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By Jason Stipp | 03-09-2011 03:00 PM

Gross Zeros Out Exposure to Government Debt

Morningstar analyst Eric Jacobson digs into the details of PIMCO Total Return's move away from government securities and outlines where Bill Gross has been putting money to work.

Jason Stipp: I'm Jason Stipp for Morningstar.

News stories surfaced on Wednesday that bond king Bill Gross made a big move out of U.S. Treasuries in his Total Return Bond Fund.

Here with me to offer some context on this story is Morningstar's Eric Jacobson. He is director of fixed-income research and also the Morningstar analyst who covers the PIMCO Total Return Bond Fund. Thanks for calling in, Eric.

Eric Jacobson: Glad to be here. Thanks Jason.

Stipp: So there were some news stories that Bill Gross had gotten rid of all of his U.S. government securities, but the actual story is a little bit more nuanced than that regarding the portfolio change that he made. Can you explain exactly what's going on there?

Jacobson: Sure, so anyone who has been following PIMCO Total Return or Bill Gross' writings knows that he is relatively negative on U.S. Treasuries, and has perhaps become more so as of late.

So this is little bit of a furtherance of a trend that we've seen in how he's been managing the portfolio in terms of exposure to Treasury bonds, and in fact his latest commentary does talk about the difference between what he perceives as the current yields available on Treasuries and what they probably ought to be given expected levels of economic growth and, ostensibly, inflation.

However, what we have right now and what happened today really is that some news started to roll around the market that he had been completely sold out of Treasuries, and lot of people took that to mean that he was so determined to avoid them that he had literally wiped them out of the portfolio, which isn't exactly true.

In essence the portfolio as PIMCO calculates these things has no market value exposure to government, either to Treasuries, government agency bonds, or in TIPS. But in fact that is a combination of the fund actually owning some TIPS (Treasury Inflation Protected Securities), some U.S. government agency bonds--3% each, in fact, totaling about 6% of the total market value--but then also using some swaps that move in the opposite direction essentially as a hedge against interest rate risk to essentially zero out the way that they calculate the market value exposure. So if you just look at the totals, it looks like zero, but in fact it's broken up with a couple of parts.

Stipp: So, Eric, is there effectively any difference between a portfolio that's sold all of its U.S. government securities and one that has a zero market exposure as you are explaining? Would there be any situation where those two portfolios would behave differently, all else equal?

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