In Part IV of the series of interviews PIMCO’s acclaimed and widely cited fund manager Bill Gross gave to Morningstar, Gross explains that in the current climate managing a bond fund with the objective of beating inflation calls for an investment strategy which is less constrained in terms of selecting bond duration. Bill Gross spoke to Morningstar’s Director of Fixed Income Research Eric Jacobson shortly before S&P downgraded its rating for US sovereign debt. See Part I: Treasuries’ Risk-Reward Balance Is Off and Part II: Better Sovereign Debt Opportunities Outside US, and Part III: Bond Investors' Menus Need to Expand.
Eric Jacobson: As you know, there is this space of, as PIMCO calls it, the unconstrained bond space. A lot of firms are using similar terminology. Just to make the comparison, Total Return last I saw, as you said, was on an overall basis short of its benchmark in terms of duration but not certainly down in the zero range.
And even though I know PIMCO Unconstrained Bond hasn’t been either, I guess the question that is probably on lot people's mind is, if you were just going to sort of clean slate go into the bond market today, because you wanted bond exposure--and you don’t have liability-matching need or some other issue to deal with--does that imply that you would favour a fully unconstrained strategy, or do you think that there is still some value in having couple of years of duration in your portfolio?
Bill Gross: Not for the Total Return fund. I mean it's $236 billion. It’s a bond fund. And it doesn’t mean it can't become less constrained, that’s how I like to describe it now. It’s a little too long; unconstrained sounds better than less constrained. If the total return fund were less constrained, it would simply mean, like I spoke to a second ago, the duration is not the dominant characteristic. It's less constrained and we have multiple choices, so I'd call less constrained. I mean to move to the zero-bound in terms of duration or even negative, speaks to a hedge fund. This is the premier bond fund in the world, by far in terms of assets. And so, we can't change its character, but we can make it less constrained in terms of duration.
At the same time, we have to be mindful that investors want what they characterise as a yield or that they want a return from this fund. I mean if it simply went to a zero-duration without any credit risk, it would yield 25 basis points and investors should go home, or take their money to the bank. Its not enough. So, the total return fund has to be less constrained duration-wise, but still provide a yield or a prospective return that investors are comfortable with relative to inflation.
At the moment, for instance, the Total Return fund yields 5.46% with perhaps a year or a year and half less of duration than a typical index. So that would mean like three and half years or so. So, it's not radically changing its character because it knows that investors want a return. But they also should want less risk from the standpoint of duration, if in fact, yields do go higher and we have a bear market.
And so, that’s what the Total Return fund is. It's really a less constrained durational fund, but at the same time mindful that what we want to do is provide 5%-5.5% yields or returns to investors, and have them beat inflation going forward. If we can't beat inflation for investors, and if we by some reason should have a succession of years with negative types of returns, then it loses its lustre. So we have to be mindful of that.
