Janus bond manager Bill Gross devotes his latest monthly investment outlook to the opportunity that an “unconstrained” fund like his can exploit, but his argument also reflects the potential peril of this lack of constraint.
That is because while he painstakingly explains an investment thesis involving risky short selling, he also acknowledges his initial foray didn’t quite work out.
The veteran bond fund manager drew significant investor attention from a tweet last month calling 10-year German bunds: “the short of a lifetime. Better than the pound in 1993. Only question is timing / ECB QE,” he tweeted.
Well, apparently timing wasn’t the only question. Execution is also a question.
That became clear when the bund fell — as Gross had predicted — but fell hard while he expected it to remain in a narrower trading range. His unconstrained bond fund actually lost 2.5%, Bloomberg reports, even though he correctly called the bund’s overvaluation.
“My famous (infamous?) ‘Short of a lifetime’ trade on the German Bund market was well timed but not necessarily well executed,” writes Gross.
In older-but-wiser vein, Gross explicates the investing insight that led him to the German bund short and explains the inherent implementation difficulties while offering some forward-looking guidelines for exploiting such trades in the future.
Today’s central-bank dominated financial world offers unique arbitrage opportunities to investors alert to disparate polices and “staggered implementation,” Gross explains.
So, for example, the European Central Bank (ECB) is committed to buying over 700 billion euros worth of bonds, to lower rates, even while the Fed declares its intent to raise rates later this year. To Gross, this spells opportunity:
“Ten-year Treasuries, for instance still trade at a 175 basis point premium to 10-year bunds versus a long-term historical average of 25 basis or so. A purchase of Treasuries and a sale of Bunds allows for not only a potential capital gain if the spread narrows, but a yield pickup while the Rip Van Winkle investor potentially waits for a probable outcome,” he writes.
The difficulty lies in the endless assumptions an investor has to make to execute a pair trade of this kind.
At the most basic level, one might question whether it is reasonable to expect asset values to return to their historical averages.