PIMCO

In light of Mr. Gross' earlier very humanitarian letter, we decided it would be sensible to demonstrate the holdings of PIMCO's flagship Total Return Fund (all 249 pages thereof) which at last check were just under $240 billion, and had a 4.92 effective duration. Setting aside Mr. Gross concerns for the broader society, we looked at what the suggested 300-400 bps adverse impact on just the the TRF's P&L would be: taking the $240 billion notional, and applying a 350 bps average hit to the fund's effective duration implies a hit of just over 17%, or a loss of about $40 billion. Assuming a comparable duration for Pimco's remaining $800 billion in AUM held in other vehicles, and one can see why Mr. Gross would be concerned about losing government backstops. We believe Mr. Gross may have forgotten to mention this slight tidbit from his letter. And for those who enjoy digging through letter appendices, oddly excluded in this case, here is the full breakdown of the TRF holdings.

In his latest letter, Pimco's Bill Gross explains why neither he, nor his fund, are some bloodthirsty vampire squid, monopolizing the bond market: all he wants is the greater social good, which can only be perpetuated by endless government subsidizes of the housing ponzi. What follows is truly entertaining: "Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending. The cost would be enormous in terms of yields – 300–400 basis points higher than currently offered, crippling any hopes of a housing-led revival to the economy. And why do I and PIMCO support this view? Is it some self-interested, money-making plot to allow us to dominate the bond market? Hardly. Any investor would recognize that it’s better to have a 6 or 7% yield instead of 3–4%, so it would be better for PIMCO to let the Administration flood the private market with non-guaranteed, private mortgage product and let us vultures feast on the pickins. No, the self interest rests on “Que” Street. If the housing market continues to be government dominated, then the points from originations and the fees for private insurance would all of a sudden disappear. The vested interest lies on Wall Street, not Newport Beach or Main Street." Of course, should the government go cold turkey on the housing ponzi, we leave it up to our readers to conclude what would happen to Pimco's over $1 trillion in rate exposure: here's a hint - a 300-400 bps drop in prevailing spreads will mean game over for the magnanimous Mr. Gross overnight. So yes, what's good for everyone (even as nobody really cares about rates with pretty much everyone paying down, not raising debt), just happens to be very, very, very, very good for Pimco. q.e.d.

Pimco's Total Return Fund has released its July portfolio composition. The most notable difference is the cut in US Treasury holdings from 63% (or $147 billion) in June to "just" 54% in July: an almost $20 billion reduction in UST holdings. And even as he cut his government holdings, Gross kept flat or added to all other asset classes, with MBS increasing from 16% to 18% of AUM, and EM holdings increasing to a record 11% of holdings. This is undoubtedly a function of his recently publicized interest in Brazil. The question is whether Gross' EM interest will suffer the same fate as his investment in non-US developed bonds, which peaked at 19% in February and has sine plunged to a low of 3% in June, to close July at 5%. More importantly, parsing through the fund's maturity profile, we notice that Pimco's holdings now have the longest duration they have had in at least two years, and possibly ever: just 20% of Gross exposure is in sub-3 Year maturity paper. Gross' current sweet spot is in the 3-10 year part of the curve, which of course makes all the sense for the man having made his career by frontrunning the Fed - let's recall where the Fed recently announced it would be focusing its Treasury purchases.... yep - precisely the part of the curve where Pimco now has almost 60% exposure. Good work, Bill.

For today's dose of "he really said it" hypocrisy, we turn to recent PIMCO addition, former bearded outdoorsman, Hank Paulson whipping boy, and creator of the TARP abortion, Neel Kashkari, who apparently felt it was his duty to join his colleagues in validating the New Normal (buy our BAB bonds pleeeez) and conforming to the firm's policy of bashing deficit and entitlement spending. In a brief oped likely written by his 2nd year analyst or executive assistant, titled "The Cultural Challenges of Entitlement Reform" the bald one says "bailing out the financial system went directly against our shared beliefs in free markets and fair play." Yes, you read that right. This is the same person who singlehandedly devised the biggest taxpayer blank check bailout to banks in history (until of course Europe had to bail out its own banking system two months ago, where incidentally, everything is peachykeen once again) as captured by the following email: "We have $11 trillion residential mortgages, $3 trillion commercial mortgages. Total $14 trillion. Five percent of that is $700 billion. A nice round number." In fact, let's continue: "Seven hundred billion was a number out of the air,” Kashkari recalls….”It was a political calculus. I said, ‘We don’t know how much is enough. We need as much as we can get [from Congress]. What about a trillion?’ ‘No way,’ Hank shook his head. I said, ‘Okay, what about 700 billion?’ We didn’t know if it would work. We had to project confidence, hold up the world. We couldn’t admit how scared we were, or how uncertain." Ah yes, an uncertain and scared then-35 year old bailing out the world... And now, a grizzled and veteran Kashkari, who certainly recalls his wood chopping days with joy at the PIMCO campfires, in which Build America Bond receipts are used for kindling, is encouraging the administration to cut the benefits of the same taxpayers whose money was used to prevent the insolvency of, among others, his current employer? Yes, ladies and gentlemen, we bring you today's unbridled hypocrisy courtesy of the latest and most worthless addition to the Pimco team.

