The Bond King Does an About-Face

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Outside of Federal Chairman Ben Bernanke, PIMCO founder and Co-CIO Bill Gross is the most influential man in the global bond market. When he speaks, investors listen.

It’s not for nothing that he is called the “Bond King.” His firm manages more than $1 trillion in assets, and his flagship fund — the PIMCO Total Return Fund (MUTF:PTTRX) — is the largest mutual fund in the world. Yet despite the fund’s size and high profile (both of which make investing more difficult), Gross ranks in the top 1% of all bond funds in his category for the past 15 years. According to Morningstar, the Total Return Fund has generated annualized returns of 7.2% during that period. Not bad for a collection of boring, old bonds.

Gross has had a rough go of it in 2011, however. The Bond King swung big with a much-hyped short of U.S. Treasuries — and struck out.

As a result, Gross has vastly underperformed the competition year to date. The Total Return Fund has seen gains of just 1.9%, while the passive Barclays Capital U.S. Aggregate Bond Index has enjoyed Gross-like returns of 6.7%. Gross ranks in the 91st percentile this year. This means that out of 100 bond fund managers, only nine performed worse. Ouch.

Even an investing demigod like Gross can have a bad trade. But what separates a truly great investor like Gross from the rest of the pack is his ability to dust himself off and jump back in. He doesn’t let a bad trade — and, in his case, the bad press that comes with it — shake his confidence. He simply adapts to the new reality and moves on.

So what is the Bond King buying today?

Mortgages. Lots of mortgages. And he’s even borrowing money to do it.

According to Reuters, Gross went on a mortgage buying spree in September, raising the Total Return Fund’s allocation to mortgage-backed securities to 38% in the belief that the Fed’s Operation Twist will boost their prices. In the process, he increased the leverage of the fund from 9% to 19%. When Mr. Gross bets, he bets big.

The move represents an abrupt U-turn for the Bond King. His main rationale for shorting Treasuries earlier this year was his belief that long-term rates were too low and that they’d be rising once “QE2” was wound down. But in aggressively buying long-duration mortgage bonds — and in using leverage to do it — Gross clearly believes low long-term rates are here to stay for a while.

The Fed’s recent commitment to Operation Twist certainly is one reason for Gross’ bullishness toward long-dated bonds. But looking at the bigger picture, lower rates are consistent with what Gross and his colleague Mohamed El-Erian have dubbed the “New Normal” — a prolonged period of sluggish growth and higher-than-usual unemployment.

In his October investment commentary, Gross identifies three “structural roadblocks” that should help keep growth muted and inflation low for the foreseeable future:

  1. The deflationary effects of globalization (Gross ties this to a populist argument about wage growth).
  2. The deflationary effects of technology.
  3. Aging demographics that favor savings over consumption.

If Gross is correct about inflation being benign — and I believe he is — then investors should make income a major focus of their portfolios.

You could go the route of Gross and buy long-duration bonds. But a better option might be to load up your portfolio with high-dividend stocks. Most importantly, make sure the stocks you pick have a history of growing or at least maintaining their dividends during even the most difficult economic conditions. If a company can raise its dividend in a year like 2008, it’s likely to survive anything.

A few contenders for your portfolio:

All but Microsoft (NASDAQ:MSFT) currently yield more than the 30-year Treasury — which yields 3.15% at time of writing — and Microsoft is awfully close. It should also be added that all of these companies have long histories of raising their dividends, whereas bond payments are fixed.

Whether you buy high-dividend stocks or follow Mr. Gross’s lead and buy long-dated bonds, make sure you’re getting paid. As the market action of 2011 has proven, capital gains can be elusive, but dividends allow you to realize real returns every quarter. And in an environment of low inflation — or even mild deflation — those dividend checks will go a long way.

JNJ, MSFT, INTC, and MO are all recommendations of The Sizemore Investment Letter and are portfolio holdings of Sizemore Capital clients.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. Sign up for a FREE copy of his new Special Report: “Top 5 Contrarian Stocks for 2012.”


Article printed from InvestorPlace Media, https://investorplace.com/2011/10/the-bond-king-does-an-about-face-bill-gross-pttrx-dividends/.

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