Our Masters of Finance series continues with Bill Gross, the talented fund manager the media has dubbed ‘The Bond King’. Unlike other Masters of Finance including Berkshire Hathaway’s Warren Buffett and former Legg Mason Chief Investment Officer Bill Miller, Gross stands out in the rather mundane world of fixed income.
With a career spanning four decades, Gross has developed an almost cult-like following. His market insight is followed by thousands of loyal investors through his monthly newsletters where he muses on esoteric topics (this month he talks about the sun swallowing Earth).1
Despite ditching the trademark mustache he donned for decades, he remains one of the most recognizable figures on financial news networks and is often featured in periods around the Federal Reserve’s policy decisions.
At age 71, Gross, now worth almost $2 billion, shows no signs of slowing down.2
Originally from Ohio, Gross received an undergraduate degree in Psychology from Duke University, and later went on to receive an MBA from UCLA in 1971.3 After a few more years, he was awarded the CFA (Chartered Financial Analyst) designation. With the current debate being whether to pursue a CFA or MBA, some ambitious professionals, like Gross, decide to get both.
But Gross learned about risk management with real money as a professional blackjack player in Las Vegas. After graduating from Duke, and armed with $2,000 in his pocket, he left for Vegas and was eventually playing blackjack and counting cards for 14 hours per day.4 He reportedly did quite well, but left for the financial world anyway. Today, Gross’s outside interests are a bit tamer, often philanthropic in nature. Gross is also an avid stamp collector and is reportedly one of only three collectors with a completed 19th century U.S. postage stamp collection.
Gross co-founded the Pacific Investment Management Company, PIMCO, in 1971 with $12 million in assets.5 The firm has always had an air of rebellion in it, and its corporate headquarters in Newport Beach, California, not Wall Street, attest to this. Today, PIMCO is a prominent investment management company handling assets for millions of clients.
PIMCO is best known for its flagship Total Return Fund, one of the most popular widely owned mutual funds in history. The fund is comprised of various classes of fixed income instruments, mostly bonds. But the fund’s golden era was probably last decade. This was the period when Bill Gross was named Fund Manager of the Decade (for the 2000s), by Morningstar.6 Over that stretch, the Total Return Fund returned 7.7% (40% higher than their category average) making investors $47 billion richer.7 Chasing returns, the fund became increasingly offered in corporate 401k plans (today it is the second most popular mutual fund in American 401k plans).8 As the fund’s track record continued to outperform the assets under management ballooned and Total Return became the largest bond mutual fund on the world in 2013 when its assets peaked at $293 billion.9 The Total Return Fund was in such demand that it also created a tracking exchange traded fund for increased access.
It should be noted that Gross also managed five closed-end funds at PIMCO, their ‘High Income Fund (PHK), Corporate and Income Opportunity Fund (PTY), Corporate and Income Strategy Fund (PCN), Income Strategy Fund I (PFL) and Income Strategy Fund II (PFN).10 Closed-end funds are investment portfolios that trade all day on an exchange, where the net asset value of the underlying securities can deviate from the price quoted on the exchange. These funds Gross managed averaged annual returns ranging from 23%-30% while Gross was at the helm.11 Gross acts more like an owner and less of simply a fund manager. Gross personally owned close to 3.4 million shares of the PIMCO Corporate and Income Strategy Fund he ran, engendering loyalty amongst investors.12
His profitable record reportedly came from foreseeing what other bond managers missed. Gross made deft yield curve bets, betting one way on longer duration (maturing) bonds and the other way on short to intermediate maturity bonds. Gross later made money trading against the U.S. dollar in 2006 and exited before the dollar soared as a safe haven during the crisis. One of Gross’s biggest wins came during the throws of the 2008 financial crisis when he upped stakes in agencies Fannie Mae and Freddie Mac, predicting that they would be bailed out, which they were. Another reason for Gross’s success is the ability to see value during chaos. Following the financial crisis, Gross also bought auction rate preferreds at ‘fire-sale prices’.13 A strong track record brings in new flows of capital and PIMCO’s total assets under management swelled to over $2 trillion in 2014. But nobody’s perfect and Gross was vilified in the media for missing the massive moves in U.S. Treasuries that began in 2011 with the Federal Reserve’s QE program.14 Right or wrong, Gross never shies away when asked his opinion on the state of the economy or markets.
All good things must come to an end. A public feud between Bill Gross and other high ranking executives at PIMCO eventually led to Gross’s departure in 2014. The specifics of the situation are still debated. Gross is attempting to recoup hundreds of millions of dollars he believe is owed to him by PIMCO.15 Nervous investors started draining funds out of PIMCO with their “King” no longer on the throne. January saw $1.1 billion leave the fund through outflows. February shed another $600 million, leaving the fund with $88 billion under management at month’s end. The fund has returned just 0.34% after fees through this time period, trailing its benchmark which returned 2.1%. While still large, the Total Return fund is now just one third its former size.16
The Move to Janus
Following Gross’s departure from PIMCO, he landed at Denver-based Janus Capital Group where he currently runs their $1.47 billion Global Unconstrained Fund. This is a natural fit where Gross is free to explore any opportunities he sees fit and invest in it (i.e. unconstrained”). Assets have continually flowed into Janus as Gross supporters move to invest with the bond king once again. At Janus, Gross is employing a strategy that worked well for him at PIMCO, personally investing in the funds he manages. He reportedly placed $700 million of his own money into the unconstrained fund he runs.17
What Does he See Now?
Today, Gross demonstrates a very cautious stance and in his March newsletter warns of the risks in negative yielding sovereign debt (bonds of foreign governments).18 Globally, there is now over $7 trillion in bonds with negative yields.19 Most investors in these bonds aren’t planning on holding the negative bonds until maturity, which would guarantee them a loss, rather they are looking for capital appreciation as the bond prices rise, sending yields further into negative territory.
In case rates increase, Gross suggests fixed income investors look at bonds with shorter maturities which are less sensitive to moves in interest rates. Remember, bond prices and interest rates move inversely. For a bond with 5 years remaining until maturity, a one percentage point increase in interest rates should result in a 4.4% decrease in your bond’s price. But for a bond with 20 years remaining until maturity, that same one percentage point increase in rates should result in a decrease of 12.6% in your bonds price.20 As you can see, the longer the time until maturity, the more sensitive bonds are to interest rate movements, in this example almost three times as sensitive. This makes sense since there are now more attractive interest rates in the market for investors, making your bond with the lower yield look relatively less attractive. And it will look increasingly less attractive the longer the maturity. Conversely, if rates decreased it would magnify the gains in your bonds price, all else equal.
Gross also alludes to how sensitive bond prices are to interest rate changes starting at today’s historically low levels. He warns the annual income received when an investor buys a 30 year United States Treasury bond with a 2.5% yield can be wiped out with a quick 10 basis point move in the bond’s price.21 The lower the level of interest rates, the larger the percentage losses will occur from a given interest rate increase. Always consult your financial advisor before making any investment decisions since investors risk preferences and time horizons can be drastically different.