gundlach were the attraction for investors, however, a board would have to ask whether the environment that supported his track record — including trading, compliance, the firm's executive leadership and so on — can be replicated at a new firm, Mr. Harman said.

Instances of directors opting to switch a mandate from a fund's subadviser to another firm are rare, observers say. In the late 1990s, independent directors lost battles to replace two advisers — Navellier & Associates Inc. and Yacktman Asset Management Co. — in high-profile court cases. More recently, in late 2005, the three independent directors of the Clipper Fund Inc. — closely associated with a retiring team led by James H. Gipson, at Old Mutual Asset Management subsidiary Pacific Financial Research — successfully opted to have Davis Selected Advisors LP take over the fund instead of Barrow, Hanley, Mewhinney & Strauss Inc., the replacement offered up by Old Mutual.

Patrick C. Haden, the independent chairman of TCW Fund's nine-member board, did not return phone calls or e-mails seeking comment. Matthew K. Fong, another independent director, in an e-mail response, said all requests for comment were being forwarded to Mr. Haden.

The TCW board has four other independent directors, none of whom responded immediately to e-mailed queries. Three of them — Samuel P. Bell, Richard W. Call and Charles A. Parker — are listed as private investors. The fourth, John A. Gavin, is listed as founder and chairman of Gamma Holdings, an international capital consulting firm.

The remaining three directors are TCW executives — CEO and Chairman Marc I. Stern, Charles W. Baldiswieler, group managing director, and Thomas E. Larkin, vice chairman.

While boards are given considerable leeway in hiring and retaining a fund's investment adviser, a contentious break with a star manager can prove especially challenging.

The legal relationship of the fund a board oversees is with the money management firm rather than an individual portfolio manager, but in the case of a real star manager, investors presumably bought the fund on the strength of that manager's track record, noted Gregory D. Sheehan, a Boston-based attorney with Ropes & Gray LLP. “When they go to war” it can leave a board in a very difficult spot, he said.

In such cases, a board's first concern is that the money management firm find a credible replacement for the star manager so “everybody isn't running for the exits,” said Mr. Sheehan.

Observers say the team at Metropolitan West — whose own top-decile total return bond fund's performance is within hailing distance of Mr. Gundlach's — is certainly credible.

Despite that, outflows from the TCW Total Return Bond fund since Dec. 4 have been considerable.

According to Morningstar Inc., TCW's Total Return Bond fund had $6.6 billion in client assets as of Dec. 23, down $5.3 billion, or 45%, since Mr. Gundlach was fired.

On Dec. 11, when redemptions stood at $3.5 billion, Ms. Freeman said that outflows had trailed off sharply. Even so, over the following 12 days, investors removed another $1.8 billion from the fund.

In the interview, Mr. Gundlach predicted outflows could continue, arguing that some investors could simply be waiting for him to set up a new fund, or craft a subadvisory arrangement with an existing fund, before moving to reunite with his team. DoubleLine's future doesn't depend on winning a mandate to manage the TCW Total Return Bond fund, but “from a TCW business perspective,” hiring his firm as a subadviser would make sense, he said.

One lawyer, who declined to be named, said the board's decisions are unlikely to be questioned if the fund manages to stabilize with enough client assets to continue enjoying economies of scale. But if the board members see no end in sight to the outflows, at some point they might be forced to reconsider their options, said the lawyer, who termed the current environment an extremely “unhappy” one for the board. The lawyer, whose firm represents neither TCW nor DoubleLine, said with the fund at more than $6 billion, the board probably isn't sweating just yet, but if it's at $2 billion in a few weeks, that could change.

It's virtually never the case that a manager is fired by a board, and it's difficult to say when turmoil at a fund — such as a wave of redemptions — would reach a point where a board could not reasonably be judged to have met its duty of care, said Joshua Deringer, an attorney with Philadelphia-based Drinker Biddle & Reath LLP.