Bill Gross is betting on leverage to lift returns in an environment of persistently low interest rates and inflated asset prices, an approach he says he shares with hedge fund managers Ray Dalio and Robert Prince.
Gross wrote in an investment outlook for Janus Capital Group Inc. that investors could opt for several approaches to balance risk with reward, espoused by managers including Jeremy Grantham, Warren Buffett and Jack Bogle. Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, wrote that he is most aligned with the philosophy of Dalio and Prince at Bridgewater Associates, of being “cautiously levered” while being wary of the risk of shocks.
“If an investor borrows short term to invest longer and riskier, the potential alpha necessarily demands choosing the correct assets to lever,” wrote Gross, referring to the use of borrowed money to amplify gains. “That is not easy these days since almost all assets are artificially priced.”
Gross, chief investment officer at Pacific Investment Management Co. until his abrupt departure in September, has said that global interest rates will remain subdued for a prolonged period. Low to negative interest rates have pushed investors to take on higher risks to boost returns, and in turn pushed prices past reasonable levels, Gross has said.
Gross wrote that he is avoiding the debt of the U.S., U.K. and Germany and instead is selling insurance tied to their price swings.
The European Central Bank’s stimulus will “keep yields low in Germany and therefore anchor U.S. Treasuries and U.K. Gilts in the process,” he wrote. “I would not buy these clearly overvalued assets but sell ‘volatility’ around them, such that much higher returns can be captured” if their prices trade within a certain range.
Gross has recommended staying conservative, holding high- quality bonds and stocks with low ratios of share prices to earnings.
There are several ways investors could deal with what Gross called a “hostile” market environment. Gross said they could wait out the market in low-yielding assets such as cash, much like Grantham and his team at Grantham, Mayo, Van Otterloo & Co. Investors like Buffett profit through a “perpetual closed-end business structure” that allows them to buy stocks when they’re cheap. The approach advocated by Vanguard Group’s founder Bogle of investing in low-fee products might be another way to offset uncertain markets, Gross said.
“Knowing how to maximize return versus risk in these new waters will be key,” Gross wrote.