Bill Gross, manager of the world's biggest bond fund, is proving once again that he's willing to suffer short-term pain for long-term gain.
The billionaire investor and co-chief investment officer of Newport Beach, Calif.-based Pacific Investment Management Co. has seen his flagship Total Return Fund gain 2.52% since eliminating U.S. government debt from his holdings in February, and betting against the securities, forgoing an additional 3.1% in Treasury returns in the last three months, according to data compiled by Bloomberg. The fund beat just 55% of its peers in the past month, the data show.
While that might seem disappointing for a manager who has outperformed 99% of his rivals the past five years, history shows that Mr. Gross' calls often seem wrong before proving accurate and generating above-average returns for investors. In 2007, his fund lost about 0.8% through June, trailing the performance of 80% of comparable funds before rebounding to beat 99% of them for the year as the Federal Reserve began to lower interest rates, as he predicted.
“I certainly don't have any regrets,” Mr. Gross said of his current strategy in an interview June 8. “We're beating the market by 50 basis points. We're not completely satisfied but it's not the negative headline that one sees.”
Mr. Gross, who has helped catapult PIMCO into a firm overseeing $1.2 trillion over the past 40 years, reiterated his call that the 30-year bull-run in bonds is over.
The fund, which has attracted retail investors, public and private pension and retirement funds, exited Treasuries before the securities outperformed all other debt classes in May. Mr. Gross didn't anticipate that investors would largely ignore warnings on the rising budget deficit and the stalemate in Congress on increasing the $14.3 trillion debt ceiling.
“He missed the rally,” said Edward Lashinski, senior strategist in Chicago at ABN Amro Clearing LLC. “Ultimately he may be correct. Even the smartest investment business doesn't get it right all the time. Gross has substantially underestimated the prospect for lower Treasury yields in the near-term.”
The yield on the benchmark 3.125% Treasury note due in May 2021 has fallen to 2.96% from this year's high of 3.77% on Feb. 9, Bloomberg Bond Trader prices show.
Yields have fallen as reports on jobs, manufacturing, housing and consumer confidence suggest that the economy isn't recovering as fast as forecast, keeping inflation from accelerating.
“The economy is still producing at levels well below its potential; consequently, accommodative monetary policies are still needed,” Fed Chairman Ben S. Bernanke said June 7 during a speech to a conference in Atlanta. “Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.”
Mr. Gross isn't the only manager wary of Treasuries after Standard & Poor's and Moody's Investors Service both warned that the United States' AAA credit rating is in jeopardy if lawmakers aren't able to reduce the deficit.
At the same time, the Fed's efforts at injecting cash has caused the Labor Department's consumer price index to rise 3.2% in April from a year earlier, the biggest increase since 2008. That's higher than the yields on bonds due in 10 years or less.
“We would not lend money long-term to a fiscally irresponsible entity with unattractive real yields,” said Thomas Atteberry, who manages $3.7 billion in fixed-income assets at First Pacific in Los Angeles. “I don't know if Congress will have any kind of credible debt ceiling spending reduction proposal in place by August. The level of rates today is because people believe that it's all going to work out with the U.S. credit.”
While First Pacific has 25% of its holdings in Treasuries, its longest-maturity bond is one maturing in October 2012, Mr. Atteberry said.
“We share Bill Gross' view towards Treasuries and their values,” he said. “It would have been speculative to have invested in Treasuries because even at 50 or 60 basis points ago, they still didn't offer value.”
PIMCO'S Total Return Fund has advanced 3.4% this year, ranking sixth out the 10 biggest actively managed bond funds that invest mainly in U.S. debt as of May 31, according to data compiled by Morningstar Inc.
Treasuries are considered the safest and most liquid, investments in the world. The U.S. is the world's biggest debt issuer. It has $14.2 trillion of debt outstanding, while marketable Treasuries total $9.7 trillion. Central banks and other overseas investors own $4.48 trillion, or 46 percent of marketable debt.
The fund had -4% of its assets in government and related debt in April, compared with -3% in March, according to figures from the firm's website. The negative position reflected trades that would profit from a decline in Treasuries. Cash and equivalents, the largest component, rose to 37% from 31%.
Mr. Gross has been betting against U.S. debt through short sales, in which the Total Return Fund would borrow and then sell government bonds, hoping to profit by repurchasing the securities at a lower price in the future. The fund's annual report showed that, as of March 31, it had sold short about $2.2 billion of Treasuries that mature in about 10 years and $5.8 billion of agency debt that comes due in 2041.
In addition, the fund also entered into 10- and 30-year interest-rate swaps with a face value of about $15.2 billion during the fourth quarter of 2010 and first quarter of 2011, according to filings. In order to obtain the contracts, which are the equivalent of betting against Treasuries, the Total Return Fund paid upfront premiums totaling about $331 million to 12 Wall Street banks, the filing shows.
While the swaps are costly for the fund, given that it must pay out more than it takes in under the contracts, Mr. Gross would reap big profits from the trades should long-term rates rise, causing Treasuries to tumble. Conversely, a decline in long-term rates would punish the fund's returns.