Thursday, December 22, 2011

Pre-mature To Dance On The Gross Grave

    Being that Bill Gross and the PIMCO Total Return Fund (PTTDX) represent a large portion in two of my three models, I find the need to defend Mr. Gross and his fund’s 2011 YTD performance.  I find it hilarious that a defense needs to be made, but it seems society is eager to tear down anyone who has been successful in the past.
    A big deal has been made of the fact that Gross miscalculated (for a very short period of time) earlier this year by betting against a rally in U.S. Treasuries.  This admitted misstep has been well covered in the financial media and has left the PIMCO Total Return Fund trailing many of its peers YTD.  Or has it?  Who exactly is a total return bond manager’s competition?  While the headlines are fun to read, they show a complete misunderstanding of the total return approach to investing in bonds.
    The main problem I see with managers within the total return bond sector is that they are automatically lumped in with other funds based upon their current portfolio weighting. Yes many of these funds, based upon their current positions, could be viewed as short-term government securities funds, but in reality they offer so much more with a tremendous amount of flexibility.
    A total return investing approach to bonds means that the management team is focused on the overall performance of a bond.  This means both the price and the yield of the bond are factored into total performance measures.  Unlike corporate bond, municipal bond and U.S. Treasury bond funds that have to invest specifically within those sectors, a total return bond manager is not handcuffed by these restrictions.  Good total return bond managers will try to position their portfolios in bond securities that they feel offer the potential for the highest total return on investment.
    Do you think a high quality corporate bond fund manager was happy that he or she had to own corporate bonds in 2008?  I’m sure they saw risk all over the bond horizon but there was not much they could do about it because they were mandated to own corporate bonds.  In 2008, the average corporate bond fund lost 15% of its total value, and the average municipal bond fund lost 10%.  In that same year Gross guided the PIMCO Total Return Fund to a gain of 4.48%.  The total return approach gave Gross the flexibility to avoid areas of the bond market that others could not.  Again, not all of the others are bad managers, but they simply had to stay within their sectors.  I have a large amount of respect for the management team of the Loomis Sayles Bond Fund.  The fund was down almost 22% in 2008.  Not beause the managers stunk but because there was not much they could do when the sector they invest in was out of favor.
    Sometimes the best offense is simply a good defense and that is why I prefer the total return approach to owning bonds within a strategy that deploys tactical allocation.  I want a manager that can focus on total return and capital preservation, and has the ability to sit on a tremendous amount of cash.  Not being mandated to invest a minimum percentage of your portfolio in a specific sector (ex. corporate bonds) gives these managers that ability.
    While everyone is eager to compare the PIMCO Total Return Fund to government securities funds let’s remember that is not accurate.  How did Gross achieve such outperformance in the last decade?  It certainly did not come from owning treasuries.  In fact, if we could look back 11 years ago at the fund it would most likely resemble a corporate bond fund.  As the Fed raised rates aggressively in 2000 to cool down the economy, Gross began buying a tremendous amount of high-grade corporate bonds.  As it turned out the Fed overshot and rates have been coming down ever since.  That decision provided a large amount of appreciation for the fund.  While Gross was able to lock in these gains and go to cash, corporate bond fund managers watched their portfolio values rise and then comeback down because of their mandates.
    My theory is that when someone has earned the title “Bond King”, and did not have it handed to them, then I would like that person to manage my bond assets.  So before you decide to dance on Gross’ early grave, ask yourself why it makes you feel good to do so.  We are talking about a mutual fund and a manager that is still up 3.14% YTD.  If you are living in a “what have you done for me lately” world then you need to take the blinders off.  Bill Gross’ risk vs. reward returns over the last 3, 5 and 10 years are still unmatched.
    Go ahead and bet against the “Bond King”, but if you do, I would suggest getting some pretty favorable odds.  It is a bet that I am smart enough not to make because I understand what I own and why I own it.

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”