Q&A: WILLIAM H. GROSS: ‘IT’S PRETTY HARD TO LOOK AT A 5 3/4% LONG BOND AND THINK IT’S EXCITING’

Forget Agent 007, William H. Gross is the real Mr. Bond. As managing director of $100 billion Pacific Investment Management Co., Mr. Gross has been dubbed both the Warren Buffett and Peter Lynch of bonds. True to the comparisons, his flagship Pimco Total Return Fund became second in size only to Vanguard’s Institutional Index Fund during a period when investors shunned fixed income for stock funds.

Mr. Gross admits he’s a typical bond manager — “not a super-funny type of guy.” But he reveals a knack for storytelling — and an occasionally caustic wit — in his monthly investment outlook. He’s still puzzled about the uproar over an October 1996 outlook in which he said modern women needed men only to move furniture and described “lazy, slovenly, out-of-date bonds” as male and “energized, take-charge, in-control bonds” as female.

On a more serious note — by his reckoning, we’re coming off a 15-year bull market for bonds (yes, bonds) and the market appears to be reaching its zenith. Now the heat is on Mr. Gross to keep up his above-average returns.

The pressure to perform has intensified in the past few years and he admits it wears away at him. With apologies to Harry S.Truman, Mr. Gross says he’s been able to “stay in the kitchen.” But it’s a little warmer these days.

Q Do you think the bond bull market will continue as it has?

A No. The bull market started in 1981 with the long bond at 15%. Now it’s at 5 3/4%. So there’s no real way that we could duplicate that kind of bull market in the future simply because interest rates don’t go lower than zero. And there’s not that much more room to fall.

Q Does that mean the bull market is over?

A No, it simply means that bondholders have to be content with a lower rate of return. And it’s still attractive compared to a 1% to 2% inflationary world.

Q Would this make investors even more reluctant to invest in bonds?

A The argument holds for stocks as well. When you have such a low inflationary environment it
‘s hard for corporations to increase their profits at the same rate that they have for 15 years, and my expectations for stocks would be quite similar to expectations for bonds. It’s just that at the moment, the public, and maybe financial advisers as well, continues to expect unreasonable returns from stocks. As long as they do that, you’ll have an inherent prejudice toward stocks as an investment vehicle and bonds as a second-place stepchild.

Q How do you think stocks will perform?

A I think stocks are going to return, on average, 7% to 8% over the next few years and bonds will be in the 6% to 7% category so they’re both quite close in their expected returns as far as I’m concerned.

Q Do investors consider bonds boring or are they just misunderstood?

A Both, I think. First of all, the public just doesn’t understand them. In my book, I tried to make it as easy as possible to understand. I even had what I think is the simplest example to use: the interest rate teeter-totter, showing bond prices on one side and interest rates on the other. But it’s still very difficult for investors to understand this. And for a public that’s become used to double-digit returns of the stock market, it’s pretty hard to look at a 5?% long bond and think it’s exciting in any form or fashion.

Q Which sectors of the bond market do you like now?

A At the moment, I like old-fashioned U.S. Treasuries, not because they yield the most, but because they yield the least. We have the Asia situation and potential for a Fed easing at some point based on that and a slowing economy. During those periods, Treasuries tend to do the best. Corporates, because they’re slightly more risky and they’re not rated triple A for the most part, tend to underperform during these periods of time — as do mortgages, which are now encountering this refinancing phenomenon.

My sense is that the best portion of the yield curve is the seven-to-eight-year maturity because it yields quite close to what long bonds do and would benefit, probably, the most o
n a relative basis if the Fed eased sometime in 1998. That doesn’t mean we don’t own long Treasury bonds nor does it mean we don’t own one- to two-year Treasury notes. But I would focus the brunt of our current strategy on what we call the middle of the curve.

Q Any from the international side?

A I think the United Kingdom is quite attractive. The U.K. has a strong currency and fairly low inflation and their interest rates are 100 basis points higher than in the United States. So we have some decent investments there, as well as in Australia and New Zealand.

VITAE

William H. Gross, 53, managing director, Pacific Investment Management Co., Newport Beach, Calif.

Pimco Total Return: Institutional assets: $14.79 billion; retail assets: $318.5 million.1-year return retail shares 10.94%; 1-year return institutional shares, 11.46%; 3-year annualized, 11.29%; 5-year, 8.37%.

Pimco Low Duration: Institutional assets: $2.78 billion; retail assets: $97.7 million. 1-year return retail shares, 7.66%; 1-year return institutional shares, 8.16%; 3-year, 8.68%; 5-year, 8.37%

Lehman Brothers 1-3-Year Government Index: 1-year, 7.16%; 3-year, 7.13%; 5-year, 5.49%.

Lehman Brothers Aggregate Bond: 1-year, 10.74%; 3-year, 10.17%;5-year, 7.35%

Data are as of Jan. 31.

Source: Morningstar Inc.