Pimco's Gross Insures G-7 Countries' Debt Rather Than Buying It
Gross’s Pimco Total Return Fund increased the credit- default swaps it sold on bonds from Group of Seven nations such as the U.S. and the U.K. to more than $3 billion in the first quarter, according to a June 7 regulatory filing. The $228 billion fund was insuring debt from six of the G-7 countries as of March 31, while no longer holding a $30 million contract on Italian bonds.
The credit swaps enable Pimco Total Return to earn premiums without taking the risk, frequently cited by Gross, that rising G-7 budget deficits will fuel inflation, pushing up interest rates and driving down bond values. Pimco said the chance of a default by countries such as the U.S. and U.K. is diminished because they control individual currencies with which to pay creditors, unlike Greece and other euro-zone nations.
“Pimco is probably taking the view that it might be like free money,” said Edward Grebeck, chief executive officer of Tempus Advisors LLC, a Stamford, Connecticut, debt-market strategist. “The dollar is the quintessential currency in the world and I don’t see the U.S. government defaulting per se because it can always print money.”
Mark Porterfield, a spokesman for Pacific Investment Management Co., the Newport Beach, California-based firm where Gross is co-chief investment officer, declined to comment. Gross, who helped found Pimco in 1971, didn’t respond to an e- mailed request for comment.
“We do not expect the U.K. to fail in meeting its commitments,” even as the country faces the risk of longer-term inflation, Michael Amey, Pimco’s executive vice president for U.K. fixed income, said in a June commentary on the firm’s website. Selling credit-default swaps on U.K. debt “offers a valuable opportunity for sophisticated investors,” he wrote.
Pimco Total Return has been increasing its participation in the $30 trillion market for credit-default swaps, which are used by investors both to hedge against losses on existing holdings and to speculate on a bond issuer’s future creditworthiness.
The fund has been buying protection against defaults by corporations, including home builders and retailers, while selling insurance against defaults by emerging-market nations and the G-7 countries, a group of industrial democracies that includes Japan, Germany, France, Canada and Italy along with the U.S. and the U.K.
Pimco Total Return Fund had sold credit swaps on about $3.52 billion of G-7 debt as of March 31, up from $205 million at yearend, according to the firm’s filing with the U.S. Securities and Exchange Commission. The fund receives annual premiums under the credit swaps, most of which expire in March 2015, in return for its promise to pay the full face amount of the contract to the buyer if the governments in question default.
The coverage Pimco Total Return had written on U.K. government bonds, known as gilts, climbed to $1.55 billion as of March 31 from $91.2 million as of Dec. 31, the SEC filing shows. The fund’s insurance on U.S. Treasuries rose to about 645 million euros ($794.7 million) from 20 million euros, and on French government bonds it jumped to $598.7 million from $30 million.
The fund had sold $488.2 million of protection on Japanese government debt and $10 million on Canada as of March 31, compared with none at yearend, while its backing for German bonds rose to $80 million from $30 million.
Pimco Total Return held about $2.6 billion of sovereign debt from developed countries, including $2 billion issued by the Canadian government, according to filings. The fund cut its holdings in U.S. Treasuries to $23.2 billion from $42.7 billion during the first quarter, filings show.
Gross, 66, said in his January investment outlook that public debt was soaring, with most of the increase coming from G-7 countries “intent on stimulating their respective economies” in the wake of the 2008 financial crisis. Their own central banks bought almost $2 trillion of this debt through “check writing that required no money at all,” according to Gross, who described this phenomenon as “the least understood, most surreptitious government bailout of all.”
The following month, Gross grouped the U.S., France, Japan and the U.K. with Greece, Spain, Ireland and Italy in a “ring of fire,” comprised of countries with the potential for public debt to exceed 90 percent of their gross domestic product within a few years. He labeled the U.K. a “must to avoid,” saying its gilts were resting on a “bed of nitroglycerin” because of high government debt levels.
Gross said in April that some countries might be able to avert a crisis by creating more debt, as long as they had the ability to issue their own currency and reflate with low real interest rates, among other conditions.
“Perhaps surprisingly, some of the countries on Pimco’s ‘must to avoid’ list are decently positioned to escape their individual debt crises,” including the U.K. and the U.S., but not Greece, Gross said in the commentary. That doesn’t mean their bonds “will be a good investment,” he said.
Gross said during a June 4 interview on Bloomberg Surveillance with Tom Keene that the U.S. is “the least dirty shirt” in a world full of governments with excessive debt. He boosted Pimco Total Return’s investment in U.S. government- related debt to 36 percent in April from 33 percent in March.
Pimco Total Return has outperformed about 81 percent of its peers by increasing 4.3 percent this year, including dividends. The fund returned 14 percent in 2009, ranking it above 60 percent of rivals.
Pimco Total Return was providing more than 10 percent of the net credit protection on Japan, the U.S. and the U.K., according to the most recent data compiled by the New York-based Depositary Trust & Clearing Corp., which runs a trade-reporting facility for credit-default swap transactions.
The swaps listed by Pimco Total Return equal almost 15 percent of the $10.4 billion in net protection outstanding on the U.K., about 40 percent of the $1.95 billion in net contracts written on U.S. debt and about 11 percent of the $4.45 billion in default swaps on Japan, according to figures on the clearinghouse’s website.
While most G-7 countries have traditionally been viewed as default proof, the cost of insuring their debt has been rising as members spend billions to jumpstart their economies and bail out firms hurt by the financial crisis. The transfer of risky assets such as subprime mortgages from the balance sheets of private banks to those of central banks, including the U.S. Federal Reserve, along with the deepening of the credit concerns sparked by Greece’s bailout, has contributed to the rising premiums on sovereign debt.
“Writing credit-default swaps on a reserve currency is a new phenomenon in the last few years,” said Eric Fine, managing director at Van Eck G-175 Strategies, a New York-based fund that focuses on emerging-market debt. “It might mean that we have gone from totally inconceivable to almost totally inconceivable,” in terms of a default by a country such as the U.S. or Great Britain.
The CDR Government Risk Index, a measure of credit-default swap rates on seven developed nations, including Spain and all G-7 members except Canada, traded at 3 basis points, or 0.03 percent, at the beginning of 2007, according to David Klein, the manager of credit indexes at Credit Derivatives Research LLC in Walnut Creek, California.
The firm’s index climbed to 122 basis points as of June 10, from 71 basis points on March 31, with much of the increase stemming from rising costs to insure Italy and Spain.
“Times are different now than they were in 2007,” Klein said.