It’s not for nothing that he is called the Bond King. His firm manages over $1 trillion in assets, and his flagship fund—the Pimco Total Return Fund (PTTRX)—is the largest mutual fund in the world. Yet despite the fund’s size and high profile (both of which make investing more difficult), Gross ranks in the top 1% of all bond funds in his category for the past 15 years. According to Morningstar, the Total Return Fund has generated annualized returns of 7.2 percent over that period. Not bad for a collection of boring, old bonds.
Gross has had a rough go of it in 2011, however. (See “Even the Greats Make Mistakes, Part II”). The Bond King swung big with a much-hyped short of U.S. Treasuries…and struck out.
As a result, Gross has vastly underperformed the competition year to date. The Total Return Fund has seen gains of just 1.9 percent, while the passive Barclays US aggregate bond index has enjoyed Gross-like returns of 6.7 percent. Gross ranks in the 91st percentile this year. This means that out of 100 bond fund managers, only 9 performed worse. Ouch.
Even an investing demigod like Gross can have a bad trade. But what separates a truly great investor like Gross from the rest of the pack is his ability to dust himself off and jump back in. He doesn’t let a bad trade—and, in his case, the bad press that comes with it—shake his confidence. He simply adapts to the new reality and moves on.
So what is the Bond King buying today?
Mortgages. Lots of mortgages. And he’s even borrowing money to do it.
According to Reuters, Gross went on a mortgage buying spree in September, raising the Total Return fund’s allocation to mortgage-backed securities to 38 percent in the belief that the Fed’s Operation Twist will boost their prices. In the process, he increased the leverage of the fund from 9 percent to 19 percent. When Mr. Gross bets, he bets big.
The move represents an abrupt U-turn for the Bond King. His main rationale for shorting Treasuries earlier this year was his belief that long-term rates were too low and that they’d be rising once “QE2” was wound down. But in aggressively buying long-duration mortgage bonds—and in using leverage to do it—Gross clearly believes that low long-term rates are here to stay for a while.
The Fed’s recent commitment to Operation Twist is certainly one reason for Gross’s bullishness towards long-dated bonds. But looking at the bigger picture, lower rates are consistent with what Gross and his colleague Mohamed El-Erian have dubbed the New Normal—a prolonged period of sluggish growth and higher than usual unemployment.
In his October investment commentary, Gross identifies three “structural roadblocks” that should help keep growth muted and inflation low for the foreseeable future:
If Gross is correct about inflation being benign—and I believe that he is—then investors should make income a major focus of their portfolios.
You could go the route of Gross and buy long-duration bonds. But a better option might be to load up your portfolio with high-dividend paying stocks. Most importantly, make sure that the stocks you pick have a history of growing or at least maintaining their dividends during even the most difficult economic conditions. If a company can raise its dividend in a year like 2008, it’s likely to survive anything.
A few contenders for your portfolio:
| Stock | Ticker | Dividend Yield |
| Johnson & Johnson | $JNJ | 3.6% |
| Microsoft | $MSFT | 3.0% |
| Intel | $INTC | 3.7% |
| Altria | $MO | 5.9% |
All but Microsoft (NYSE: $MSFT) currently yield more than the 30-year Treasury—which yields 3.15 percent at time of writing—and Microsoft is awfully close. It should also be added that all of these companies have long histories of raising their dividends, whereas bond payments are fixed.
Whether you buy high-dividend stocks or follow Mr. Gross’s lead and buy long-dated bonds, make sure that you’re getting paid. As the market action of 2011 has proven, capital gains can be elusive, but dividends allow you to realize real returns every quarter. And in an environment of low inflation—or even mild deflation—those dividend checks will go a long way.
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