PIMCO is perhaps the best known of the mega bond fund managers out there, and that makes Bill Gross the defacto bond king. His latest investment outlook is titled “Bond Wars” now that interest rates rose 100 basis points from trough to peak in the May to July period. Gross believes that bonds have a place in every portfolio, but there are carry risks in many forms that investors have to consider here.
As far as why investors love bonds so much, it is the safety and the competitive returns that were seen in the last secular bull market for bonds. Gross reminds us that bond yields in 1981 were above 15% and were about 2.5% in June of 2012.
Gross warns that bonds have other forms of “carry” that are not necessarily yield or interest rate dependent. He notes:
- Bonds issued by less than Aaa sovereign countries and all corporations have a credit spread that can provide a significant or even higher risk-adjusted carry than does maturity extension. These spreads might widen as interest rates rise, but historically they have not, acting as a diversifier rather than a bear market enhancer.
- Bonds also have a volatility premium that produces carry, a premium more susceptible to negative consequences if yields rise suddenly like in May and June, but not during a more gradual increase like one that PIMCO forecasts over the next few years.
- Bonds have a carry component inherent in the yield curve itself, one that refers to choices between a bullet or a barbell strategy — the bullet providing historically more carry than the barbell under most market conditions.
- Bonds also can be denominated in non-dollar currencies, all of which provide the potential at some point to enhance carry.
- Most importantly, bonds carry a maturity risk.
Unfortunately, this “Investment Outlook” was more of a public relations or marketing material piece than you may have seen in recent outlooks. Gross even said in his conclusion, “Stick with PIMCO, we’re going to win this new war!”
Gross even refers to his first “Bond Wars” piece dating back to 1986 for a comparison.