The Lessons of Bill Gross's Exit from Treasuries

3/14/2011 7:05 PM ET

By Jim Jubak

Pimco's Bill Gross just made what looks like a very smart move to get out of Treasury bonds. Here are 3 lessons from his move and 4 ways it could play out in his favor.

Related topics: Treasurys, bonds, Federal Reserve, investing strategy, Jim Jubak

Bill Gross, the manager of the world's largest bond fund, $237 billion Pimco Total Return (PTTAX), has cut the fund's holdings of Treasury bonds to zero. The move doesn't mark the end of the world as we know it -- Gross cut his fund's holdings of U.S. government debt to zero in early 2008, and the United States and the bond market are still standing.

But I'd never suggest ignoring Gross' actions, his timing or his logic. His latest move has important lessons for investors, although perhaps not the obvious ones.

Bill Gross, bond king

Let's start at the beginning, always a good place to start. In his March update on the fund's investment strategy, Gross explained that he was dumping Treasurys in anticipation of the June 30 end of QE2, the Federal Reserve's quantitative easing program designed to reduce medium-term interest rates and stimulate the U.S. economy via massive bond-buying. The Fed has been buying more than $100 billion of Treasurys a month. Since the November start of QE2, the Fed has bought $412 billion of U.S. government debt. By the time the Fed is done in June, it will have added about $1.6 trillion in U.S. government debt to its balance sheet.

Jim Jubak

Gross calculates that the Federal Reserve has been buying about 70% of all new Treasury debt, with overseas investors, banks and governments snapping up the rest. That has led him to a logical follow-up question: Who will step in to buy that 70% of U.S. debt when QE2 stops? It's not like the U.S. government is suddenly going to discover fiscal rectitude and stop running a huge annual budget deficit. The U.S. Treasury will still need to finance its debt by issuing more and more Treasury securities.

Gross' answer is that overseas buyers will have to be enticed to step up buying Treasurys through higher interest rates on U.S. debt. And higher yields on new U.S. debt mean that the price of already issued U.S. debt will have to fall. The yields on that debt will thus rise until they match the yields on the new debt. (A $10,000 bond with a yield of 5% when it was issued, so that it pays $500 a year to the holder, will have a yield of 5.6% if the price falls to $9,000. An investor has to pay less money -- $9,000 instead of $10,000 -- to get the same $500 interest payment every year.)

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And, Gross notes, overseas buyers haven't been especially enthusiastic lately about adding to their holdings of U.S. Treasury debt. There are persistent signs that governments have been looking to diversify their holdings by adding euros, gold, Canadian dollars and whatever else they can think of.

3 lessons for investors

If you're looking for lessons for your own portfolio in Gross' strategy, this is the first one: Gross isn't waiting until June to see how big a bite the end of QE2 will take out of his portfolio. He's moving now in anticipation of the end of the Fed's bond-buying spree. Investors who are concerned about what will happen when QE2 comes to an end can't wait until June to protect the value of their bond portfolio. If they do, they're likely to find themselves selling into a market that has already anticipated their fears.

So what's Gross doing with the money he's taking out of U.S. government debt? Pimco Total Return -- and remember that it's the best-performing bond fund in its class over the last 15 years, according to Morningstar -- is now positioned in debt backed by U.S. mortgages, corporate bonds, high-yield (aka junk) bonds and emerging market debt. And he has 23% of the fund in cash or cash equivalents.

Maybe those don't strike you as the most attractive alternatives to U.S. government debt. Maybe the idea of sitting in cash equivalents making a 0% return isn't your idea of a good time. But here's the second lesson: What you pay for what you own is as important as what you own.

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Then when a hurricane blows in it would distroy the platform and the bonds would fall in the water and then the storm would blow the bonds into USA waters and the goverment could claim them back under the rule of capture law. The federal reserve sub company would just go bankrupt and the USA would have its money back.      0    0ReportSpamBulldog3173 hours agoAmish77 That sound like the Enron Proceedure     0    0ReportSpamAmish774 hours agoWe need to collect 17 trillion dollars in gold.     1    0ReportSpamAmish774 hours agoSo.Any one of the tricky accountants could basically create 4 people who own fake 4 corporations and then Magically buy the Entire US Debt.The Said People who aren't real file for Bankruptcy.Sounds like an economic blackhole that we do need.     2    0ReportSpamdendl7 hours ago

Hey Readers,

Like I wrote last week, this is significant. Come June and July (maybe sooner) buyers of U.S. Treasuries are going to be in short supply. I want you to consider the $17 trillion U.S. Gov't debt at five percenr, or higher, rates. Soon we'll be in the same dilemna as Japan.

Chad in CO

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And, Gross notes, overseas buyers haven't been especially enthusiastic lately about adding to their holdings of U.S. Treasury debt. There are persistent signs that governments have been looking to diversify their holdings by adding euros, gold, Canadian dollars and whatever else they can think of.

If you're looking for lessons for your own portfolio in Gross' strategy, this is the first one: Gross isn't waiting until June to see how big a bite the end of QE2 will take out of his portfolio. He's moving now in anticipation of the end of the Fed's bond-buying spree. Investors who are concerned about what will happen when QE2 comes to an end can't wait until June to protect the value of their bond portfolio. If they do, they're likely to find themselves selling into a market that has already anticipated their fears.

So what's Gross doing with the money he's taking out of U.S. government debt? Pimco Total Return -- and remember that it's the best-performing bond fund in its class over the last 15 years, according to Morningstar -- is now positioned in debt backed by U.S. mortgages, corporate bonds, high-yield (aka junk) bonds and emerging market debt. And he has 23% of the fund in cash or cash equivalents.

Maybe those don't strike you as the most attractive alternatives to U.S. government debt. Maybe the idea of sitting in cash equivalents making a 0% return isn't your idea of a good time. But here's the second lesson: What you pay for what you own is as important as what you own.

Hey Readers,

Like I wrote last week, this is significant. Come June and July (maybe sooner) buyers of U.S. Treasuries are going to be in short supply. I want you to consider the $17 trillion U.S. Gov't debt at five percenr, or higher, rates. Soon we'll be in the same dilemna as Japan.

Chad in CO

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[BRIEFING.COM] Stocks may have settled in the red, but the loss was only about half as bad as what it could have been. ... More

Is your boss a bully?

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