It’s hard to overstate the consequences of Bill Gross’s departure from Pacific Investment Management (ALV:GR). First came the withdrawals—more than $500 million from Pimco’s Total Return Exchange-Traded Fund alone—then a rating downgrade from influential fund analyst Morningstar (MORN), which cited capital outflows and uncertainty about new management. Not good.
At the same time, Gross, as an investor, stumbled in the months leading up to his abrupt exit. He made some notably bad bets, and in the last year his Total Return Fund returned 3.3 percent, significantly behind the 4.2 percent returned by Barclays’s (BCS) U.S. Aggregate Bond Index.
Gross certainly had many years of stellar performance. The Pimco Total Return Fund was supposed to provide bond exposure and a higher return than its index, and by most measures it achieved this. The figure below shows the fund compared with its benchmark since 2004:
According to Morningstar, if you invested $10,000 in Pimco Total Return in 1987 and let it ride, you’d have $81,000, compared with just $60,500 if you invested in the index. In 9 of the last 14 years, the fund handily beat its benchmark.
It’s a rare manager who can deliver such consistent market-beating returns. Gross’s success, however, also coincided with one of the best times in history to be a bond investor. Since the start of Total Return, in 1987, bond prices have almost always gone up. Prices kept rising, and most bond investments did well; Gross did better by investing in riskier bonds.
To some extent, that strategy undermines the point of investing in bonds in the first place. Many investors hold bonds because they provide diversification from stock market risk. Estimates from Morningstar suggest that relative to a bond index fund, Gross’s Total Return Fund is twice as likely to move in tandem with the Standard & Poor’s 500-stock index. Since the financial crisis, that spread has only widened—from 2009 to today, Pimco’s fund returns began to more closely resemble the S&P 500. (The opposite happened to the Total Bond Fund offered by Vanguard: It now moves inversely with the broad stock market.)
It’s less clear how Gross would fare in a shakier bond environment. During his tenure at Pimco there were only two periods of sustained, large rate increases (1993 to 1994; 1998 to 2000). In each, the Total Return Fund was much less impressive, with returns similar to or worse than the index.
No one knows what the future holds for the markets, or for Gross at his new firm. He’ll certainly be managing less money, which will give him more flexibility. He’ll also be trading against his former colleagues, which could give him a tactical boost. The question is whether those advantages will offset the structural change in the bond market that many believe is under way: The Fed claims it will raise rates eventually, and more Americans are retiring. Perhaps Gross’s secret sauce won’t work so well when rates go up.
