PIMCO – The Downhill Marathon Machine

October 25, 2010 at 1:29 am 12 comments

How would you like to run a marathon? How about a marathon that is prearranged all downhill? How about a downhill marathon with the wind at your back? How about a downhill marathon with the wind at your back in a wheelchair? Effectively, that is what a 30-year bull market has meant for PIMCO (Pacific Investment Management Co.) and the “New Normal” brothers (Co-Chairman Bill Gross and Mohamed El-Erian) who are commanding the bond behemoth (read also New Normal is Old Normal). Bill Gross can appreciate a thing or two about running marathons since he once ran six marathons in six consecutive days.

This perseverance also assisted Gross in co-founding PIMCO in 1971 with $12 million in assets under management. Since then, the company has managed to add five more zeroes to that figure (today assets exceed $1.2 trillion). In the first 10 years of the company’s existence, as interest rates were climbing, PIMCO managed to layer on a relatively thin amount of assets (approximately $1 billion). But with the tailwind of declining rates throughout the 1980s, PIMCO’s growth began to accelerate, thereby facilitating the addition of more than $25 billion in assets during the decade.  

The PIMCO Machine

For the time-being, PIMCO can do no wrong. As the endless list of media commentators and journalists bow to kiss the feet of the immortal bond kings, the blinded reporters seem to forget the old time-tested Wall Street maxim:

“Never confuse genius with a bull market.”

The gargantuan multi-decade move in interest rates, the fuel used to drive bond prices to the moon, might have something to do with the company’s success too? PIMCO is not exactly selling ice to the Eskimos – many investors are scooping up PIMCO’s bond products as they wait in their bunkers for Armageddon to arrive. Thanks to former Federal Reserve Chairman Paul Volcker (appointed in 1979), the runaway inflation of the early 1980s was tamed by hikes he made in the key benchmark Federal Funds Rate (the targeted rate that banks lend to each other). From a peak of around 20% in 1980-1981 the Fed Funds rate has plummeted to effectively 0% today with the most recent assistance coming from current Fed Chairman Ben Bernanke.

Although these west-coast beach loving bond gurus are not the sole beneficiary in this “bond bubble” (see Bubblicious Bonds story), PIMCO has separated itself from the competition with its shrewd world-class marketing capabilities. A day can hardly go by without seeing one of the bond brothers on CNBC or Bloomberg, spouting on about interest rates, inflation, and global bond markets. As PIMCO has been stepping on fruit in the process of collecting the low-hanging fruit, the firm has not been shy about talking its own book. Subtlety is not a strength of El-Erian – here’s what he had to pimp to the USA Today a few months ago as bond prices were continuing to inflate: “Simply put, investors should own less equities, more bonds, more global investments, more cash and more dry ammunition.”

If selling a tide of fear resulted in a continual funnel of new customers into your net, wouldn’t you do the same thing? Fearing people into bonds is something El-Erian is good at:  “In the New Normal you are more worried about the return of your capital, not return on your capital.” Beyond alarm, accuracy is a trivial matter, as long as you can scare people into your doomsday way of thinking. The fact Bill Gross’s infamous Dow 5,000 call never came close to fruition is not a concern – even if the forecast overlapped with the worst crisis in seven decades.

Mohamed Speak

Mohamed El-Erian is a fresher face to the PIMCO scene and will be tougher to pin down on his forecasts. He arrived at the company in early 2008 after shuffling over from Harvard’s endowment fund. El-Erian has a gift for cryptically speaking in an enigmatic language that could only make former Federal Reserve Chairman Alan Greenspan proud. Like many economists, El-Erian laces his commentary with many caveats, hedges, and generalities - concrete predictions are not a strength of his. Here are a few of my favorite El-Erian obscurities:

  • “ongoing paradigm shift”
  • “endogenous liquidity”
  • “tail hedging”
  • “deglobalization”
  • “post-realignment”
  • “socialization losses”

Excuse me while I grab my shovel – stuff is starting to pile up here.

Don’t get me wrong…plenty of my client portfolios hold bonds, with some senior retiree portfolios carrying upwards of 80% in fixed income securities. This positioning is more a function of necessity rather than preference, and requires much more creative hand-holding in managing interest-rate risk (duration), yield, and credit risk. At the margin, unloved equities, including high dividend paying Blue Chip stocks, provide a much better risk-adjusted return for those investors that have the risk tolerance and time-horizon threshold to absorb higher volatility.

PIMCO has traveled along a long prosperous road over the last 30 years with the benefit of a historic  decline in interest rates. While PIMCO may have coasted downhill in a wheelchair for the last few decades, this behemoth may be forced to crawl uphill on its hands and knees for the next few decades, as interest rates inevitably rise. Now that is a “New Normal” scenario Bill Gross and Mohamed El-Erian have not forecasted.

Wade W. Slome, CFA, CFP®  

Plan. Invest. Prosper.  

