A Gross Miscalculation

Bill Gross is the biggest kahuna in the murky world of bonds. He runs the worlds biggest bond fund, the Pimco Total Return Fund (PTTAX), which manages over $240 billion in assets. The fund has 4 stars from Morningstar. When Gross talks about bonds, the market listens -- very carefully.

You can imagine the impact of an announcement by Gross in March, 2011 that he was eliminating government related debt altogether from the Total Return Fund. This was stunning news. The market wanted an explanation. Gross had one. He felt the yields on Treasuries were too low to sustain a demand for U.S. government debt. He advised investors to dump Treasuries and purchase debt from emerging-market nations. According to Gross, Treasuries needed to be "exorcised" from model portfolios.

In June and July, Gross reiterated his advice to dump Treasuries, using some colorful language to make his point. He noted that promises to America's ageing population made them "debt men walking."

The financial media was all atwitter. Headlines screamed "Gross dumps Treasuries." Many investors followed his advice and performed his suggested exorcism.

Fast forward to August, 2011. Gross now admits dumping bonds was a "wrong call." The U.S. economy grew more slowly than he anticipated, lowering the yield on Treasury bonds and causing the Total Return Fund to miss out on the rising market value of older fixed-rate Treasuries. Gross admitted his mistake, telling the Financial Times, "Do I wish I had more Treasuries? Yeah, that's pretty obvious."

Investors in the Pimco Total Return Fund have been impacted by this "mistake." The Total Return Fund recently ranked 501 out of 589 bond funds in its category. It has underperformed its benchmark index by 1.26 percent year to date. Gross had this response to the inability of his fund to beat a simple index: "When you're underperforming the index, you go home at night and cry in your beer... "It's not fun, but who said this business should be fun. We're too well paid to hang our heads and say boo hoo."

Investors may not be so sanguine. It was a Gross miscalculation, illustrating the vagaries of active management. Even the best and the brightest (Gross has a stellar track record) can get it wrong. If you are relying on brokers and active managers to "beat the markets" and "add alpha," you are gambling and not investing.

Dan Solin is a Senior Vice President of Index Funds Advisors (ifa.com). He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011. The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

 

 

 

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Comments

[bmora]

10:43 AM on 09/09/2011

Active Management is the crime of the century.

[sf omega man]

02:48 PM on 09/08/2011

You can't evaluate Gross's initial assumptions without accounting for the effects of the Federal Reserve monetizing the debt, and restructuring it's balance sheet to artificially skew the dynamics of the treasury market to support the long end in ways that the market has not seen before. This is not a market force, its a central bank intervention.

In order for Gross to be wrong (in the long term) we have to therefore assume that everything the Federal Reserve is doing under Bernanke will in fact be positive.

[flashrob]

08:21 AM on 09/08/2011

the FUTURE of INVESTING... what YOU SHOULD BET ON!

http://seekingalpha.com/user/107114/comments

FLASHROB

[flashrob]

09:01 AM on 09/08/2011

more on COMING MASSIVE INFLATION and "what to invest in..."

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_S/threadview?m=tm&bn=72878&tid=361883&mid=362062&tof=4&frt=2

flashrob

[flashrob]

09:11 AM on 09/08/2011

here's a better link, on the above...

http://bit.ly/qDvl8Z

maybe,

flashrob

[Caniculus]

12:48 AM on 09/08/2011

I am astounded that there are still investors who believe in the value of paper. For that matter, I'm astounded by investors who believe in the value of gold. Ye are men and women of illimitable faith. Let me know how that gold tastes spread across an invaluable stack of stocks or bonds.

On Reckoning Day, look me up if you want such cheap trivialities as peanut butter, canned tuna, beans, fish hooks, shotgun shells, Penicillin, or bottles of Scotch. You know as well as I do that it's coming to that. What will your fortune of paper or gold buy you then? In that near future, what will you pay, mate, for this bottle of Johnny Walker Black?

Peace. And good luck.

[Sundialsvc4]

03:12 PM on 09/07/2011

The key problem here, Dan, is that "the 'value of' Treasuries" can be, at least on paper, anything and everything that the US Treasury and the Federal Reserve want it to (appear to) be. Because it all revolves, and revolves exclusively, upon "borrowing from Peter to pay Paul, stipulating further that by definition you can never run out of new Peters."

But that "definition" is wrong. Maybe not on paper, maybe not in the "computers-feed-computers (very fast...)" world of technical high-finance, but certainly in the actual world of economics and business. The money to redeem these Treasuries isn't coming from economic activity: it is coming from the issue and sales of other Treasuries, literally a government-approved Ponzi scheme.

If the only litmus test that is to be applied is, "was the bond redeemed?", then by definition the Treasury Note is an irrefutable investment. However, if the question is extended to ask, "but where did the money to do so come from?"," it becomes a Ponzi fraud. Charles eventually ran out of suckers, but a Government cannot.

Or, can it? The Treasury Note has become an abstraction, literally "valuable because we say that it is," that is steadfastly walking against every other economic indication. What should the bond investor believe? The magic carpet that is flying high, or the solid earth below that is retreating?

[jcaunter]

08:09 AM on 09/07/2011

The value of all fiat currencies, and the assets denominated in fiat currencies, eventually goes to zero.

The only investments I am considering in these days of imminent global fiat destruction are physical gold, silver, rations, and solar panels. Stick to paper if you want; it'll just prolong the time that real assets will remain cheap for those of us in the know.

[mjk0259]

07:39 AM on 09/07/2011

One percent isn't much if you are a long term investor. Gross still has a pretty good record in bonds over long time periods. How an investment that yields 2-3% and could depreciate 80% rapidly when inflation comes back could be attractive is a mystery to me but I felt the same way when interest rates where 5%.