“Bond king” Bill Gross has lost his crown. The PIMCO Total Return Fund (PTTRX), which is down nearly 4% for the year, is no longer the world’s largest fund. That title now goes to the Vanguard Total Stock Market Index Fund (VITSX).
So is this just a temporary problem, or are there some long-term issues for Gross?
First of all, the success of VITSX should be no surprise. Investors have warmed up to equities, especially large-cap holdings like Apple (AAPL), Exxon Mobil (XOM), Google (GOOG), Johnson & Johnson (JNJ) and Chevron (CVX). Besides, VITSX has a rock-bottom expense ratio of 0.17%.
The general move to equities means there is less money to devote to bonds. It is also a sign that memories of the financial crisis are fading away, and investors are willing to take on more risks. So far, that strategy has been paying off. Over the past five years, the average compound annual return for VITSX was 18.69%.
This certainly makes bonds look like a bad deal. For example, during the same period, the average gain for PTTRX was 7.8%.
But there may be more at work than relative returns. Let’s face it, the Federal Reserve has engaged in unprecedented efforts to keep interest rates at low levels in order to increase growth in the U.S. economy.
But how long can that last? According to Gross, it could remain that way for decades.
That kind of long-term involvement seems far-fetched. For the most part, the bond market has enjoyed a bull market since the early 1980s. Thus, it seems reasonable that the trend will come to an end — and it could be soon.
In fact, there are already signs that the U.S. economy is getting its mojo back. Just look at the strength in auto sales and housing starts. At the same time, unemployment has been declining at a steady rate. Given all this, it seems that the Federal Reserve will soon start to “taper” its easy monetary policy.
Unfortunately, rising interest rates are terrible for bond funds. Keep in mind that the price of a security will fall, so as to make them more attractive to new investors.
But the situation could be exaggerated for Bill Gross. It looks like he has been taking on higher risks to find better yields, such as by loading up on exotic mortgage securities. These types of investments could fall even farther with rising interest rates.
Something else to consider: If there is a bout of inflation, the impact would be horrible, as we saw back in the 1970s.
Granted, a return of inflation seems unlikely, but that was the sentiment during the late 1960s, too. Inflation is something that can take time to work through an economic system and also be tough to eradicate. But with the Fed pumping trillions into the US economic system, a return of inflation could be a real possibility.
But even if we manage to avoid inflation, it still looks like interest rates will continue to increase as the Fed lightens up on quantitative easing and the U.S. economy continues to rebound. All of which makes it tough for Gross to rack-up strong returns and take back his crown.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.