Bond King Bill Gross’ Next Act
In an exclusive interview, Pimco’s former boss explains his new role at Janus, and why he thinks interest rates will stay low.
Come Monday morning, Bill Gross’ business card will read Portfolio Manager, not Chairman, Chief Executive, President, or boss of anything. For one of the most powerful investors on the planet, the abrupt transformation might be a letdown, but it is in some ways a relief. More important, it could be an unusual opportunity.
Unless you’ve been living on a distant planet, you’ve heard by now that Gross, known on Wall Street as the Bond King, bolted on Sept. 26 from Pacific Investment Management, the Newport Beach, Calif.–based investment firm he co-founded 43 years ago, ran in what some former colleagues allege was a tyrannical fashion, and built into a $2 trillion colossus that dominates the world of fixed-income investing. His new home, Denver’s Janus Capital Group (ticker: JNS), serendipitously named for the Roman god of beginnings and transitions, manages just $178 billion.
Gross’ new fund, Janus Global Unconstrained Bond (JUCTX), is a mere skiff, with $12.9 million in assets as of Aug. 31, alongside Pimco Total Return (PTTAX), the $202 billion mega-yacht he captained for 27 years, beating the market handsomely in most of them before hitting the shoals in the past few years. Yet the relatively small size of his new vehicle—it will be larger, possibly much larger, by week’s end—could pose an advantage for Gross, just as the “Unconstrained” of its name could liberate him to go almost anywhere in search of returns.
A member of the Barron’s Roundtable, Gross, 70, shared his expectations for his new job, and his current investment views, in an interview last week. Whether the Bond King can maintain his crown remains to be seen. That he remains one of the most educated, engaged, and insightful students of markets is beyond doubt.
Barron’s: You have been at this game for more than 40 years, Bill. You have plenty of pocket change, and most people think the bond market, to use a term you’ll understand as a yoga practitioner, is about to assume a Downward Dog pose. Why not simply retire instead of starting anew at Janus?
Gross: Managing money is in my blood. I like to get up at 5:30 in the morning and make money for clients and compete against other money managers. That’s something that doesn’t go away. I am obsessed with delivering value to investors and winning the game from a personal standpoint. Retiring at this point in my career just doesn’t suit me.
But is it the right time to launch a new bond fund? The Federal Reserve is winding down its asset-buying program and is expected to raise interest rates next year.
I will be managing an unconstrained bond fund—the Janus Global Unconstrained Bond fund, open to U.S. investors, and an offshore version for non-U.S. investors. Because of its unconstrained nature, it will typically have less duration, maturity, and interest-rate risk than a traditional fixed-income portfolio. Most intermediate-term bond funds are benchmarked to an index of bonds with an average maturity of five to seven years. Unconstrained funds have no such benchmark.
The unconstrained universe, in general, wants a 4% or 5% return with little interest-rate risk. A fund like this seeks to earn a positive return regardless of prevailing market conditions. Although fixed income will constitute at least 80% of the portfolio, this opens up a lot of choices. You can take credit, volatility, liquidity or duration risk. This is probably the best time to manage an unconstrained fund.
Janus Unconstrained Bond was launched in May, and had less than $13 million as of the end of August, about 60% of it parked in cash. Call it coincidence, but this fund looks like it was created for you.
It wasn’t set up for me, although I considered it important to have a vehicle to manage. [A Janus spokesman says the fund wasn’t launched with Gross in mind.]
What can you do at Janus that you couldn’t at Pimco?
Janus is a much smaller shop. Obviously, there will be fewer executive and people responsibilities, so I’ll be able to devote more time to managing money, as opposed to managing an organization. I’ll still be intense; I figured out long ago that I can’t change that. But the intensity and decibel level drop a bit in a smaller place. Also, common sense suggests that it will be easier to implement ideas in a $100 million portfolio than in a fund with more than $200 billion.
Did Pimco Total Return finally grow too big to manage effectively?
I don’t want to get into that. Total Return had advantages and disadvantages because of its size. All I can say is: It will be easier to establish positions without the press noticing on a daily or monthly basis. The bond paparazzi will be less interested in Janus than they were in Total Return.
But they probably won’t be less interested in Bill Gross. You used derivatives liberally in Total Return to boost returns and enhance liquidity. Will derivatives play an important role in the new fund?
The Total Return fund used financial features, such as credit-default swaps, to the advantage of clients. The new funds will use some derivatives, but not a lot.
Will Janus create exchange-traded funds to mirror your funds?
It takes a while to develop and register an ETF, but it is on Janus’ plate. One reason I went with Janus is to be able to offer something the small investor can access easily and at low cost. An ETF allows for that, as will the unconstrained fund. We plan to put together a menu of offerings that serve the small investor and the institutional investor.
You worked with a first-rate team of analysts and managers at Pimco. Are you expecting to build a big team at Janus?
There is a team in place already. That is another reason I thought Janus was perfect for me. Also, I have had a 20-year association with Dick Weil [Janus CEO Richard Weil], who worked at Pimco for 15 years and served as chief operating officer. His wife was my executive assistant for a few years. I went to Denver last Friday [Sept. 26] to visit with Janus for the first time. The firm has a well-established credit-research and bond-management team that has done really well. In fact, they outperformed the Total Return fund for the past few years.
Won’t you be lonesome in an office in Newport Beach?
