Bond King's big debt bet is on the mark, rivals say
By Jennifer Ablan
NEW YORK (Reuters) - With his 67th birthday just weeks away, the investor widely known as the Bond King has taken one of the biggest bets of his life -- but at least Bill Gross has got some company.
Gross' decision to dump all the U.S. government debt holdings at his $236.9 billion PIMCO Total Return fund <PTTRX.O> could be defining, either confirming him as one of the smartest investors of his generation or badly tainting his reputation.
He may also be taking a political risk whatever the outcome by making an extreme call against the U.S. government because of its worsening budget deficit and debt problem, especially given the fund still owns debt issued by Brazil, Spain and other foreign governments.
But Gross - who helps oversee $1.1 trillion as co-chief investment officer at Pacific Investment Management Co. - is far from alone among the titans of the American bond world.
Even some of his fiercest rivals acknowledge that Gross, whose flagship fund has performed better than 93 percent of its intermediate investment-grade peers over the last three years, may have got it right.
The U.S. budget deficit and soaring debt burden, together with the Federal Reserve's effective printing of money through its so-called Quantitative Easing bond buying program, are seen by Gross and Fuss as undermining the U.S. dollar and having an inflationary impact.
That in turn will undermine the value of government debt and push up yields as investors demand more compensation for risk.
"My guess is that rates will go up for a very long time with cyclical interruptions. Yes, we bond managers may buy opportunistically, but that doesn't change the underlying trend of higher rates," Fuss added.
"REASONABLE AND BALANCED"
The bearish bond fund managers have been buying inflation-proof assets such as emerging market stocks, bonds and currencies, and U.S. stocks exposed to commodities. The picks play on solid growth in countries such as Brazil and China.
Among the other major bond market players who have hit the sell button on U.S. debt in recent months are TCW's Tad Rivelle and Wells Fargo's Margaret Patel.
"I think it seems like a reasonable and balanced decision by Bill," Patel said of his big debt bet. "The biggest risk to his call is if Treasury yields plunge and he loses the capital appreciation. When you look at where Treasury yields are sitting coupled with inflation creeping upward, to me, that is a small opportunity cost that he is paying."
In a sign of how bearish Gross has become, he raised his cash and cash equivalent holdings to 23 percent as of February 28. from 11 percent at the end of January.
Patel said, "I think this is the biggest sea change we are seeing in our careers. For the last 30 years, all bond managers have known is relatively high yields and capital appreciation."
"Bonds have had it so good for so long," she added.
Over the past five months, worries over the ballooning U.S. budget gap estimated at $1.645 trillion for 2011, political stalemate in Washington over how to narrow it and inflationary fears have all contributed to a steep sell-off in Treasuries.
What's more, Gross has raised red flags over demand for Treasuries when the U.S. central bank ends its controversial Quantitative Easing program.
Indeed, Gross recently said that he views Treasury yields as perhaps 150 basis points too low, given expectations for nominal GDP growth.
That would put the yield on the benchmark 10-year note at about 5 percent, up from 3.40 percent currently and its lows of 2.39 percent in October 2010. Yield moves inversely to price in the bond market.
MORE YOGA, SOON?
Five years ago, Gross had endured some bad, highly visible calls for Federal Reserve rate cuts that proved a year too soon. He also passed over a bull market in junk bonds, sensing big trouble on the horizon. Together, those two convictions drove his fund to its worst ranking in a decade in 2006.
There are also those who have chosen to ignore Gross' latest announcement altogether.
"I don't know anything about (his fund). All I know is what I read in the newspapers." said Jeffrey Gundlach, chief executive of DoubleLine Capital and recently anointed by Barron's as the "new" Bond King.
He said U.S. Treasuries have the potential to rally over the short-term and that the end of the Fed's $600 billion program of purchases, expected in June, is already priced into the bond market so that yields will not change "one bit."
Even Gross' remaining bond holdings -- in such areas as mortgages and corporate credit -- are in much shorter-term maturities than usual, another sign of his bearish thinking related to longer-term prospects of much higher inflation and interest rates.
Eric Jacobson, director of fixed-income research at Morningstar, said after careful examination of the PIMCO Total Return fund, the fund's overall duration appears to be 3.9 years versus 5.1 years for the Barclays Aggregate, the U.S. bond market's benchmark index.
"That's a 1.2 year difference - or about 23.5 percent short of the Aggregate. That's pretty unusual, even for Gross," Jacobson said. Duration is a bond's sensitivity to interest rate fluctuations, and going short duration is an investment strategy when rates are expected to rise.
TCW's spokesman said while it has no comment on Pimco and its portfolio, Rivelle, the firm's chief investment officer of fixed income, said: "We do not believe that Treasuries represent good long-term value and have been de-emphasizing Treasuries and shortening our portfolio durations."
(Additional reporting by Al Yoon; Editing by Martin Howell)