A New Normal world is likely to
be one with frequent flips between “risk on” and “risk off” days. With
so much profit and loss riding on tail events and so little profit and
loss tied to the cluster of outcomes near ex ante means,
repositioning will likely be more frequent. This is because many
investors lack conviction in their understanding of the true
distribution, so that each passing day provides an opportunity to learn
or unlearn how likely the relevant tail events are. Positioning
for mean reversion will be a less compelling investment theme in a world
where realized returns cluster nearer the tails and away from the
mean. James Carville said twenty years ago that he
wanted to be reincarnated as the bond market because the vigilantes had
so much clout over policymakers. But in the New Normal world, he might
wish to be reincarnated as the Asian equity markets because they are
where traders in Europe and the U.S. look to see if it is a “risk on” or
“risk off” day. With so much money chasing fewer assets with known
return distributions, and with reliable investment rules of thumb
scarce, frequent flips between “risk on” and “risk off” days will likely
be a continuing symptom of the Knightian uncertainty that still, to
some extent, hangs over global financial markets.

- Richard Clarida, Pimco

As part of its Commercial Real Estate Project, PIMCO has conducted an extensive overview of opportunities in the U.S. CRE market. In this most perplexing of markets, where if one follows REIT stock prices, a V-shaped recovery is all but guaranteed, PIMCO has a notably less optimistic outlook. Based on the framework of its well-documented "new normal" paradigm, the Newport Beach asset manager is far less sanguine about investment opportunities in the market - in evaluating prospects for the most relevant CRE valuation metric, PIMCO sees a gradual return to 8% capitalization rates. "the market can expect long term cap rates near or above 8%. In this case, even if properties with floating rate debt can successfully avoid defaults in the short term, rising longer term rates will create a floor for cap rates and limit recoveries." On the other hand, extrapolating from current CMBS spreads, the prevailing market expectation is for a current and future cap rate up to 150 bps lower. Which means that as securities backed by existing assets see their cash flows dry out, as all valuable assets get extinguished, the repricing in assorted CRE fixed income securities, and their equity counterpartes in the REIT realm, will likely have a very dramatic downward repricing event in the future.

Earlier on CNBC, Pimco's Tony Crescenzi was discussing the NFP number, and trying to infuse calm in the market, which is to be expected: with Pimco way past the full-scale size at over $1 trillion in fixed income holdings, where it is the de facto market in the bulk of its products, and thus critically reliant on marginal price makets, any further disruption in market confidence may just result in a, gasp, down month for the TRF. Yet, while the agenda was clear, one of Tony's statements was blatantly false. "The money market gauges such as Euribor, the amounts of money deposited at the ECB, commercial paper market, etc, all of these have improved since May." Uhm... Tony, perhaps it is time to take another hard look at the monitors on "McCulley's moneymarket desk"-  perhaps you are just looking at the chart depicting popular trust in economic pundits on CNBC, which has, indeed, been flat at +/- 0.

Even as most asset managers experienced a devastating May, with many recording drops in AUM of -10% or worse, there is nothing that can topple the trillion+ bond giant out of Newport, which is so large it is now virtually the market in most of its product verticals. In the May performance report, of Pimco's flagship Total Return Fund, the fund's total assets grew once again, hitting $228 billion, an increase of $3.4 billion over April, and 45% higher than last year. Combing through the fund's holdings, the firm has now officially said goodbye to the "foreign developed" bond experiment, with non US developed holdings plunging by more than 50%, to just 6%, compared to 13% in April, and a high of 19% in February. The beneficiary of this adjustment were US bond holdings, which surged from 36% to 51% of all holdings, or a MOM increase of over $35 billion! This represents about a third of all (settled) US bond issuance in May. Who needs QE2 when you have Pimco. Another notable observation is that the fund is now once again acting on margin, with a -4% net cash position. The last time the fund was on margin was in October 2009. Lastly, TRS has been slowly shifting further out in duration, with holdings of 5 Year or longer maturing notes rising to 56%, compared to 51% in April, and a low of 8% in November 2008, just after the Lehman bankruptcy.

Just headlines for now, but rather self-explanatory, or should we say self-contradictory.