There are a few people in the office now [administrative and technology personnel]. I expect to have an assistant portfolio manager and a trader, and constant video connections with the Denver team. Another plus is that I’ll be associated again with Myron Scholes, Janus’ chief investment strategist. Myron [a Nobel Prize-winning economist] gave us the idea in the early 1980s to use financial futures. He was on the Pimco board for a time. Along with Myron, I’ll be part of the team that is focused on global asset allocation, so, no, I won’t be isolated here in Newport Beach.
Will you have any management role at Janus, other than running the funds and advising on global asset allocation?
I don’t expect to have any role in setting the company’s direction. I had enough of that at Pimco. People management and business planning are all up to Dick and his team. I was always an investment guy, and the other stuff—hiring, paying people, planning, and so on—became a problem for me. I am uniquely exuberant about clearing all that stuff off my dish.
Switching to the markets, stocks are getting crushed. The Dow Jones industrials have fallen 1.6% from last month’s record high. Is this the beginning of a much steeper selloff?
It is a well-deserved rest. Stocks have gone up for the past five years. In the U.S., much will depend on whether the economy grows by 3%, 2%, or 1%. A growth rate of 3% isn’t a slam-dunk, especially when the rest of the world is at zero or less. I am expecting a 2% growth rate. The domestic economy functions rather independently, but the U.S. isn’t an island. It is connected to places that are struggling, such as China and Europe.
Why has the global economic recovery been so lackluster since the recession?
There are several reasons. The world is still highly levered. Growth in the U.S. and elsewhere has been facilitated in the past 30 years by the expansion of credit and leverage. Once capitalists recognize that they can’t continue to accumulate leverage at the same pace, growth slows. Demographics also are contributing to diminished economic growth. The boomers aren’t booming. They are getting older and retiring.
Not you! You’re starting a new job Monday.
Most boomers need health care, but they don’t need another house or a third car. The aging of our society is putting curbs on economic growth. Thirdly, technology is a boon and a wonder, but it also has eliminated jobs that aren’t being replaced at the same pace. Apple [AAPL] is a wonderful company, but it doesn’t hire as many people as the old General Motors [GM].
Finally, globalization is an issue. The U.S. has been the world leader in globalization since the end of World War II. We have benefited from mercantilistic expansion, and because the dollar has been the reserve currency. Now things are turning sour elsewhere. When you fly into head winds, you fly at a different speed.
Many investors think the bond market is about to hit major head winds after a 30-year rally. Do you?
A three-year German bund trades at negative six basis points [hundredths of a percentage point]. If that’s not a head wind, I don’t know what is. Interest rates are low around the world. That doesn’t mean yields can’t fall and bonds can’t rise when people worry about something going amiss, whether it’s slowing growth in China or the spread of the Ebola virus. Bonds are protection against inflation and disaster. But my low-growth outlook suggests that bonds will earn their coupon.
The Fed has said that the appropriate interest rate long-term to keep the economy in balance is 3.75% to 4%. I say it’s 2%. If the Fed follows through by raising the federal funds rate to 4% in the next few years, there will be bear markets for all assets.
Why is your outlook so at odds with the Fed’s?
There is no model for what happened after the collapse of Lehman Brothers, other than the U.S. in the 1930s and maybe Japan’s asset-bubble collapse. From a commonsensical perspective, it doesn’t make sense in a highly levered world to return to the old normal of a 4% federal funds rate. Some academics argue that it makes sense to keep interest rates lower than normal to heal a levered economy.
My 2% is just a round number, and as much of a stab at an answer as the Fed’s 4%. What I’m really saying is that interest rates have to be kept lower for longer than central banks expect because of the structural head winds we’re facing. It doesn’t mean that Gross and Janus are smarter than the Fed, but Fed Chair Janet Yellen and the Fed staff are model-driven, and they don’t know how to model the structural changes we have discussed. There are things a model can’t accommodate.
The Fed is planning to end its quantitative-easing, or asset-buying program, this month. Might geopolitical crises or a severe stock-market selloff give Yellen cover to launch QE4?
The political blowback would be enormous, and the Fed is worried about maintaining its independence, especially with an election coming up. It’s enjoying the [rate-cutting] handoff to the European Central Bank, and before that, to the Bank of Japan. Absent a catastrophe, which I don’t sense, another round of QE isn’t coming.
Where do you see the best opportunities in fixed income today?
Most of the opportunity, which has developed in recent weeks, is offshore. There is significant opportunity in Mexico, which has half the debt level of the U.S., and interest rates in the 6% range. Mexico is attached to the U.S. in terms of trade, so it is a pretty safe emerging market. This is an opportunity I would try to take advantage of in the unconstrained fund.
I expect the fund to have a decent percentage of short-term high-yield paper on Monday—10% to 25%—that yields 3% to 4%. Both Janus and I like one-to-three-year high-yield paper issued by companies such as Ally Financial [ALLY] and HCA Holdings [HCA]. Currencies are another possibility. As the euro and yen fall, there is an opportunity to take advantage of the relative strength of the dollar. Mild short positions in the euro and yen could be attractive.
What looks dangerous in bond land?
Longer-dated corporate bonds could be problematic. Verizon Communications [VZ] and Apple have been the biggest issuers in the past 12 months. Investment-grade corporates in the five-, 10-, and especially 30-year space are vulnerable, not from a default standpoint but from a liquidity standpoint. If investors look to raise cash because they are worried about world events or slower growth in the U.S., there could be a rush to the exits in this small theater.
Any final thoughts, Bill?
I don’t intend to downscale in intensity, but Janus is the right spot at the right time for me. I appreciate Dick’s putting this together so quickly, in a matter of 24 to 48 hours at most, and I don’t intend to disappoint.
Thank you.