By Dan McCrum and Michael Mackenzie in New York
Bill Gross has made a big U-turn in the investment strategy of his $242bn fund after a high-profile bearish call on the US Treasury market backfired, triggering deep underperformance by the world?s largest bond fund.
After largely exiting US bond markets in February on fears of a spike in inflation, the Pimco bond manager has reversed course, placing a big bet on lower long-term interest rates that radically shifts the composition of his fund.
The move, revealed by Pimco this week, comes after a humbling year for a fund manager often feted for his investing acumen and influence on the bond market.
His flagship fund has produced a return of just 1.9 per cent for its investors so far this year, leaving him ranked 552 out of his 604 peers according to Lipper, a research house. By comparison, the Barclays US aggregate bond index has returned investors 6.7 per cent year to date. The latest bet on lower long-term rates represents a bold call by Mr Gross. These rates have been rising recently in spite of the US Federal Reserve?s so-called Operation Twist, an intervention in bond markets designed to lower them. As yields rise, the price of bonds fall.
Bond managers typically follow the Barclay?s index, which consists of Treasuries, mortgages, corporate bonds and other fixed income securities. Having underweighted the Treasury component of the Barclays index and trailed its return so far this year, Mr Gross now appears intent on outperforming this benchmark via a heavier weighting of long-term debt. Bond managers can influence their portfolio performance by adjusting its duration, a measure of a fund?s sensitivity to changes in interest rates. Expressed as a number, it shows the percentage gain or loss for the portfolio for a 1 per cent move in bond yields.
Barclays? US aggregate bond index currently has a duration of 5. An investor who is bearish on bonds would structure their portfolio to have a duration lower than the index they benchmark, the approach taken by Mr Gross earlier in the year, when he turned negative on US Treasuries and reduced his duration to 3.6.
However, the strategy backfired as prospects for economic growth dimmed and investors rushed to the safety of government bonds.
Now, the Total Return fund has a duration of 7.6, indicating a view that interest rates will fall, pushing up bond prices. The average bond fund duration of 4.8 is slightly bearish versus the index, according to Lipper. The yield on 10-year Treasuries dropped to 1.77 per cent, a 65-year low after the news of the Twist, but has subsequently climbed to 2.21 per cent, its highest level since the end of August.
? The Financial Times Limited 2011