Bill Gross Used $45 Billion Derivatives To Lift Pimco Fund Gains

Treasury Allocation

Pimco Total Return’s allocation to Treasuries, including futures, options and swaps as well as nominal and inflation- linked debt, climbed to 49 percent from 43 percent in the second quarter. By adding futures, Total Return maintained much of the duration that would otherwise be lost through the sale of the Treasury notes, said Claude Erb, a former money manager at Los Angeles-based TCW Group Inc.

The portion of Pimco Total Return’s duration, a measure of how sensitive a fund’s assets are to changes in interest rates, provided by government futures increased to 35 percent as of June 30 from 8 percent at the end of March. Its effective duration rose to 5.7 years from 5 years, indicating Gross is taking on more interest-rate risk as the firm sees low rates persisting longer under Fed Chair Yellen than many of its peers do.

Because of SEC restrictions on their use of leverage, mutual funds must set aside cash or highly-liquid securities to cover the potential liability they incur when entering into a derivative contract.

Emerging Markets

Dozens of the firm’s stock and bond funds have limits on the amount of emerging-market securities they can hold, ranging from 15 percent of assets at Pimco Total Return to 50 percent at the Pimco Unconstrained Bond Fund. As of Oct. 14, the caps will no longer apply to “investment grade sovereign debt denominated in the local currency with less than 1 year remaining to maturity,” according to the Sept. 12 filing.

Total Return increased its stake in European sovereign debt by more than 50 percent in the second quarter, adding $4.9 billion of Spanish bonds, $6.1 billion from Italy and $121 million from Greece. The fund added $5.7 billion of Brazilian sovereigns, raising its holdings to $7 billion.

Gross invested $23.7 billion in an internal cash-management fund and added $8.5 billion in short-term instruments, including $606 million of treasury bills issued by Greece, $6.5 billion of T-bills from Mexico and almost $3 billion of certificates of deposit. The increases were offset in part by a $2 billion reduction in repurchase agreements.

Wider Discount

Treasury futures usually trade at a small discount to the value of cash bonds to compensate for the lack of interest payments on the derivative contracts. The discount can widen at times, providing what Pimco quarterly reports call “the opportunity to outperform government securities due to cheapness of futures contracts.”

Such a scenario arose in the second quarter, said Terry Pigott, a principal at Gladstone, New Jersey-based Glacier Peak Capital Management LLC who previously headed U.S. government trading at Daiwa Securities America. As conflicts in Ukraine and the Middle East intensified, investors flocked to the cash market for Treasuries, making them relatively expensive, Pigott said.

“Cash outperformed the futures,” Pigott said in a telephone interview. Pimco is “just looking on a relative value basis, what is the cheapest thing to buy.”