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Pacific Investment Management Co.’s Bill Gross said investors should embrace a defensive strategy because of the limits of zero-bound interest rates and systemic debt risk in global financial markets.
“An instant replay of these past few decades would have shown that accelerating asset prices weren’t due to any particular wisdom on the part of academia or the investment community but an offensively minded Federal Reserve and their global counterparts who were printing money, lowering yields and bringing forward a false sense of monetary wealth that was dependent on perpetual motion,” Gross wrote in a commentary posted on Newport Beach, California-based Pimco’s website today.
Emphasize income, de-emphasize derivative structures that are fully valued and be willing to accept returns lower than historical averages, Gross wrote. The period of muted growth in developed economies, high unemployment and orderly deleveraging Pimco dubbed the “new normal” in the aftermath of the 2008 financial crisis is morphing into a world of credit and zero- bound interest-rate risk, Gross said last month.
“The offensively oriented investment world that we have grown so used to over the past three decades is being stonewalled by a zero bound goal-line stand,” Gross, the founder and co-chief investment officer of Pimco, wrote today. “Investment defense is coming of age.”
After saying that the rally in Treasuries was over and eliminating Treasuries from his portfolio last year, Gross has boosted the proportion of U.S. government and Treasury debt in his $250.5 billion Total Return Fund (PTTRX) to the highest level since July 2010. In January, he raised the holdings to 38 percent, while increasing his portion of mortgage debt to 50 percent, the highest since June 2009.
The Total Return Fund has gained 2.82 percent this year, beating 95 percent of its peers, according to data compiled by Bloomberg. The world’s biggest bond fund has returned 6.44 percent over the past 12 months, placing it in the 48 percentile, according to data compiled by Bloomberg.
Treasuries with maturities from five to seven years have been the focus of purchases with longer-term debt unattractive due to risk of a pick-up in inflation, Gross said in an interview Feb. 3 on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. The Fund increased its allocation of Treasury Inflation Protected Securities, or TIPS, to 8 percent, Gross said that day.
“Leveraging has turned into deleveraging,” Gross wrote today. “Fifteen percent yields have turned into zero percent money.”
U.S. debt entered a bull market in the 1980s, after Federal Reserve Chairman Paul Volcker raised interest rates to as high as 20 percent to tame inflation. In the years that followed, inflation and interest rates declined, pushing up bond prices, which move inversely to yields. The 10-year Treasury yield, which reached a high of 15.8 percent in September 1981, fell to a record 1.67 percent on Sept. 23, 2011. The 10-year note yield fell two basis points today to 1.90 percent.
The Fed cut rates to zero to 0.25 percent in December 2008 and pledged in January to keep the target rate at or near zero until at least late 2014.
“It is Main Street that has failed to keep up with Wall Street and corporate America in the race to see who can benefit more from lower yields,” Gross wrote. “As the interest component of personal income gradually weakens, the ability of the consumer to keep up its frenetic spending is reduced.”
Pimco, a unit of the Munich-based insurer Allianz SE, managed $1.36 trillion of assets as of Dec. 31.
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