Pimco’s Biggest Problem (Other Than Bill Gross)

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What happens when you are the manager of the world’s largest bond fund, you overestimate inflation, you misjudge the Fed’s moves on interest rates, you make portfolio selections accordingly, then suffer the consequences by losing terribly to your primary benchmark?

bill gross pimco bond kingIf you guessed “get fired,” you would only be partially correct.

As co-founder and chief investment officer of Pimco, Bill Gross is not likely to fire himself. However, shareholders of his Pimco Total Return (PTTRX) fund have said goodbye in the form of 13 consecutive months of outflows. The resignation of his co-CIO and heir apparent, Mohamed El-Erian, was another noteworthy exit that magnified and extended Pimco’s problems. Are the brighter days ahead for Gross and Pimco or might there be bigger problems ahead?

From ‘Bond King’ to Bond Fool?

The problems for Mr. Gross started back in 2011 when his warning of rising interest rates and falling bond prices began to get louder. Here’s an excerpt from his January 2011 Pimco Investment Outlook:

“Eventually, as reflationary policies take hold, long-term bondholders lose their heads (and a portion of their principal as well), as yields rise to reflect higher future inflation. Bondholders’ metaphorical warning: ‘don’t go near those longer term bonds you fool.'”

But the fool ended up being Bill Gross.

Putting his money where his mouth was at the time, he shortened the duration on his bold holdings to protect against larger declines in price (the longer the duration, the more bond prices fall when interest rates rise).

To Gross’ credit (or I suppose I should say, to his debt), many financial media pundits were also warning of inflation, rising interest rates and the end of the great secular bull market for bonds. But Bill Gross was supposed to be the “Bond King.” Surely he of all fund managers could navigate the end of a secular bull market for bonds. Or might his reign be over?

In 2011, his call for inflation and falling bond prices was too soon as Pimco Total Return gained 3.49%, which was 435 basis points below the benchmark, Barclays Aggregate Bond Index. In the bond world, this is considered a colossal failure. Gross’ 2012 was better, as he beat the index, but his return to losing to the bond benchmark in 2013 and early 2014 grew the seeds of doubt in the minds of investors. By May 2013, the exodus of shareholders began and the outflows have continued every month through May 2014.

Outflows Can Lead to Bigger Concerns for Pimco and Bond Investors

But Bill Gross’ mistakes, the subsequent tarnishing of his crown, and the mass exodus of investors may lead to a bigger problem for Pimco and its remaining bond fund shareholders. Retaining assets and attracting new investors is the lifeblood of managed portfolios. The monthly outflows for the past year are like a wound that won’t heal until the bleeding stops. Not even superior security selection and good timing can ensure a return to leadership in the bond world for Pimco and Gross if investors continue pulling their money away.

The challenge is, to accommodate outflows, fund managers are forced to hold more of the portfolio’s assets in cash (or use derivatives to borrow against the fund’s assets like Gross has been known to do), which can place additional downward pressure on the portfolio’s net gains. Therefore, subpar returns are very possible until confidence in Pimco and Gross is restored, which can be today, tomorrow or never.

In different words, Pimco is bleeding assets, and manager Bill Gross has one arm tied behind his back.

Americans love to see a comeback, but investors are wise to do their observing from a distance and consider bond funds better than Pimco Total Return.

As of this writing, Kent Thune did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2014/06/pimco-problem-bill-gross/.

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