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Gross Zeros Out Exposure to Government Debt

Jason Stipp

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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Jacobson: It's a lot less so in this case than a bunch of other scenarios that I could name for you, because you are talking about things that are very, very close to plain-vanilla Treasuries. There is a little bit of a difference, potentially, because in theory agency bonds don't have to move exactly with Treasuries, and, though I am not actually certain down to the security level which kind of swaps they are using, it's possible that they are hedging out a lot of nominal, as we call it, interest rate risk of those TIPS bonds, but still maintaining some exposure to the inflation adjustment. So, it's possible that they could act a little bit differently, but we are talking about something really on the margins here, and in fact this is probably, in a net way, kind of a value play on those particular bonds; whereas, he is of course somewhat negative on the entire government bond space.

And in fact when you look at what we call the duration-weighted exposure to these sectors, you will find that he is actually very negative on Treasuries overall, and in fact, oddly enough, the number that hasn't been cited by too many people, but which is arguably even more stark and noticeable, is that as a percent of duration, in other words, the duration-weighted exposure as we say, government-related securities are actually minus 14% in this portfolio at the end of February, which is reflective of that very negative sentiment. And then when you look at the overall interest rate sensitivity in the portfolio, it's almost about 24% shorter than the Barclays Aggregate benchmark that everybody uses, and so that's a pretty strong statement.

Stipp: Interesting to note that this is a continuation of a trend that we had seen and an elaboration on what he's been saying and what his views have been on the U.S. Treasury market. So, if he is negative on Treasuries, Eric, what is he investing in? How is he positioning the portfolio? Is he putting that money to use?

Jacobson: He sure is. Now, there is some cash in the portfolio; to some degree that's probably an extension of that interest rate positioning that he is taking, but he is also got a pretty good stake in U.S. mortgages, mostly agency but some non-agency mortgages, at a market value basis, that's about 34% as of the end of February. A good dose of corporate bonds, mostly investment grade, but also some high yield, and the investment grades are tilted pretty heavily toward banks--there are a lot of big banks that they still find a lot of value in the investment-grade corporate market. Like I said, they've got some high yield.

There is also--I don't know for sure that I could say it's the highest number in history--but if you look at the history of the fund, they are certainly somewhere up in the upper echelons in terms of non-U.S. developed market bonds at about 5% and emerging-markets, interestingly enough, at about 10% of market value.

There is also a good chunk of municipal bonds; in fact, of the overall duration of the portfolio, it's even more--the numbers look relatively small at 4%. But they've got a pretty strong statement on those with some longer maturity municipals that they seem to like.

Stipp: All right, Eric. Well, thanks so much for the context on this move in the PIMCO Total Return portfolio and for calling in today.

Jacobson: Glad to be with you, thanks.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.