Even the Greats Make Mistakes, Part II

By The Sizemore Letter

In an earlier article, I commented that even the all-time greats make mistakes.  Michael Jordan missed that occasional dunk—and world-class investors like George Soros and John Paulson botch the occasional trade.

What can I say, it happens.  Investing is not an exact science.  It’s an exercise in making educated guesses with incomplete information.  And no matter how well-researched you are, you will not always guess correctly.

Good investors learn from their mistakes; this ability to grow is what defines them as good investors.  Luckily for us, we can also learn from the mistakes of the all-time greats.

Let’s consider the case of the Bond King himself, Bill Gross, who as manager of the Pimco Total Return Fund (PTTRX) is the largest money manager in the world.

When it comes to investing, being big is more of a curse than a blessing as it becomes almost impossible to quickly enter and exit trades without moving the market.  Yet this didn’t stop Gross from being ranked in the top 1% of all bond funds in his category over the past 15 years.  It’s good to be king.

His Majesty, however, swung for the fences and missed when he dumped his U.S. Treasury holdings earlier this year and even took a small short position against them.  Gross had bet that yields would rise when the Federal Reserve ended its quantitative easing program.   Instead, the 10-year Treasury yield fell from over 3.5% to less than 2.0%, and Gross’s fund has underperformed 85% of its competitors this year.

PIMCO Total Return Fund (PTTRX)

Flash Player 9 or higher is required to view the chart Click here to download Flash Player now

 

 

Gross’s mistake?  He oversimplified.

He was partially right. When the Fed’s QE2 program ended, it did indeed drain liquidity out of the financial system.  But it was not Treasury securities—the primary objects of the Fed’s buying—that suffered.  It was instead riskier assets like stocks and commodities that fell as investors ran to Treasuries as a safe haven.  The same happened when Standard & Poor’s downgraded the United States’ credit rating from AAA to AA+.  In the aftermath, panicked investors sold everything except for the freshly-downgraded U.S. debt.

Gross wasted no time feeling sorry for himself.  In a recent Financial Times interview, he joked that after taking a loss like this, “you go home at night and cry in your beer. It’s not fun, but who said this business should be fun. We’re too well paid to hang our heads and say boo hoo.”

Well said, Mr. Gross.

So, what can the rest of us learn from Gross’s Treasury short gone bad?  There are two points I would take away:

• Good portfolio management means not putting all of your eggs in one basket.  Gross bet big on Treasury yields rising, but he did not put the entire portfolio at risk on one leveraged bet.  He was still well diversified, and though he might have underperformed his peers his losses were manageable.  At time of writing, the Real Return fund was still safely in positive territory for the year, and Gross lives to trade another day.
• Albert Einstein allegedly once said that “Everything should be made as simple as possible, but no simpler.”  That is remarkably good investment advice.  The world we live in is infinitely complex, while our ability to understand it is very finite.  We have to break this complexity down into bite sizes that we can digest, otherwise our poor, fragile brains would explode.  Still, make your model too simple, and you draw the wrong conclusion.

Gross will be back on top in no time because he learns from his mistakes.  And luckily for us, so can we.

Related article: Even the Greats Make Mistakes

If you liked this article by Sizemore Insights, you’d probably enjoy The Sizemore Investment Letter, our premium members-only newsletter. Click here for more information.