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Bond baron Bill Gross delivers fat returns
Pimco's founder and chief investment officer has become the Peter Lynch of the bond market, making money for his shareholders year in and year out. But his fund isn't for the risk-averse.
By Timothy Middleton
Bill Grosss office couldn't have been used by the Gordon Gekko character in the movie "Wall Street." Its far too modest, on a low floor of a squat office building and barely large enough for his desk and a couple of chairs. Its also 3,000 miles west of Wall Street, in Newport Beach, Calif.
Yet William H. Gross is one of the most important people in the securities business. He's manager of the nations largest actively managed mutual fund, Pimco Total Return (PTTRX), which has assets just shy of $70 billion. He's founder and chief investment officer of Pacific Investment Management, the nations premier fixed-income investment house, with assets in excess of $300 billion.
Hes not in this business for the trappings, Eric Jacobson, senior analyst for Morningstar, says of the 58-year-old Gross. I think he really stays in the game for the joy of the competition and the craft of examining the world and making money doing it.
Grosss 30-year investment record sets him so far apart from his peers that, to turn a familiar comparison on its head, famed money manager Peter Lynch could be called the Bill Gross of equities. But Gross rarely receives such public accolades, because bonds are boring.
Treasurys dont have stock-option plans, or managements that talk about their prospects on CNBC, says Jim Grant, editor of Grants Interest Rate Observer. They dont split 2-for-1, or do a lot of the other things that make stocks so telegenic. But they dont go down 20% a year, either.
Stepping into the light
But if the bond markets lack of glamour has hidden Grosss light under a bushel, the bear market in stocks has taken it off. Last year, Total Return shot up 10.2%, well above the funds 10-year average of 8.3%, which was enough to make it the No. 1 fund of its type in the industry. In the three years ended Dec. 31, Total Return beat the stock market by more than 25 percentage points annually.
By the same token, Gross admits the salad days are over for Treasury bonds, and the great bull market in them that began 20 years ago is ending. If so, their prices could be forming a bubble that higher interest rates will pop -- possibly leaving todays bond investors splattered with red ink.
Gross speaks so softly that he cant be heard above the hiss of the tape recorder I used during a recent interview in a conference room just off the Pimco trading floor at The Beach, as Pimco followers refer to the companys headquarters. (Theres nothing wrong with the machine; on the tape, I sound like Foghorn Leghorn.)
But the investment community is only too happy to lean closer when he talks. In January, he published a column arguing that the grand scheme of things called for a lower dollar. News wires seized on the comment and the dollar fell 1% against the euro.
Last year he questioned General Electric's (GE, news, msgs) balance sheet. Though he was talking about the companys debt, its stock came under immediate attack, and finished the year at nearly half the level it was in the first quarter.
Indeed, in 1997 he wrote a book, "Bill Gross on Investing," which gave five specific investment recommendations:- Lengthen bond maturities
- Invest in emerging markets debt and equity
- Buy mortgage bonds
- Buy Treasury Inflation-Protected Securities (TIPS)
- Sell stocks
But except for emerging markets stocks, which have done worse than the U.S. stock market since then, all of these ideas were long balls, and talking down stocks was a home run.
Drawing criticism
Some of his calls have attracted critics. For instance, Slate wrote in September about Gross's call that stocks were overpriced. The online magazine, which like MSN Money is owned by Microsoft (MSFT, news, msgs), asked why a bond-fund manager was making a call on stocks. Its answer: To attract more investors to bonds.
I always take what he says regarding equities with a grain of salt -- after all, hes a bond manager, says Harold Evensky, an investment adviser in Coral Gables, Fla. Evensky himself believes stocks are still overvalued. Still, he thinks Gross may be overstating the case. I dont think thats a reason not to be in the market.
Gross is a one-time psychology major who taught himself to count cards and, after graduating from Duke, turned $200 into $10,000 playing blackjack 16 hours a day in Las Vegas. He then went off to become a Navy pilot in Vietnam, but found he didn't like to fly, and ended up snaking around Vietnamese rivers in a boat.
He also discovered hes not good at handling the myriad details that separate a pilot from a bus driver. Im more of a conceptual person, he says. Self-knowledge is rare on Wall Street: Jesse Livermore, the most fabulous stock speculator of the fabulous 1920s, attributed his success to knowing his own limitations better than his rivals knew theirs.
If you know your weaknesses, you can adjust, says Gross, who keeps a picture of the owl-eyed speculator in his office. One weakness he admits is usually being early in making macroeconomic calls, which are the ones that have made him and his customers successful.
Comparing his instincts to a clock that signals the ideal buying opportunity at 6 oclock, he says his own alarm goes off around 4:30. Knowing that, he steels himself against acting immediately on his instincts, instead waiting for time to ripen.
It's a losing battle
He also learned another Livermore lesson: Dont fight the tape. Gross is a bolder investor than most bond managers, willing to make big bets on changes in the direction of interest rates and other market conditions. But if his bets misfire, he adjusts.
Going into the middle of 2001, Gross was overweight in mortgages, says Morningstar's Jacobson. Total Return was lagging the intermediate-term bond category. Everybody was wondering, 'Is this going to be the year he finally underperforms?' says Jacobson. "Then he put on an aggressive interest-rate bet in the middle of the year, the fund rallied back hard, and he turned in a great record for the year."
