Pimco’s Gross Betting $200 Million on Low Interest Rates
Gross, who has an estimated net worth of $2 billion, poured almost $60 million of his wealth into closed-end funds in May and June, adding to the about $140 million he already had in such holdings, according to data compiled by Bloomberg. The chief investment officer of Pacific Investment Management Co. has been buying the funds on the belief that they will do well in a world of a low interest rates that he predicts.
Pimco in May unveiled its investment outlook for the next three to five years, predicting an era in which interest rates will stay low and growth will be slow and stable. That type of environment benefits closed-end funds, which can use borrowed money to amplify returns. If Gross, whose main Pimco Total Return Fund (PTTRX) is trailing most competitors for a third year in four, is wrong and interest rates rise more than he anticipates, that leverage would mean losses.
“I love ’em,” Gross, 70, said about closed-end funds in a June 19 interview in Chicago. “If you can borrow cheaply and lend like a bank, it’s the perfect time for a new neutral to allow for relatively safe alpha creation,” he said, referring to market-beating performance.
U.S. 10-year (USGG10YR) note yields rose to the highest in two months today as the unemployment rate fell to an almost six-year low of 6.1 percent and employers added more jobs than forecast. Gross said today in a radio interview on “Bloomberg Surveillance” that wage growth that is keeping inflation below the Federal Reserve’s target will keep the central bank on course for slow and below-average interest-rate increases.
Unlike traditional open-end mutual funds, closed-end funds trade on an exchange and don’t accept new money after an initial public offering. They can trade at a premium or discount to their net asset value depending on investor sentiment. Most use leverage to borrow money cheaply and invest it in longer-dated assets such as mortgages, municipal bonds and high-yield debt.
Gross owns shares in 14 Pimco closed-end funds. In May and June, he added to funds including Pimco Dynamic Income Fund and the Pimco Dynamic Credit Income Fund (PDI), both of which invest across global credit markets in assets such as mortgage debt, corporate bonds, sovereign and asset-backed securities. Gross brought his stake in Pimco Dynamic Income to 880,575 shares valued at $28.9 million, according to regulatory filings. He brought shares of Pimco Dynamic Credit Income Fund to 2.17 million, worth $51.1 million, the filings show.
The strategy has worked well this year. Pimco Dynamic Income Fund, led by Pimco manager Daniel Ivascyn, gained 21 percent in the first half of 2014, including dividends, according to data compiled by Bloomberg. Pimco Dynamic Credit Income Fund, (PCI) also led by Ivascyn, returned 10 percent.
Gross’s $225.2 billion Pimco Total Return Fund advanced 3.7 percent this year through June 30, compared with the 3.9 percent return for the Barclays U.S. Aggregate Index.
Ivascyn is one of six Pimco deputy chief investment officers who was named to the new role in January. His $37 billion Pimco Income Fund (PIMIX), a traditional mutual fund, beat 99 percent of rivals over the past five years, according to data compiled by Bloomberg. Ivascyn and his co-manager on Pimco Income, Alfred Murata, were named Morningstar’s fixed-income managers of the year for 2013.
Closed-end funds on average gained almost 11 percent this year through July 1, according to an estimate by Patrick Galley, chief investment officer at Chicago-based RiverNorth Capital Management LLC, which trades closed-end funds.
The 600 or so U.S. closed-end funds hold about $226 billion, according to the website of the Closed-End Fund Association, a trade group. By contrast, traditional mutual funds had assets of $15.4 trillion as of May, according to the Investment Company Institute, which represents the mutual-fund industry.
Closed-end funds appeal to income-oriented investors because they tend to have higher dividend yields than mutual funds that buy similar assets, boosted by the use of leverage. Christopher Larsen, head of closed-end fund products at Baltimore-based Legg Mason Inc. (LM), which manages $14.4 billion of the offerings, said leverage can range from less than 20 percent to almost 50 percent of a fund’s underlying assets.
While borrowing money when rates are low or stable can contribute to returns, the same leverage can detract from performance when rates climb, said Tom Roseen, a senior analyst for Denver-based fund-research firm Lipper.
“Leverage is a two-edged sword,” Roseen said in a telephone interview.
Rising rates aren’t the only potential threat to closed-end fund returns. They could also suffer if credit spreads -- the gap between the yields on Treasuries and corporate or high-yield bonds -- widen, depressing the price of the underlying securities, said RiverNorth’s Galley.
Closed-end funds tumbled last year after former Federal Reserve Chairman Ben S. Bernanke in May signaled that the central bank might begin to scale back its bond buying program. As interest rates rose in anticipation of the change in policy, investors dumped the funds to avoid losses, Galley said. Industry tracker Thomas J. Herzfeld Advisors Inc. in Miami Beach, Florida estimates that discounts, which averaged less than 1 percent before Bernanke spoke, reached a peak of more than 10 percent in mid-December 2013.
Funds that buy municipal bonds were especially hard-hit because investors worried about possible defaults in places such as Detroit and Puerto Rico. Municipal funds represent about 45 percent of all closed-end funds, according to data from Chicago-based Morningstar Inc. (MORN)
This year has been the reverse image of 2013 for closed-end funds. Yields on 10-year Treasury notes, about 3 percent at the beginning of the year, have come down to 2.7 percent, as the Federal Reserve has signaled it’s in no rush to boost interest rates. The central bank last month repeated its view that the rates are likely to stay low “for a considerable time.”
Lower rates have boosted bond prices, and in closed-end funds, that increase has been magnified by leverage. Discounts on the funds remain relatively wide, Galley said.
“It is the simple magic of borrowing at 25 basis points and lending at 7 or 8 percent,” Gross said in the interview. A basis point is one-hundredth of a percentage point.
Gross’s biggest single closed-end fund holding, valued at more than $61 million, is in Pimco Corporate Opportunity Fund (PTY), which he manages. The fund gained 14 percent through June 30.
Pimco Corporate Opportunity Fund trades at a premium to its net asset value of more than 17 percent, according to data compiled by Bloomberg. Gross said he prefers to buy funds that sell at a discount or “at the right price.”
The large gains racked up by closed-end funds in 2014 have not diminished Gross’s enthusiasm for the investments.
“I really like the trade,” he said. “I’ve been recommending it to anyone who asks.”
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