Wisdom from the Bond King
When Bill Gross tweets, investors listen. After getting his start playing blackjack in Las Vegas upon graduation from Duke University in 1966, Gross turned to investing, and over the last 40 years has made a name for himself as a prescient strategist and market mover (not to mention an avid yoga enthusiast and stamp collector). Today, Forbes estimates his net worth at $2.3 billion and puts him at No. 206 (in a 12-way tie) on its list of the country's 400 richest people.
Since 1971, Gross, 68, has deftly steered PIMCO, the Newport Beach, Calif., investment firm that he cofounded and where he is currently co-chief investment officer, overseeing some $1.8 trillion in assets. He manages PIMCO Total Return Fund, the world's largest mutual fund and a stalwart of the fixed-income world that has returned more than 7.3 percent annually over the past 15 years, helping to earn Gross the unofficial title of "bond king." Gross recently spoke with U.S. News about what he sees as a "new normal" for the markets and for investors. Edited excerpts:
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What have you done that has accounted for the Total Return Fund's impressive and continued success?
To be fair, the near double-digit returns are a function of falling interest rates more than anything else. It's sort of like a teeter-totter; when interest rates go down, prices go up. So the Total Return Fund, [just] as all bond funds, has done well in part because interest rates have gone down, down, down. We've also outperformed the [investment-grade bond] market by close to 2 percentage points a year. Individual strategies in terms of trading hopefully account for the track record. That leads, I guess, to another question: Can those returns be duplicated going forward?
I imagine that's on a lot of investors' minds. What should they expect?
You start with the obvious: The Federal Reserve has lowered short rates to close to zero. The investment-grade bond market, which includes treasuries and corporates and mortgages, all in one big pot, yields 1 3/4 percent. It's hard to manufacture near double-digit returns from that. It's the metaphorical concept of squeezing juice out of an orange; almost all of the juice has been extracted, so to speak.
So investors looking for a repeat of historical performance are bound to be disappointed, and that's why I wrote several months ago--which caused a ruckus in the market--about the [dying] cult of equity. It was the same thing with the cult of bonds, the "cult" meaning that there was a belief that historical returns could be projected into the future. They can't. They can't for bonds and they can't for stocks either, in my opinion.
The PIMCO Total Return Fund starts with a universe that yields 1 3/4 percent. If we can outperform the market by 1 to 2 points a year and things stay the same, then investors can get a 3 to 4 percent type of return. But they shouldn't expect a 6 or an 8. A 10 percent return, it's nearly impossible, at least from a generic [investment-grade] type of universe. We can speak to high-yield and we can speak to opportunities elsewhere, but they, of course, involve risk-taking. [Now we are concentrating on] more short- and intermediate-term bonds, mainly mortgages and, in some small percentages, bonds in Italy and Spain.
What's your economic forecast for the months and year ahead?
In terms of economic growth, PIMCO originated the famous phrase the "new normal." That was us three years ago, and it's the same today: The growth is much slower than what it was, not just in the U.S., but in Europe, obviously, and even in China. That's because in 2008 the world was too highly levered and ever since it's been in the process of de-levering, which means that consumers and businesses cannot take on the same amount of debt that they did in the past. Don't think that anytime soon we're going back to the "old normal" because these cycles of de-levering are biblical in nature.
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An investor probably has to look forward to higher inflation. Slower growth and higher inflation--that's not a positive, by any means. Individuals would want it to be just the reverse. The de-levering and the check-writing on the part of central banks, that's really what produces the situation.
Are you worried about debt in the United States and Europe?
Slow growth and inflation have a tendency to accompany large deficits and increasing debt as a percentage of GDP. Unless we begin to reverse that course, we could resemble Greece within a decade.
So where are the investment opportunities for individuals?
Both from the standpoint of stocks and bonds, an investor wants to go where the growth is. There are countries that should grow faster than Euroland countries, and countries that should grow faster than the United States. They would be the big obvious ones: China and Brazil, and even Mexico.
In terms of the bond market, there are opportunities in what are known as closed-end funds, [which issue a fixed number of shares and] trade like stocks. The magic to them is that many of them are slightly levered: They borrow basically at zero percent or close, and then reinvest back into their asset class. Municipal closed-end funds with bonds that yield typically 4 to 4 1/2 percent can be turned into a 6 to 7 percent tax-free investment on the basis of this borrowing and the mild leverage. Many PIMCO funds, many BlackRock funds, many Vanguard--they're all over the place--you can buy them at 6 percent yield, tax-free, and they provide the opportunity for investors to get those historic 6, 7, 8 percent returns that I said at the beginning were not available through generic types of investments. So I say buy these closed-end funds, because they yield 6 to 7 percent and there's basically the same risk as in the generic universe.
The Total Return Fund holds a hefty percentage of mortgages. Several years before the subprime mortgage crisis, you seemed to see it coming and time your moves accordingly. How do you do it?
PIMCO's foundation is one that attempts to analyze what we call the secular outlook, which means, for us, the next three to five years. When it came to 2007 and 2008, we were exploring the long-term metrics of housing and debt accumulation.
One of the things we did in 2006 was we took 10 of our credit analysts that were analyzing individual companies and we turned them into real-estate buyers. We said, instead of visiting Coca-Cola and IBM, we want you to go to Las Vegas and to Miami and to Des Moines and to Cincinnati. Get us an on-the-ground feel for what the housing market was doing because we were suspicious of many of the things that were taking place. [As a result, we] sold lots of lower-quality bonds in anticipation of a large recession. It was just a common-sensical shift, I guess, from corporate credit to exploring the housing market.
So I think why PIMCO's been successful has been, one, we look at the longer term; and two, we just employ a lot of common sense, with an understanding that things don't go on forever. The critical element, of course, is how do you know when? The fact is that nobody knows when. So far, so good, I guess.
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Is that kind of combination something that investors should really take to heart?
Oh yeah. An investor has to have a longer-term view and shouldn't be day trading the market. It just can't be done. Returns are not what they used to be.
Because of that, they've got to watch their fees. If you're in a 4 or a 5 percent world and you're paying 1 percent or whatever it is that you're paying, that's my point. You can't afford to give much to the manager. Make sure that your fees are reasonable relative to the returns and make sure that you're looking at long term and forget about the day trading. It only makes money for Wall Street as opposed to Main Street.
Do you invest this way yourself?
The closed-end funds that I talk about, I own bunches of them.
The older you are the more bonds you want, and the younger you are the more stocks you want, but personally I've got about 50-50 in terms of a mix. The stocks I own, I make sure that they're relatively high dividend-yielding--I want a 3 to 4 percent dividend. If your reader is 30, then I'd say own 80 percent dividend-yielding stocks and 20 percent bonds, and vice versa for somebody that's 75. Hopefully that makes a lot of money. Or at least a little.
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