PIMCO’s Gross Fights for the 1% (of ‘Excess Return’) in a 4%-5% World

PIMCO manager says we’ve entered new epoch of low returns driven by income rather than capital gains, making skilled management all the more critical.

“Capital gains will be harder to come by” in the future, Bill Gross says. “Capital gains will be harder to come by” in the future, Bill Gross says.

PIMCO bond manager Bill Gross is fighting for the 1%.

Not necessarily the wealthiest segment of U.S. investors (though they are doubtlessly overrepresented among PIMCO shareholders), but for that extra 100 basis points of alpha, which he argues are more elusive than ever in a new era in which “capital gains will be harder to come by.”

The world economy has entered a new epoch, the fund manager declares in his August investment outlook, for a number of reasons, foremost among them that declining interest rates have been the most important driver of investment returns.

Because the Fed can no longer lower rates, and indeed is looking to very gradually raise them, further economic advances will depend on organic growth, which has become much harder to achieve than in the past.

Gross, a veteran of the Vietnam War, recounts in his outlook a chance encounter with a Vietnamese cab driver, whom he paid $20 for an $8 fare to appease his feelings of war guilt.

Extending the analogy of U.S. involvement in Indochina, Gross says consumers today are experiencing their own economic “Vietnam” — i.e., disaster — which accounts for structurally deficient economic growth resulting from low demand and a surfeit of supply.

That is because consumers are aging, overly indebted, outdated and “outjobbed by technology” and “overwhelmed by corporations with the power to contain wages.”

And stunted as U.S. growth now is — “2% real growth since the Great Recession is nothing to brag about,” he writes  — that’s about as good as it gets in today’s world.

South America, he says, is in “virtual recession,” Europe is treading water but with unemployment averaging around 20% in peripheral countries, Russia is in economic retreat and Japan and China are sustained only by credit, i.e. “growth due to paper, not productivity.”

One implication of today’s structural headwinds is that income, not asset price growth, will drive future returns. Returns will be low but relatively dependable, Gross says. 

They will be low because central bank policy rates will be low. Gross reiterates his previously expressed view that the Fed will keep rates on hold until mid-2015, raising them only gradually to “our New Neutral 2% by 2017,” referring to PIMCO’s current template for understanding the market.

That view, essentially, posits that while the Fed will raise rates, it is constrained by a levered global economy that can only withstand very low rates. Indeed, Gross says today’s economy is “closer to deflation than inflation.”

For all these reasons — a slow-growing economy, a market that will offer little in capital gains but wil be driven by income, and even that low-returning — Gross says getting that extra 1% through skilled investment management “is all the more valuable in a 4%-5% low-returning world.”

In a bit of a commercial, Gross adds that “this is where PIMCO shines,” citing the asset manager’s “bottom-up credit analysis,” “top-down macro template” and “income diversifiers.”

Stung by what he perceives as unfair media criticism (a view he expressed publicly in June at the Morningstar Investment Conference), Gross quips “just check the numbers, not the headlines.”

ThinkAdvisor has checked and has verified that PIMCO’s flagship fund, the PIMCO Total Return Fund (PTTAX), has outperformed its benchmark, the Barclays U.S. Aggregate Bond Index, through the year ending June 30, with a return of 4.48% vs. 4.37%. Yet it underperformed its arch-nemesis, the DoubleLine Total Return Bond Fund, which returned 4.71% during the same period.

The DoubleLine fund has been surging with investor inflows even while the PIMCO fund has bled assets over the past year. Gross is hoping to reverse that tide, and promises strategies including “indexed durations” and “credit positions that are mildly overweight” going forward.

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