In the beginning of the year, Pimco became the biggest supporter of German Bunds, actively adding over $20 billion worth of German sovereign securities to Pimco's flagship Total Return Fund. Yet in our monthly update of TRF holdings, we noticed a material rotation out of Bunds and back into USTs: an over $10 billion reduction in non-US developed holdings. In a symbolic Q&A with Pimco Managing Director Andrew Balls, we read the confirmation for the change in strategy in Newport Beach that brought about this defection from the continent. It appears that the fund which in many aspects is now the defacto market in most forms of fixed income (especially Build America: Pimco would just love if you could buy some Build America bonds... from them) has realized that as the European wave of uncertainty migrates further toward the core, it could become among the largest bag holders of a rapidly depreciation asset class. As Balls says: "given the potential for eurozone governments or the ECB to be drawn deeper and deeper into providing support, we do not see German Bunds as offering significant advantages over the secular horizon compared with U.S. Treasuries." The time may be approaching when Nic Lenoir's thesis of shorting the Bunds may finally come to a profitable fruition.

In this brief interview with Morningstar, Doubleline's star MBS analyst, and the bane of TCW's existence, Jeff Gundlach, points out the glaringly obvious: i.e., that "if Citigroup was too big to fail, then so much greater is the risk for asset managers at a multiple of that market cap." Obviously the mortgage expert here is contemplating asset manager behemoths such as PIMCO and BlackRock, which have quietly become even more institutionalized within the fabric of the financial markets, than some of the TBTF banks. And without access to the Fed's discount window, liquidity threats to firms like PIMCO are exponentially greater than even for a bankrupt POS like Citigroup. No wonder Gross was offloading European sovereign debt with gusto as of last check. With total assets of over $1 trillion, saying that a failure by PIMCO, and by extension its Fed-unmoderatable counterparty risk, would have huge implications on the US financial system, is so obvious, that it is completely understandable that there is not one single provision in the Senator from Countrywide and the Congressman from Fannie's FinReg proposals on how to tackle this most recent threat to capital markets.

The April update for Pimco's Total Return Fund is out. The credit fund, which is now a quarter of a trillion juggernaut, clocking in at $224.5 billion, or $5 billion more than March, and 50% more than the $150 billion last April, has rotated aggressively out of non-US developed holdings (i.e. Bund and other exposure), and put the money back into the US. Total European holdings declined from $40 billion, or 18% of holdings, to $29 billion, or just 13%. At the same time, US holdings increased from 33% to 36%, or a $8 billion increase to $81 billion.Not too surprisingly, mortgage holdings are a scant 16% of holdings, compared to 86% in February of 2009. Is Pimco's European experiment over? Yet another bad sign for Bunds, which Pimco did a whirlwind tour pitching in early 2010 after it had established a position.

On August 9, 2007, game over. If you have to pick a day for the Minsky Moment, it was August 9. And, actually, it didn’t happen here in the United States. It happened in France, when Paribas Bank (BNP) said that it could not value the toxic mortgage assets in three of its off-balance sheet vehicles, and that, therefore, the liability holders, who thought they could get out at any time, were frozen. I remember the day like my son’s birthday. And that happens every year. Because the unraveling started on that day. In fact, it was later that month that I actually coined the term “Shadow Banking System” at the Fed’s annual symposium in Jackson Hole.

It was only my second year there. And I was in awe, and mainly listened for most of the three days. At the end, Marty Feldstein always does the wrap-up. Everybody wanted to talk. And since I was a newbie, I didn’t say anything until almost the very end. I stood up and (paraphrasing) said, “What’s going on is really simple. We’re having a run on the Shadow Banking System and the only question is how intensely it will self-feed as its assets and liabilities are put back onto the balance sheet of the conventional banking system.” - Paul McCulley

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PIMCO has released the March statistics of its massive Total Return Fund, which as od March 31 has grown to a massive $220 billion, an increase of $5 billion from the $214.3 billion in February. The YTD performance on the TRF is now 2.97%, and just like everything else in America has a short effective duration of just 4.81. It is stunning that one fund now has more in AUM than most countries generate as GDP. And this excludes the other $800 billion or so that the Bill Gross firm is managing in other vehicles. In terms of composition, there was little change in actual holdings: Government Relates Securities declined slightly to 33% from 35%, mortgage securities was virtually unchanged at 16%, the same as IG Corporates; High Yield is also a tiny 3% of AUM. The firm's rapid expansion in Non US-denominated developed countries has plateaued and declined by 1% to 18% in March. And cash increased marginally from just 2% in February to 5% in March. What is more interesting is the portfolio composition by maturity: Gross is starting to reach into the longer-dated side of the curve. The firm's holding of debt 3 year and longer are now the biggest since June 2009. The firm was not short any particular tenor: the last time it was short was in 2008 when Gross was shorting the 20+ year bucket.

A former Goldmanite who failed to bail out the world and was called a Chump by Elijah Cummings, proceeded to chopped down trees for kindling and fight off bears in the backwoods, is now stuck peddling a second-tier equity product for a bond fund. The world sure is messed up.