On April 19, three weeks before he said the 30-year bull market in bonds was over, Bill Gross announced he was buying TIPS—Treasury Inflation-Protected Securities.
In doing so, the bond guru bet that money printing by the world’s central banks would push up consumer prices. While the price of conventional Treasuries subsequently fell as he had predicted, so did the market’s fear of inflation, driving down the value of TIPS. That amplified losses for Gross’s $268 billion Pimco Total Return Fund (PTTRX), which fell 4.7% in May and June, prompting $9.9 billion in withdrawals last month, the most on record.
The losses highlight the difficulties Gross faces as he steers Pacific Investment Management, the investment firm he helped found. With $2 trillion in assets, Pimco is arguably up against the biggest market challenge since its inception in 1971. Gross has had 9% to 12% of Pimco Total Return’s net assets invested in TIPS since at least the end of 2011, convinced that efforts by Federal Reserve Chairman Ben Bernanke and other central bankers to stimulate their economies will ultimately fuel inflation. TIPS were the biggest factor in Pimco Total Return’s losses in May, according to Eric Jacobson, an analyst at Morningstar. Gross didn’t respond to requests for comment.
Rival Jeffrey Gundlach, head of the investment firm DoubleLine, has avoided TIPS, which he called a “disaster” and a “trap” during a webcast in late June, because he sees no sign of inflation. Gundlach’s $38 billion DoubleLine Total Return Bond Fund (DBLTX) lost 2.6% in the two months through June and is down 1.3% this year, beating 80% of similar funds.
TIPS guard against inflation because the principal value of the bonds is adjusted every six months to keep pace with consumer prices. One way to measure the market’s view of inflation is to compare the yields of Treasuries and TIPS. The wider the gap, the higher the market’s inflation expectations. Although yields on Treasuries have risen since May, when Bernanke raised the possibility of slowing the Fed’s monthly bond purchases, yields on TIPS have risen even faster. (Bond yields rise when prices fall.) As a result, from May 1 to June 24, the gap between 10-year Treasuries and 10-year TIPS narrowed to 1.92 perccentage points from 2.34, before widening to 2.08 on July 8.
The narrowing showed that investors viewed inflation as less of a threat and were cutting the price they’d pay for insurance against it, according to Daniel Shackelford, a fixed-income portfolio manager at T. Rowe Price. “Inflation expectations haven’t budged after three or four years” of the Fed’s efforts to stimulate the economy, says Shackelford, who runs the $496 million T. Rowe Price Inflation Protected Bond Fund (PRIPX). When the Fed started talking about slowing its bond purchases, he adds, “it was sort of the worst news that the TIPS market could receive.” TIPS funds fell an average of 7.2% from the end of April to June 28, more than double the 3.3% decline in the Barclays U.S. Aggregate Bond Index, a fixed-income benchmark, according to Michelle Canavan, a mutual fund analyst at Morningstar.
Gross made a bad bet on Treasuries almost two and a half years ago. In February 2011 he eliminated his allocation to Treasuries, only to miss out on a rally in government bonds that left Pimco Total Return trailing 70% of its peers. Gross, in a letter to clients at the time titled Mea Culpa, called 2011 a “stinker.” His fund lost an estimated $5 billion to withdrawals that year, according to Morningstar. Pimco Total Return rebounded in 2012 to beat 95% of peers and has outperformed 91% of rivals over the past five years, according to data compiled by Bloomberg.
So far, Gross is making no apologies for his bet on TIPS. In a June 6 interview on Bloomberg TV he said that with the economy remaining weak, inflation will be contained in the short run. Even so, he said, “trillions of dollars of check writing” by the Fed and other central banks will fuel rising prices over the next three to five years.
