October 11, 2011
Ranked 536/584 this year, PIMCO turns bullish on bonds after historic rally

536 out of 584.  That is the 1yr ranking of PIMCO’s Total Return Bond fund as of 9/30/2011 versus other funds in their Lipper intermediate grade fund group.  To put this in numbers, PIMCO is up 1.9% YTD versus the category average of 5.9%, all this during the biggest bond rally in history.  What is the most famed bond manager to do in light of this performance?

This afternoon’s news out of Newport Beach was nothing short of astounding: PIMCO raising effective duration of their $200+billion Total Return Fund up to 7.14.  Zero Hedge erroneously reported duration of 8.97, which is their weighted average maturity.  Categorically, the only major changes to PIMCO’s allocation was an increase in MBS from 32% to 38% and a further reduction of cash from -9% to -19%.  How did they accomplish this?

  • Longer MBS- They DIDN’T accomplish this by buying longer MBS.   In this prepayment environment, even low coupon 30yr passthrough such as a 30yr 3.5% pool has a duration no more than ~7-8.  This would only move the needle marginally.
  • Copying Gundlach?- Could they have taken a page out of Doubleline’s book by buying last cash flow, locked out CMO’s?  Possibly, but given the size of the fund, I find that it unlikely that they could add this type of CMO in any type of significant size.
  • Bond Swap?- This is the most likely reason.  I would venture to guess that PIMCO swapped out shorter term treasuries & IG credits for longer maturities.  Adding 30yr-ish bullets such as these would have the most impact of adding duration. Treasuries & IG credits are among the most liquid bonds, hence they’d be able to trade in enough size to affect a portfolio this large.

Did Gross & Co front run the Fed?  Doesn’t seem like it. 1 month return for PTTRX is -0.57% versus a positive 1.46% for the Barclays index.  In fact, given the recent backup in the 10yr (from 1.75%-2.15%), once could argue that PIMCO loaded up the boat with long bonds at a potential bottom.

It’s a bit premature to call a bottom on rates, and diminishing economic growth prospects coupled with the European crisis could prove these moves to be quite prescient.  What is known is clear however-  one of the most famous bond managers of all time, on the heels of atrocious relative performance, has just made a dramatic bet on interest rates continuing to stay low or go lower.  Poor short term performance or not, this view by PIMCO should open eyes to their apparent bearish view.

We’ll revisit this in the coming months, and for the sake of Mr. Gross let’s hope this decision ends being categorized as “better late than never” instead of one who mocked Netflix all the way up only to buy at $301.  Fun times we live in!

  1. economicmusings posted this
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