Gross was a, and possibly the, pioneer of boosting fixed-income returns by actively trading the portfolio. He entered the business in 1970, when inflation was just beginning its historic roar. Bond prices were dropping 20% a year, he recalls.
He wanted a stock-analyst job, but wasnt offered one, so he took a job in an insurance companys vault supervising clerks who clipped coupons. That was bond investing in those days -- you bought a bond and put it in a vault for 30 years, he says.
Gross quickly comprehended that this classical approach had been overtaken by events.
Fortunately for him, his employer, then called Pacific Mutual Life Insurance, wanted to offer investment services and was willing to indulge his bold ideas. Pimco was born in 1971, and within four years had grown its initial stake to $40 million from $5 million.
Gross became the cowboy of the polo grounds. In two consecutive years he posted 18% returns, while the rest of the bond market was slouching toward Gomorrah (in memorable words used by Robert Bork in a different context).
A bond bull market
And then, when Federal Reserve Chairman Paul Volcker tamed inflation and launched a bull market in bonds that has continued for more than two decades, Gross really prospered. Since 1973 his portfolios have delivered average annual returns of 10.6%, Pimco claims.
Gross was and is iconoclastic. He wears designer ties, but doesnt tie them, instead draping them around his collar. He dresses up for Mass on Sunday, but thumb wrestles with his son if the homily bores. He calls himself a publicity hound, but gives white-knuckle interviews, shy as Garrison Keillor.
If a single word could be used to describe Gross, it is focus. He spends an hour a day doing yoga, sometimes sweating on his head under the tutelage of a former Marine. At his desk on the Pimco trading floor, surrounded by a forest of Bloomberg and other computer terminals, he sits as erect and unmoving as a mantis, only his head slowly pivoting as it follows his gaze around the screens. (Gross, also mantis-like, is extremely tall, well over six feet, and rail-thin.)
Pimcos few score of analysts and portfolio managers aid his concentration, and their own, by being quieter than visitors to J.P. Morgans library. Gross demands the same intensity of his workers as himself. Outside Pimcos windows, just beyond the palm trees of the Newport Beach Country Club, is the brilliant blue Pacific, and Santa Catalina Island 26 miles away. But Grosss back is to the view, and nobody else is gawking, either.
Those analysts and managers pick the individual securities that comprise Pimcos 35 bond funds and its far larger institutional portfolios. Gross is the big-picture person, what Wall Street calls a top-downer.
Into the distance
He says he tries to look out three to five years, as far as anyone could confidently hope to project current trends, to discern the likely direction of securities, and especially bond, markets. His current view isnt much different than that of 1996, except he would shorten maturities and be more open to corporate, especially junk, bonds.
Treasurys have had their historic run, he says, and face long odds from here, with interest rates much more likely to rise than fall. We are in a low-return world, he says. Forget fastballs you can hit out of the park: Our job is to accept the pitch, even if its a curve ball.
If stock returns average in the 7% range in the coming decade, as Warren Buffett predicts, bond funds will become increasingly attractive to investors. Already they are attracting more new money than stock funds, although the latter continue to have far more in total assets.
Nobody in the fund business is better prepared to benefit from this trend than Pimco. Uniquely, Gross has twice been named Morningstars Fixed Income Manager of the Year. (Journalists get so few opportunities to use the word unique.) Barron's magazine calls him the Baron of Bonds.
And Gross shows no signs of giving up the game. He is three years into a five-year deal with Allianz (AZ, news, msgs), the German insurance company, which paid him a quarter-billion dollars for his Pimco shares when it bought the company, plus a signing bonus to stay on as chief investment officer at $40 million a year.
A violator
But that doesnt mean Gross is necessarily your cup of fixed-income tea. For one thing, he violates the same kind of business-school orthodoxy that condemns equity stars like Buffett and Lynch to be considered statistical freaks -- Managers we dont think can bring a lot to the table on interest-rate plays and macro calls, says Morningstars Jacobson. We look much more for individual security selection and measured bets.
What Gross brings to the table, in short, is more risk than a plain-vanilla bond fund. High returns really do involve (relatively) high risk. Pimco Total Return is more volatile than the typical bond fund, and conservative investors can find that distressing.
You have to sell down to the sleeping point, says Gross, quoting another of his market heroes, Bernard Baruch. Total Returns worst three-month period ever occurred between February and April of 1994, when it shed 4.8% of its shareholders principal. If you cant stand that thought, you belong in a different fund.
What he's buying now
Pssst: Gross almost never gets a chance to give hot tips, but heres one: Buy emerging-market debt. The reason: The developed world, aghast at the violence deflation has done to the Japanese economy, has committed itself to forcing higher prices. Commodities take off in a reflationary environment, Gross says, and many developing nations depend on them, such as coffee in Brazil. Also, weakness in the dollar -- its down 20% in the last 10 months -- makes it easier for them to service their debt, much of which is denominated in dollars.
At the time of publication, Timothy Middleton owned shares of Fremont Bond Fund, which is also managed by Gross.
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