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What Gross Is Really Doing With Treasuries

The PIMCO Total Return manager offers more definition on the fund's current Treasury positioning and the motivation behind it.

Eric Jacobson: Hi, I'm Eric Jacobson, director of fixed-income research for Morningstar, and we're here today at the Morningstar Conference with Bill Gross. He is the co-CIO of PIMCO and, of course, the manager of the flagship PIMCO Total Return Fund, and he will be speaking this week at the Morningstar Investment Conference. Bill, thanks so much for joining us.

Bill Gross: Thank you Eric. It's good to be in the Windy City.

Jacobson: We're very thrilled to have you.

Gross: Thank you.

Jacobson: So, we've had a couple of conversations over the last few months, it's been all over the news, there has been all this talk about how you've been reacting to the Treasury market, and as we've discussed before, your positioning in PIMCO Total Return and across a lot of portfolios isn't necessarily meant to convey what I think a lot of people are interpreting it as. Maybe I'll just leave it at that for a second and ask you to help walk us through what you're doing there with Treasuries.

Gross: Domestically, the Barclays Aggregate Index is half Treasures and agencies and half corporates and mortgages and other. So, if Treasuries become overvalued, which is the case in PIMCO's view in terms of low historical yields, then perhaps other bonds, corporate bonds, mortgage bonds, other alternatives that are part of that index become more attractive. And so it's not an anti-U.S. thing, it's not a debt default, debt ceiling deficit problem at least in immediate terms.

Jacobson: And I want to say even though those are issues that you're concerned about, have been talking about and writing about, you're thinking that more as a near- to middle-term to long-term issue, that's not necessarily what you're expressing today in the portfolio?

Gross: Exactly. Just to put it on the table in terms of the yield, which is a relevant fundamental metric--not necessarily always because there are flows and stocks of bonds that can move markets over short periods of time--but in terms of yield, the Treasury market, and this includes everything from twos all the way out to thirties, only yields 1.55%. Now just to draw a graphic comparison, the Japanese Bond market, the JGB bond market, averages 0.85%. So, we're within 70 basis points of Japan, and if in fact the United States economy is going the way of Japan, and perhaps there are more capital gains to be had, but we're very close to levels which don't seem to make much sense.

Jacobson: I think that last part is where some of the questions keep coming up--there are a handful of people out there who watch the day-to-day movements of the Treasury market, and even though as you and I discussed, the Treasury market has not had great gains this year, when you have these kind of swift moves on a day-to-day basis, they keep saying, "oh, you are missing out on that." But really what you are saying, I think, and maybe you can explain that, is that with the yield that low, and the room to move kind of constricted, yeah, it might go up a bit here and there, but you are not going to spend your portfolio weightings just trying to eke that out. Is that kind of what you are saying, too?

Gross: Exactly. I mean, there are better alternatives, and just to cite some numbers for the year of 2011. The fact is that mortgages, corporates and other bonds within that Barclays Index have done better than Treasuries, and so actually that's been a relatively prescient call, although in combination I would certainly admit that we wish we had more bonds in total. I mean, our duration exposure, if 4.5 years is the index average, it's been about a year shy. So, that hasn't been exactly a great call, but the non-Treasury portion has certainly outperformed the Treasury portion.

Jacobson: One last question on that sort of narrow issue; so occasionally in the last few months, we've seen overall net exposure in the government space of PIMCO Total Return, for example, looking a little bit negative, and I think that's also where people have sort of jumped on the wagon and said, "he is shorting the Treasury market." My impression is that, to some degree, that's a fallout of your overall duration positioning, which you are saying was not necessarily your best call, but part of a bigger-picture decision. Now, tell me, is that correct, and is not necessarily a call that says, "oh, I am shorting the Treasury market?"

Gross: It is correct, and it's partly our fault because the SEC asked us to--or some authoritative body asked us to--categorize the bonds, and we had a rather large bucket of bonds called Treasuries, agencies, FDIC-insured bonds as well as swaps, and so having done that, the actual short position was in the swaps markets, and we've always been long--as I've maintained in the press--we've always been long Treasuries. There haven't been very long maturities. In many cases, they've been six month bills and one and two year Treasuries, but the short Treasuries was always something that came out of blog space, and to be self-critical, because of the way we categorize them, we've changed that this week, for instance, the new categorization will segregate Treasuries from swaps and investors will be able to know more accurately.