Bill Gross has gone on the attack in his latest war reference-laden investor note as the bond star fights to defend his asset class against the advent of a new era for alternative assets.
The manager of the $267 billion PIMCO Total Return bond fund used World War I’s Battle of the Somme as the starting point of his August investor note.
‘Now that bonds have suffered a near Somme-like defeat in the past few months, fixed income investors are concerned about their prior conceptions of bonds as an asset class.’
With low yield and negative 3-4% two-month return for bond indices, investors are wondering if the bond has given way to the alternative asset of a new era, says Gross.
Although his group’s strategic execution in May/June was openly criticised and publicly faulted, Gross says there is a way for bonds to win the war.
‘All investments, bonds included, have a number of modern-day weapons at their disposal which can be used to defend against higher interest rates, weapons that don’t necessarily go down in price as yields rise. These weapons can collectively be categorized as “carry.”'
All bonds, he says, have carry in the following form: maturity risk, credit risk, volatility risk, curve risk and currency risk.
The question is how much carry should a portfolio manager hold for their clients today relative to their desired indices?
‘If capitalism is faltering (recession) in developed/developing economies and yields are close to the zero bound, then portfolios should have less carry than before. If prospects are mediocre, portfolios should be overweight carry.’
‘If prospects are very bright, they should again be underweight bond carry. If we can be mindful of this, and accurately forecast it, we will be successful.'
‘This may be the most important conceptual change I have ever written about in an Investment Outlook. Readers who have stuck with this Outlook at least to this point have a scoop, if not a magic feather.’
The necessity to adapt to the advent of the alternative asset era and also be mindful of bonds' evolution has never been so important, according to Gross.
‘Know that maturity extension worked well for 30 years and will work less well with yields close to zero.'
‘Know that there are other weapons at your disposal, but they too contain risk and their combined carry is itself probably the most critical variable in future asset return wars.'
‘And know that bonds – while containing a certain amount of maturity risk by very definition – will never be antiquated.’