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Bill Gross–The King of Bond

On 2014-09-26, Bill Gross - the King of Bond, aged 70, left PIMCO, a firm he co-founded 43 years ago (1971) with almost $2 tn as Chief Investment Officer of PIMCO.  His flagship fund – PIMCO Total Return Bond Fund peaked at $290 bn before poor performance led to customers outflows of nearly $70 billion over the past 16 months.

According to Morningstar, if you invested $10,000 in Pimco Total Return in 1987 and let it ride, you’d have $81,000, compared with just $60,500 if you invested in the index. In 9 of the last 14 years, the fund handily beat its benchmark, a rare phenomenon.

Interestingly, it is worth noting that Gross’s success was coincided with one of the best times in history to be a bond investor.  Since the start of Total Return, in 1987, bond prices have almost always gone up. Prices kept rising, and most bond investments did well; Gross did better by investing in riskier bonds.

Estimates from Morningstar suggest that relative to a bond index fund, Gross’s Total Return Fund is twice as likely to move in tandem with the Standard & Poor’s 500-stock index. Since the financial crisis, that spread has only widened—from 2009 to today, Pimco’s fund returns began to more closely resemble the S&P 500. (The opposite happened to the Total Bond Fund offered by Vanguard: It now moves inversely with the broad stock market.)

During his tenure at PIMCO, there were only two periods of sustained, large rate increases (1993 to 1994; 1998 to 2000). In each, the Total Return Fund was much less impressive, with returns similar to or worse than the index.

What went “wrong” with Bill Gross? 

It’s the “spell” of unconventional monetary policy - Quantitative Easing.  Since that start of the quantitative easing, Mr Gross was first wrongfooted by government in January 2010, where he declared that the British bond market was “sitting on a bed of nitroglycerine”, suggesting UK sovereign bond yields would rise.  It seemed a rational bet, given that UK had a 7% structural budget deficit, a postwar high.  But British bond yields subsequently fell to a record low because the Bank of England started buying bonds…

Similarly, there was sound logic to Mr Gross’s declarations in 2010 and 2013 that the bull market in bonds was over. But instead of rising, yields fell to new lows in the US and Europe.

More recently Gross has placed heavy bets on the idea that the “new neutral” for US interest rates should be 2 per cent. This implies that the US Federal Reserve will not raise rates as high as markets currently predict, making medium-term US government bonds attractive. But this trade also produced losses.

When the Fed’s crisis-fighting policies end, Mr Gross’s bets may turn out to be correct. It is also possible that fundamentals will start to shape markets more forcefully – allowing bond investors to intimidate governments again.

But, as John Maynard Keynes observed, the problem with markets is that they can remain “irrational” longer than investors can stay solvent – or than eccentric investment gurus can command respect.  Perhaps, “it is better to be roughly right than precisely wrong”, as John Maynard Keynes said.

Reference:

  1. BloombergBusinessweek, Allison Schrager, 2014-09-30, “Bill Gross’s Investing Secret: A Rising Market and Extra Risk”
  2. Financial Times, Gillian Tett, 2014-09-28, “After a life of trend spotting, Bill Gross missed the big shift”
  3. Reuters, Paritosh Bansal & Jennifer Ablan, 2014-09-26, “’Bond King’ Bill Gross Quits PIMCO for Janus”