Bill Gross Treasury Scare Illustrates the Problem of Predicting Bond Markets

The man is nearly synonymous with actively-managed bond investing, and arguably with good reason: his Total Return Fund has hundreds of billions of dollars under management, has done very well overall and Bill Gross also makes a point of being vocally opinionated about equity and bond markets (and is thus frequently found on the front pages of financial newspapers and magazines). But even the bond guru himself is not always right – in fact, as a recent example shows, he can be wrong at the worst of times.

In May and June of 2011, it was hard to find anything Gross had to say that didn’t involve warning people away from US Treasuries. And, in a sense, his predictions bore fruit: at least one ratings agency has since downgraded US debt from an AAA to an AA+ rating – ironically, however, this just sent people into a panic, which, in turn, sent them to (you guessed it) the warm comforting arms of United States debt securities. So in the sense of what you should or should not have bought, he could not have been more wrong.

Now, let us not be hasty – it is all too easy to see in retrospect that when Quantitative Easing, round two, ended the markets might turn fearful and want to hold more in cash and Treasury notes, bills and bonds … but no one could have known what would happen with certainty ahead of time. The point is not that he got it wrong and we could have guessed or estimated (let alone predicted) better, but that a wise investor takes a balanced approach, and never banks heavily on their own opinion (educated or not) about the direction of markets, particularly in the short term when anything can happen.

Everyone has their own reasons for wanting bonds in a portfolio, but given their limited upside compared to stocks, for many passive investors the core reason is safety vis a vis predictability and volatility. In other words: many people hold bonds not just for total return but to have something that zigs when the market zags. And while PIMCO’s long-term track record is relatively good on the former count, it is less ideal on the latter – when worry started to take over the markets, Gross’s fund fell rapidly behind, ranking in the 500s of less than 600 bond funds in annual performance. In the end, he grudgingly admitted he was wrong, but that is little consolation to those who counted on him to be a level-headed captain through the storm … and who would have been better off sticking to a long-term course of holding a combination of assets, including safe bonds, all along.

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