Bill Gross is applying Pacific Investment Management Co.’s theory of the “new neutral” beyond bonds, wagering that volatility across markets will remain abnormally low.
“We sell insurance, basically, against price movements,” Gross, chief investment officer of Pimco, said in an interview yesterday in Chicago at Morningstar Inc.’s Investment Conference. “At Pimco, that’s what we’ve tried in the last four or five weeks.”
The wager on low volatility by the $2 trillion asset manager is “part and parcel” of its outlook for the next three to five years, an era it calls the “new neutral,” Gross said. The outlook is characterized by low interest rates and lower, more stable global growth. Stocks and bonds will only return about 5 percent and 3 percent respectively, as any changes in Federal Reserve policy will be taken cautiously, the Newport Beach, California-based firm said in a report in May.
The firm’s money managers “all know all parts of the new neutral,” and incorporate it into their trading, Gross, 70, said. “Historically, Pimco has succeeded in selling volatility, and yes, it’s nice volatility’s come down.”
Pimco’s strategy has caused traders to speculate that the company was selling calls and puts on the Standard & Poor’s 500 Index in April and May in a bet that prices won’t spike or drop, and also amassed positions in interest-rate swaps to express the same view, according to four people who heard about the trades, all of whom asked not to be identified because they aren’t authorized to discuss them. Gross declined to discuss specific trades at Pimco.
“People came into this year thinking we were on the verge of a breakout in economic data, it hasn’t happened and people realize Fed policy isn’t threatened anytime soon,” said David Schawel, a money manager at Square 1 Bank in Durham, North Carolina. “That’s a green light for low volatility to prevail.”
The trades are probably “less about compelling value and more about a belief that the path for credit risk is very low for the foreseeable future,” Schawel said. “The longer this benign environment drags on, the more people are willing to expect the status quo remains.”
The Chicago Board Options Exchange Volatility Index, which measures price swings in stocks, closed June 18 at 10.61, the lowest level since February 2007. This year’s high of 21.44 on Feb. 3 compares with a five-year average of 19.7.