Wearing sunglasses that made him look like a patient recovering from cataract surgery or the skinniest member of a crime family, Pimco's chief investment officer began his talk at Morningstar's annual investment conference by joking about all the bad press he had received.
First, he compared himself to Gen. George Patton berating wounded soldiers. The boatload of bad press Gross has received since his co-CIO, Mohamed El-Erian, resigned was clearly a shock for someone who has won nothing but the most glowing admiration for most of his 40 years in fixed-income management. Making comparisons to The Manchurian Candidate, he jokingly challenged reporters to come to Newport Beach and play a few rounds of poker with him to see who would get the two red queens.
He then went on to outline three elements of Pimco's structural template that he has used in the Pimco Total Return Fund and which he believes explain its long-term outperformance. The first is a “Bonds Plus” concept credited to the late Peter Bernstein. It joins interest rate futures and swaps with short-term six- to 12-month corporate notes and turns Treasurys into corporate bonds. This adds a return of 30 to 40 basis points annually, which can add up over a decade in a competitive market where consistent small advantages help.
The second secret entails buying intermediate-term bonds and letting them roll down the yield. Gross quickly conceded it has not worked well in the first five months of 2014. But over 100 years, returns on five-year Treasurys have equaled the performance of 30-year Treasurys.
"The reason is it rolls down a positive five-year yield curve," Gross said. "There is a lot of noise in a five-year Treasury. The secret is patience. A five-year versus a three-year is a great bet."
Secret No. 3 involves derivative sales. Gross said this is a strategy employed by Warren Buffett and Berkshire Hathaway's insurance companies. It involves, among other things, selling volatility by owning 30-year mortgages. Sometimes in years like 2011 and 2013, he concedes, it doesn't perform so well. "It doesn't pay to sell insurance right before a flood, but over time it pays off," he said.