Bloomberg News

Pimco Shunning Longer Gilts Misses Dynamite Returns: U.K. Credit

May 01, 2013

PIMCO Co-chief Bill Gross

Bill Gross, co-chief investment officer of Pacific Investment Management Co. (PIMCO), said in an interview with the Financial Times published on April 22 that the U.K. and almost all of Europe had erred by believing that fiscal austerity would boost growth. Photographer: Andrew Harrer/Bloomberg

The world’s biggest bond fund is missing out on some of the best returns in global debt markets as it shuns the longest-maturity gilts, having branded Britain a “must to avoid” in 2010.

Investors buying U.K. government securities due in 10-years or more in January 2010 would have made a 43 percent return through yesterday, compared with 16 percent for global sovereign debt of all maturities, according to Bank of America Merrill Lynch indexes. Pacific Investment Management Co.’s Bill Gross said then that gilts were “on a bed of nitroglycerine.” The firm is still avoiding U.K. bonds due in more than 10 years, says Michael Amey, a London-based money manager at Pimco.

Britain’s debt outperformed Treasuries and German bonds since the end of 2009 as Bank of England purchases to stimulate the economy and a government pledge to tame the deficit enhanced their appeal as a refuge from the euro area’s financial crisis. While Gross said in 2010 the high amount of U.K. debt and the central bank’s ability to devalue its currency presented “high risks,” Chancellor of the Exchequer George Osborne says falling yields show market confidence in the government.

“They made this big call in 2010 that gilts were deemed to be nitroglycerine and of course since then yields have been falling steadily,” said Robin Marshall, a director of fixed income at Smith & Williamson Investment Management, which oversees about $20 billion. “We’re quite happy to hold 20-, 30- year paper. It’s hard to make an argument against gilts based on the fact they do have monetary sovereignty.”

Total Return

Excluding currency adjustments, only the government debt of South Africa, Hungary, Poland, Ireland and New Zealand has offered investors a better return since Gross’s comments, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. The South African securities returned more than 50 percent, versus 30 percent for the U.K.

Gross’s $289 billion Pimco Total Return Fund (PTTRX:US), the world’s largest mutual fund, outperformed (PTTRX:US) 82 percent of its peers in 2010 with an annual gain of 8.8 percent. The fund beat 30 percent of its rivals in the following year, and bettered 95 percent in 2012 when it returned more than 10 percent, according to data compiled by Bloomberg.

‘Real Yields’

Pimco does own British government bonds, preferring those maturing in five-to-10 years and 10-year inflation-linked debt, according to Amey.

“We have a relative-value view on gilts against other markets but we still own gilts,” Amey said in an interview in London on April 25. “There are parts of the world where real yields -- so, yield after inflation -- remain positive. We will allocate to those markets in preference to the U.K. and other developed markets.”

The 30-year gilt yield was at 3.02 percent as of 7:20 a.m. New York time, down from 4.41 percent on the day before Gross’s Jan. 26, 2010 comments. The average yield over the past decade was 4.19 percent and it reached a record-low 2.76 percent on June 1.

The so-called real yield on 30-year gilts, the yield after subtracting the consumer-price index, was at 0.21 percent today, compared with as high as 1.02 percent on Oct. 17.

‘Derisory’ Returns

“All these government bond markets suffer from the obvious fact that real yields are negative, that returns are derisory,” Kit Juckes, global strategist at Societe Generale SA in London said in a phone interview. “People may not like it, they might wish they could get higher yields, but if you’ve got lots of people who would like to buy at higher yields, eventually someone will just come in and buy anyway.”

Amey said he prefers the debt of Mexico, which has a 30- year real yield of about 1.08 percent, and Brazil. Pimco said April 24 that it reduced its holdings of Spain’s and Italy’s government debt starting in March after buying the securities last year. Spanish and Italian bonds generated returns of 14 percent, and 12 percent, respectively from August to the start of last month, according to the EFFAS indexes.

Baring Asset Management, which oversees about $50 billion, is concerned the outperformance of gilts may be drawing to an end, according to Dagmar Dvorak, the director of fixed income and currencies in London.

“Gilts have done really, really, well compared to other markets, but going forward we think that the market is expensive,” she said in a phone interview on April 29. “The long-term trend for yields in the U.K. should be going up. What we’ve done over the course of this year is switch some of our nominal holdings into inflation-linked bonds.”

Haven Appeal

The U.K.’s debt to gross domestic product ratio climbed to 90.3 percent last year from 79.4 percent in 2010, according to data published by the International Monetary Fund last month. That compares with 106.5 percent in the U.S. and 82 percent in Germany in 2012.

“I can’t promise the road ahead will always be smooth, but by continuing to confront our problems head on, Britain is recovering and we are building an economy fit for the future,” Osborne said on April 25 after data showed the nation escaped a triple-dip recession.

The chancellor, who is sticking with spending cuts to control Britain’s debt load, told BBC Television in December that low interest rates demonstrated investor confidence in the U.K. Gross said in an interview with the Financial Times published on April 22 that the U.K. and almost all of Europe had erred by believing that fiscal austerity would boost growth.

BOE Stimulus

Fitch Ratings cut Britain’s top credit grade on April 19, citing a weaker economic and fiscal outlook, the second company to do so within two months. Minutes of the Bank of England’s April meeting showed six of the nine policy makers saw risks to inflation expectations as weighing against further monetary stimulus after the central bank bought 375 billion pounds ($583 billion) of securities to push down borrowing costs.

Even so gilts have climbed since the downgrade by Moody’s Investors Service in February.

The securities remain a haven for investors amid concern that the euro-area recovery risks stalling and a new government in Italy may prove unstable, according to Sam Hill, a fixed- income strategist at Royal Bank of Canada in London.

“It’s certainly difficult to see such returns being repeated but the difficulty in the short term is that there is still an awful lot of risk aversion and an awful lot of asset purchases going on by other central banks,” Hill said in a telephone interview yesterday. “It’s difficult to say that there will be a reversal in yields any time soon.”

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net


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Companies Mentioned

  • PTTRX
    (PIMCO Total Return Fund)
    • $10.93 USD
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