It completely came out of the blue. On Friday September 26th Bill Gross, founder and director at PIMCO, resigned from his position and moved to Janus Capital. Rumor has it that the most influential bond specialist on this planet was about to be fired and Gross did have a reputation of making strong statements, which is something that not all employees appreciated. Mohamed El Arian already left PIMCO earlier this year, also because of Gross according to insiders, and the letters from dissatisfied co-workers were apparently getting out of control in recent months.
But what is more relevant to investors is the fact that PIMCO’s Total Return fund had almost reached 300 billion dollars at a certain point under the leadership of Bill Gross. For decades the fund outperformed the market year in, year out. This created a bit of complacency with private bankers and such; recommending this fund was never a big risk to your career. When things would not end up as expected you could always say that PIMCO was going through a temporary rough period, and that everything was going to be fine in the end. Gross was untouchable.
In recent years the fund did not perform as well as it did in the past, unfortunately, and Gross lost a lot of his shine. The fund started showing up in the bottom 25% of its peer group, especially since Gross misplaced a bet against United States Treasuries in 2011. The fund lost more than a tenth of its value in September with around 20 billion dollars net being withdrawn. On the day of Gross’ resignation the fund suffered its biggest outflow in its existence, although PIMCO did not release the exact figures.
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Source: Business Insider
While the competition was recovering from a miserable 2013 and slowly picking up gains this year, the PIMCO fund kept underperforming. Investors were getting anxious as a consequence and withdrew about 80 billion dollars in the 17 months leading up to Gross’ exit. Investment research firms, like the influential Morningstar, also voiced their opinions as analysts dropped the fund’s rating from ‘Gold’ to ‘Bronze’, because of the uncertainty around the new management team. Fortunately for Gross, the bond market in which the fund invests is one of the most liquid in the world, with 700 billion dollars’ worth of assets changing hands daily on average. The fund, consequently, never really ran into liquidity problems.
It is a mystery why investors keep pumping money into bonds in the current environment of extremely low interest rates but, nevertheless, tens of billions of dollars flow into these kinds of funds. Investment funds and ETFs in the bond segment that are listed pulled in no less than 116 billion dollars of fresh cash this year up to and including the month of August. It would be a lie to say that all the money is going into the stock market, which is a lot smaller and less liquid regardless.
It is only a hypothesis of course, but maybe after 43 years of Bill Gross on the bond markets we will see the end of the secular bull market in government bunds. During that whole period interest rates have been constantly decreasing and Gross outpaced the market during all those years with tremendous returns. Despite all the statements about the superior returns of stocks in the (very) long term, bonds have been leading the market for the last 4 decades (!). Below you can see a chart of the 10-year Treasury yield, which has been on the decline since 1982.
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Source: Yahoo! Finance
Investing in bonds has certainly become a lot harder than in the ‘80s. Back in the day you could assume that you were certainly going to be paid back, but now bond ratings have come into play much more and that takes a lot more work from an analysis perspective. Managing a bond fund has become much more complicated as a consequence. It used to be the case that you could buy long-term bonds and keep them until maturity. There was no doubt that you would make a profit if you had to sell before that date, since interest rates were decreasing anyway. Today, fund managers have to work with derivatives to make a difference.
For example, try getting a decent return with a 0.92% yield on German bonds over 10 years. These types of yields do not reflect the economic reality at all, moreover, and not many market watchers realize how hard it is for insurers and other parties to meet those long term obligations and get some sort of a return. The central banks are pushing everyone to take risks, even the ones who do not want to take them. Warren Buffett recently stated in an interview on CNBC on the 2nd of October that he does not really understand global interest rates, but that he does not have to understand them. If Buffett already does not understand…
Is Gross preparing for the worst? Has he noticed that after 40 years of superior bond returns, his ‘Bond King’ empire is over with? He does not have to do it for the money: his 200 million dollar yearly salary plus bonuses will cover everything. Although the man tweeted on his 70th birthday that he was ready to add another 40 years, we doubt that the end of his career will play out on the bond markets.
Bill Gross’ departure is a game changer for the bond markets. Those who still expect decent returns for bonds are probably expecting deflation to hit. That is not what we, at Sprout Money, believe is going to happen. We expect for the cash that has been created over the last few years to find its way to the markets at one point or another. Most likely the money will not flow to the ‘old’ bull market, but to a new candidate that is yet to be selected. There are many options: stocks, gold, commodities, real estate... all alternatives the government cannot print more of. Position yourself in real assets and avoid the ‘confiscation certificates’, which is what bonds are at the current rates.
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