Bill Gross, manager of the world’s biggest bond fund, urged investors to stick with him after losses since May prompted client redemptions.
“We are confident that we know how to win this evolving bond war,” Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., wrote in a commentary posted on the firm’s website. “Stick with Pimco, we’re going to win this new war.”
Pimco is preparing for an era of lower fixed-income returns after unprecedented investor deposits into bonds since 2008, which helped the firm more than double assets to $2 trillion in the past five years. That trend may be reversing as investors pulled money from Gross' Pimco Total Return Fund for three straight months following a selloff in debt markets, triggered by Federal Reserve Chairman Ben S. Bernanke’s comments that the central bank may pare back bond purchases.
Under Chief Executive Officer Mohamed El-Erian, Pimco has been expanding into stocks and bond strategies that can weather the impact of rising interest rates and declining market returns. Those shifts didn’t insulate Pimco from record withdrawals in June, when investors pulled $14.5 billion from the firm’s U.S. mutual funds, according to Morningstar Inc. in Chicago. Clients have removed $18.7 billion from Gross' Total Return fund since May, Morningstar estimates.
Gross' $262 billion Pimco Total Return Fund has declined 2.3 percent this year, trailing 61 percent of rivals, according to data compiled by Bloomberg. Over the past five years, the fund has advanced 7.4 percent, beating 89 percent of peers.
Gross, 69, acknowledged this year’s underperformance, saying the “strategic execution” in May and June “can and has been publicly faulted.” A bet on inflation-linked Treasurys hurt Gross this year after the market fell on muted expectations for rising prices.
Gross made another bad bet on Treasurys 2 1/2 years ago. In February 2011, he eliminated his allocation to Treasurys, only to miss out on a rally in government bonds that left Pimco Total Return trailing 70 percent of peers. Gross, in a letter to clients at the time titled “Mea Culpa,” called 2011 a “stinker.” His fund lost an estimated $5 billion to withdrawals that year, according to Morningstar.
Bond managers need to adapt to an era of lower fixed-income returns by being flexible and embracing “unconstrained” strategies that protect investors from market risks, Gross said.
“Unconstrained strategies, alternative assets and stocks will be flexible choices in a dynamic future environment,” Gross wrote. “We want to continue managing them for you. But don’t give up on bonds.”
Even though extending the maturity of bond portfolios as a way to obtain higher returns “will work less well with yields close to zero,” investors can still profit with fixed-income securities by focusing on the difference in yields between different types of credit, non-U.S. dollar-denominated debt and bonds with higher volatility, Gross wrote.
Bonds issued by less than Aaa-rated sovereign nations as well as corporations contain “credit risk,” which causes their yields to be greater than those of countries such as the U.S., providing an opportunity for bond investors, Gross wrote in his commentary.
Investors also require more compensation for bonds perceived to have greater risk of yield swings, or “volatility premium.” Trading strategies that profit from movements in yield differentials between debt of different maturities, the so-called yield curve, will be another avenue for bond fund managers to garner profits, Gross wrote.
“We know maturity/duration extension is becoming a tired horse, but it may still have a place on the battlefield under certain conditions,” Gross wrote in the note. “Total carry, or the total ‘yield,’ of a portfolio is Pimco’s dominant focus, not duration reduction.”
Duration measures a security’s price sensitivity to changes in yields and generally increases with maturity.
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