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Gross: It's Been a Fixed-Income Decade

Eric Jacobson

Eric Jacobson: Hi, I'm Eric Jacobson with Morningstar. I'm a director of fixed income research. I'm here today with Bill Gross. Bill is the co-CIO at PIMCO, and he's also the manager of PIMCO Total Return. In fact, he's also nominated for the 2009/2010 fund manager of the decade.

Bill, thanks very much for joining us today.

Bill Gross: Thank you, Eric, for coming this far at this time.

Jacobson: It's good to see you.

The decade, let's talk about that for a second. A lot has gone on, a lot has changed. How has managing a fund like PIMCO Total Return--which as we all know is a very large fund. How has that evolved over time and what has it meant for the way you manage it?

Gross: Well, it's certainly gotten larger. In my office I have a copy of the day three years ago when Total Return turned $100 billion. I've got a new copy of the day that it turned $200 billion. So in three years, doubled the size, $100 billion on top of $100 billion. So it's been significant.

Actually the decade has been one in which funds have seen their glory, out-performing stocks in terms of total return, depending upon your category, I suppose. But it's been pretty much of a fixed income decade from the standpoint of interest rates coming down and many of the positive aspects of bonds, the higher income, et cetera, moving to the bottom line.

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It's been a decade too, as you know, in terms of the economy, where we've had two bubbles. We had a significant dot-com stock market bubble, then a housing bubble. And here we are perhaps in the midst of a third, in terms of the government checkbooks and the expansion of balance sheets that are attempting to support the asset markets. And to this point doing a pretty good job.

Jacobson: You mentioned sort of the second bubble period. I'm thinking about the fact that that was such a critical time, not only for everyone else in the system, but if you think of PIMCO Total Return and the money you manage.

We're getting to point where managing that size of money, I'm sure, becomes harder and harder in some ways. Yet you were able to sort of anticipate events with the team and all the research they do.

Talk to us a little bit about that and what that was like from a managerial perspective, coming into the crisis and the things that you learned and were working on. And then the transition to this--I know we're still in the crisis--but sort of a post-downturn period in terms of the market, and how you've been able to do what you've done this year.

Gross: Sure. I'll try. [laughs] That's a mouthful.

Jacobson: It is a mouthful.

Gross: PIMCO has been helped throughout the entire period, but certainly during the second bubble, by our top-down kind of thinking. Mohamed [El-Erian] and Paul McCulley in our investment committee has been significant in avoiding some of the pitfalls in the housing-related markets, and then taking advantage of the some of the dynamics in the bond market as yield curves have steepened and short-term rates have dropped dramatically.

PIMCO has been able to take advantage of that. At the same time I think we've had an excellent bottom-up contribution from our specialty desks, whether it's mortgages or emerging markets or government or derivatives. And all of them combining for a top-down/bottom-up type of recipe that has produced rather consistent alpha in Total Returns over the 10-year period of time. So we're very proud of that.

In terms of today's marketplace, we've got a sense that perhaps the hardest question to answer has to do with how appropriately valued the bond market is. Certainly from the standpoint of government bonds and the lower Fed Funds rate at, that zero percent rate, which would indicate--as Bernanke testified--that you can't go any lower.

And wondering when that moves higher, when sovereign credits, Treasury bonds, begin to under-perform as opposed to outperform. And much of that has to do, I think, with some of the recent programs, not just Fed programs, what they call "quantitative easing programs," where the Fed has written a trillion and a half dollars worth of checks for mortgages and agencies and so on.

And trying to analyze the importance of that in terms of its compression of interest rates and its elevation, therefore, of bond prices is a difficult task, but one that we're trying to zero in on at our investment committee on a day-to-day basis.

A quick conclusion would be that probably as much as 50 basis points of compression if you had a 10-year Treasury, for instance, at 3.75. We'd probably say that 50 basis points compression, in other words, 4.25 to 3.75 has been due to simply that the check-writing ability of the Fed through mortgages and agencies and Treasuries.

So we would be a little cautious at this point, as they're trying to phase out of that dynamic over the next three months.

Jacobson: And is anything at this point still looking particularly attractive in terms of valuation?

Gross: What we're trying to do--and this is where a big firm and a big fund, the Total Return fund at $200 billion, can really move pretty deftly. We're thinking rather than Treasuries that there are other points of the globe, there are other economic specialty centers.

On the one end, one we particularly like is Germany. And in the ECB's monetary policy as opposed to the Fed's, less inflationary, less quantitative easing, and therefore less compression. And so the shift from Treasuries to bunds is something that can't be accomplished in a day, but it's something that in a few weeks period of time, a month period of time, a month and a half, we can move from our significant overweight of Treasuries into a decent weighting of Germans bunds.

Because in our opinion it's a much more stable fiscal situation, a much more stable monetary situations, and probably a better credit, to tell you the truth, than the U.S. Treasury. And so the theory has it, the basis of a new strategy for PIMCO Total Return that can be done quicker than most skeptics would give us credit for.

Jacobson: Great. Thank you very much. We appreciate you spending the time with us today.

Gross: You're welcome. Thank you, Eric