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in PIMCO/Allianz, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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Sentiment Indicators: Reading the Tea Leaves QE2 Drowning TIPS Yields Below Water

12 Comments Add your own

  • 1. dude  |  October 25, 2010 at 12:42 pm

    I don’t like Pimco either as an investment advisor. Like you said, as El Rian advocated bonds recently, meanwhile, Bill Gross is advocating stocks. Just now, 9/3:“no compelling pressure to move to QE2.” , then 10/4: A new round of quantitative easing is likely.

    There is no coherent vision, it’s a lot of tit for tat at Pimco. With that aside, they are still at the top of the game. Pimco Total Return, Emerging Markets beat most competitors in funds/etfs. Over the past decade, Total Return has doubled compared to flat for DOW, and performance is similar to SPY over 20y, except a lot less volatile.

    If interest rates rise, it’s not like they have to sit their and watch their money burn, they can go short, look at currency appreciation, credit default swaps, invest in undervalued securities like they do now. Yes Pimco are big time double speaking marketers, but I think you should give them some credit for being more than lucky.

    Reply
    • 2. sidoxia  |  October 25, 2010 at 5:58 pm

      Your points are well taken. If the game was too easy, PIMCO would never be as large as they are today. My main gist is PIMCO had an unusually favorable environment over the last 30 years to make their billions, and now the risks are much higher just as investors are diving in head first. Rather than explain the risks, they are pouring fuel on the fire.

      I am unaware of any PIMCO products that allow managers to short bonds, but if you come across some, please let me know.

      Cheers,
      ~WS

      Reply
  • 3. John  |  October 25, 2010 at 7:28 pm

    Agree with Dude… they may have had favorable conditions (especially relative to an equity manager), but many other bond managers have failed to ride the wave while they have excelled (gotta give them their props).

    I’ll agree with you on endogenous liquidity (no f’n clue what that means), but below are some simple translations….

    “ongoing paradigm shift” = times are a changing
    “tail hedging” = hedge your portfolio
    “deglobalization” = the world is not flat
    “post-realignment” = after things realign
    “socialization losses” = heads banks win… tails you lose

    Reply
    • 4. sidoxia  |  October 25, 2010 at 10:25 pm

      JT:

      I like your explanation better…thanks.

      ~WS

      Reply
  • 5. dude  |  October 25, 2010 at 10:31 pm

    http://www.allianzinvestors.com/Products/pages/283.aspx This fund they have can “short U.S. stocks”. I read elsewhere that their All Asset All Authority could go long/short any kind of asset with any kind of leverage, it might be there in the prospectus somewhere.

    http://www.allianzinvestors.com/Products/pages/346.aspx

    “The Fund may use derivative instruments for hedging purposes or as part of its investment strategy”

    It doesn’t specifically outright say it can’t short bonds in the prospectus, though CDS serve the same function, with more flexibility. Or, hereThe main reason you see this is because most of this comes from M* data and many sites don’t seem to know how to handle leveraged positions on both the short and long side. For example, PTTRX is 567% long cash and 570% short cash (for a net 3% short position). It is 110.2% long bonds and 10.6% short bonds, for a net 99.6% long position.

    Cheers to you.

    Reply
    • 6. sidoxia  |  October 25, 2010 at 11:38 pm

      Dude:

      Thanks for the info.

      It looks like the first link you listed (All Asset All Authority Fund -PAUAX) is effectively a fund of PIMCO funds with very little short exposure.

      The next fund (Fundamental Advantage Total Return Strategy Fund A – PTFAX) is a net neutral fund with a bond overlay.

      PIMCO StocksPLUS TR Short Strategy Fund A (PSSAX) looks like a legitimate short equity fund, but this is $2 billion out of $1+ trillion.

      Overall it looks like they have very little product on a short basis and on the fixed income side it looks like most of the derivative strategies are based on using futures to hedge (protect), not to take net short positions.

      Longer term, you could be right, that they migrate strategies to take advantage of short positioning. For the time being it doesn’t appear like they are very diversified and will get creamed if rates rise.

      There’s a reason they are trying to kick-start their equity efforts because they see the writing on the wall. Time will tell if they can adjust quickly enough.

      Thanks again!

      ~WS

      Reply
  • 9. dude  |  October 25, 2010 at 10:36 pm

    Another thing about Pimco I don’t like is they have all kinds of funds. It’s kind of a weasel way to say they have winners in all kinds of markets… But compared to Vanguard or something like that, most are doing better than average actually.

    Reply
  • 10. BA  |  October 27, 2010 at 12:07 pm

    Wade,

    Right on cue, Mr. Gross making his daily walk around on CNBC.

    Reply
    • 11. sidoxia  |  October 27, 2010 at 2:01 pm

      Thanks Alexander!

      ~WS

      Reply
  • 12. Top 10 of 2010 « Investing Caffeine  |  January 7, 2011 at 1:00 am

    [...] PIMCO – The Downhill Marathon Machine [...]

    Reply

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