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Bill Gross illustrates how bond investing has changed

Bill Gross

Just over a month after Jack Bogle died, another giant of investment management is leaving the field. Bill Gross, long known as the bond king, has announced he will retire March 1.

His retirement is the end of a remarkable career and the end of an era. During much of Mr. Gross' career, it was possible for talented bond managers to generate excess returns by spotting mispricing in the bond market through diligent research. Mr. Gross and a few others also were skilled at moving ahead of interest rate changes and recognizing and taking advantage of potential changes in interest rate spreads.

That has changed. Mr. Gross' retirement is a reflection of the evolution of the bond market. Now, as in the stock market, returns in excess of the market are difficult to achieve at all, let alone consistently. Like the stock market, the bond market has become more efficient, largely because computer programs can quickly spot and arbitrage away any mispricing. As a result, active bond management will come under increasing pressure, as has active stock management.

Institutional investors will have to adjust to this new reality. Bond portfolios will likely continue to form the anchor of a diversified portfolio, offsetting the risk incurred in stock portfolios' domestic, international and emerging markets. These days that anchor often takes the form of an immunized portfolio or cash-matched portfolio, both of which tie fund liabilities to the value of the bond portfolios. But bonds are unlikely to produce long-term returns much in excess of the coupon yield, leading to increased indexed bond management.

Before Mr. Gross and others showed how the inefficiencies in the bond market could be used to produce excess returns, bond investors mostly bought and held long-term bonds to maturity, clipping coupons to receive interest payments along the way. Immunized and cash-matched portfolios may be considered the modern version of that old practice.