Investors in U.S. Treasuries are being lulled into a false sense of security by positive returns this year because yields aren't high enough relative to inflation, according to Bill Gross.
Bond investors face a similar fate as a frog that remains in a pot of water while the temperature is gradually increased — until the amphibian is cooked, said Mr. Gross, who oversees the world's biggest bond fund at Pacific Investment Management Co. LLC.
Inflation erodes the value of the fixed payments of bonds over time.
“Much of the Treasury yield curve now rests in negative territory when compared with expected future inflation, and that should send our bond investors into a hopping funk,” Mr. Gross wrote last week in the monthly investment commentary he posts on Pimco's website. “Prices are already nearing the boiling point.”
Treasuries have returned about 2.6% this year. As of April 30, Mr. Gross had reduced government and related debt in his $243 billion Total Return Fund to -4% of assets.
Countries such as the United States are intentionally keeping interest rates low to help reduce record debt levels, he said.
The fund has returned about 0.56% in the past month, lagging behind the performance of 77% of its competitors, according to data compiled by Bloomberg.
“Bond yields at least have a mathematical zero bound below which they cannot journey for more than a few nanoseconds,” Mr. Gross wrote. “Monetary policy in developed countries has been lowering the temperature and absolute level of yields for the past two and a half years, post Lehman Brothers [Holdings Inc.].”
REAL YIELD
The
Federal Reserve has kept its target rate at a record-low range of zero to 0.25% since December 2008 to help stimulate growth in the face of the worst
recession since the Great Depression.
Yields on 10-year notes fell below 3% last week for the first time since December after ADP Employer Services reported that U.S. companies added fewer jobs last month than economists had forecast. With the consumer price index rising 3.2% on an annual basis in April, the benchmark note offers investors a so-called real yield of -0.2 percentage points.
Mr. Gross recommends that investors buy “cheap bonds” and focus on “safe spread,” or buy more floating and fewer fixed-rate notes. Investors also should add credit components that may include investment-grade, high-yield, nonagency-mortgage or emerging-markets sectors and increase the nondollar-emerging-markets-currencies portion of their portfolios, he wrote.
TOTAL RETURN FUND
The Total Return Fund Ticker:(PTTAX) has returned about 8.13% in the past year, beating 78% of its peers, according to data compiled by Bloomberg.
Mr. Gross, the founder and co-chief investment officer at Pimco, has averaged returns of 8.93% annually over the past five years, topping 98% of his competition.
The fund can have a negative position by using derivatives or futures, or by shorting. Shorting is borrowing and selling an asset in anticipation of making a profit by buying it back after its price has fallen.
The firm's U.S. government-related debt category can include conventional and inflation-linked Treasuries, agency debt, interest rate derivatives, Treasury futures and options, and bank debt backed by the Federal Deposit Insurance Corp., according to the company's website.
Pimco, a unit of insurer Allianz SE, managed $1.28 trillion of assets as of March 31.
