As investor assets pour out of PIMCO’s flagship Total Return bond fund, its manager, Bill Gross, is throwing down the gauntlet in the battle for fixed-income investors squarely in the conservative camp, ceding higher yields to risk-embracing competitors.
That seems to be the message behind Gross’ latest investment outlook, which is more technical than usual but also quite telling about the strategy he envisions for his embattled fund, still the world’s largest but hemorrhaging even as Jeffrey Gundlach’s rival DoubleLine Total Return fund sees large inflows.
Gross argues that today’s markets present a unique challenge to investors after decades of rising asset values occurring against a backdrop of generally low volatility. That has produced high Sharpe ratios (a good thing, meaning that returns are high relative to risk).
But past Sharpe ratios do not foretell future ones and, indeed, Gross argues that it was the gentle decline in 10-year bond yields which, in part at least, generated the high return on assets of the recent past.
Yet “there comes a point where prospective returns relative to risk don’t ensure such optimistic outcomes,” he warns, and using a technical measure called “yield per unit of duration,” he explains that we’re at such a point today.
Today a unit of duration yields just half the norm of the past 15 to 20 years, meaning that “in order to get the same yield today for a single unit of duration for AAA, BBB, and HY [high-yield] bonds, an investor has to take twice the price risk!”
That leaves bond managers such as Gross two fundamental choices:
“Either double your position–double your duration–and maintain the same yield as historically noted or maintain or even lower your duration as a concession to an overpriced market that may continue to suffer increasing yields and lower prices,” he writes (with emphasis in the original).
In a telling acknowledgment of the elephant standing in the bond market room, Gross suggests nothing less than the future of “investment management firms hang in the balance.”
Thus he, Gundlach and others must “double up to catch up” or be “willing to suffer the lower yields, wait for ‘mean reversion’ as do some of our competitors, and hope that the client cash outflows don’t cash you out before you have a chance to play another game.”
Gross casts his lot with the long-suffering through an overweighting of credit and underweighting of duration.
Specifically, Gross thinks short-duration bonds should “hold current levels” but “5- to 30-year maturities are at risk.”
The bond manager is betting that the 5- to 30-year bonds the Fed has been buying will have to be sold, post-taper, at “higher yields to entice the private sector back in.”
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