The retiring announcement of “Bond King”, Bill Gross, was the biggest news in investment field during the Chinese Lunar New Year. Bill Gross has over 50 years extensive experience in asset management and was the co-founder of Pacific Investment Management Co. (PIMCO). He left PIMCO in 2014 and announced his formal retirement recently. After his announcement, Gross accepted a Bloomberg TV interview on the topic of quantitative easing, investment strategies and hedge funds.
Impacts of quantitative easing and long-term low interest rates
Gross agrees that the central bank is moving away from the Phillips curve theory and investors need to adapt to this new change. The quantitative easing program in the past few years has allowed bond investors to enjoy capital appreciation. However, the Fed has started to tighten the monetary policy, and the European Central Bank has begun to stop asset purchases, which will change the bond investment trend of the past few years.
Gross predicted that the Fed will stop shrinking its balance sheet in the next few quarters, with an aim to lower the leverage. However, he cannot predict whether investors will satisfy with the result. The decline of potential inflation rate and the negative interest rate environment may put depositors, banks and insurance companies at risk. And it has been proven in Japan that the impact of potential inflation rate cannot be improved by having long-term low interest rate.
Is the unconstrained investment strategy appropriate?
Investors’ view towards Gross’s investment strategies are varied. There is a rumor that Gross left PIMCO because he is required to accept more restrictions in investing. During the Bloomberg TV interview, Gross was being asked if he regretted in choosing an unconstrained investment strategy, and he claimed he is disappointed to the performance of funds with unrestricted strategies over the past four year, but he reiterated that the nominal returns are still positive. Also, he added that he should stick to the total return strategy and meanwhile accept some restrictions.
The most famous deal of Gross was to bet on the spread of US and Germany government bonds. When the spread was 190 basis points, Gross bet the interest rate spread would be narrowed. Unluckily, the spread has been widened to 250 basic point. Gross said that the gambler bankruptcy theory tells investors that they should not bet more than 2% of the principal. And it is no doubt that Gross is betting too much on the spread between US and Germany government bonds.
Hedge funds are dead
At the end of the Bloomberg TV interview, Gross questioned that the traditional hedge fund model is no longer exists. Investors expect that they can enjoy 5% return from investing in hedge fund, but the actual return is only 1% to 2%. In the past, hedge funds gained extra return from bearing additional risks through long and short positions. More importantly, investors may use a variety of strategic hedge funds to spread the portfolio risk.
However, the risk that is bear by hedge funds becomes more concentrated, such as increasing leverage to gain return. Therefore, when the market decline is in a risk-avoidance environment (such as the market environment in December), the portfolio may face higher risks. And investors need to further diversify their portfolios.
To conclude, the prediction of Gross may be right that the interest rate spread between US and Germany government bonds may narrowed in case the European Central Bank tighten its monetary policy. However, investors should focused on the risk management of the active investment portfolio rather than just believe in the fund manager superstitiously. In the next article, we will further discuss on the risk management of active investment.
Source: REUTERS/Lucy Nicholson