The old abnormal: How even PIMCO's Bill Gross can err

Fri Jan 6, 2012 12:33pm EST

Jan 6 (Reuters) - No matter what theme you adopt in a market forecast, predictability has always been a bugaboo. Just ask Bill Gross, the legendary manager of the PIMCO Total Return bond fund.

Gross's $244 billion baby saw at least $5 billion in assets flee in 2011, more than $1.4 billion in the fourth quarter alone. Relative to the size of his fund, this is a notable vote of no confidence ().

Investors voted with their money because of Gross's bet against U.S. Treasuries last year. Like many of us, he digested the headlines and became dyspeptic over the Congress defaulting on its debt, sluggish economy, the S&P credit downgrade and euro zone debt woes. Yet what actually happened didn't follow Gross's "new normal" script. Instead we got the "old abnormal" of unpredictability.

While none of those perils can be dismissed - nobody is out of the woods - something odd happened. U.S. debt remained a safe haven and even more money flowed into Treasuries, which became the best-performing bond class and returned 17 percent last year.

In the second half of last year, U.S. Treasury prices climbed, while hot money fled European paper. It wasn't too long ago that the euro was seen as a respectable currency while the buck was being battered. Gold, that ultimate nervous Nellie insurance policy, also went south for a while.

"The 'new normal' thesis at PIMCO was predicated on a low interest rate environment dragging safe bonds down as investors sought higher-yielding opportunities elsewhere," said Jeff Tjornehoj, director of research at Lipper, a Thomson Reuters company. "That was reasonable in 2009, but started to fade in 2010 and was completely undone in 2011 as credit conditions in European banks deteriorated and investors rushed to safety."

So it's time to question whether Bill Gross is on target with his new "paranormal" theory and more importantly, if active managers can consistently predict market movements and protect your wealth.

Is Gross still on track? Here's what he said in his most recent "Investment Outlook" ():

"For 2012, in the face of a delivering zero-bound interest rate world, investors must lower return expectations. 2-5 percent for stocks, bonds and commodities are expected long term returns for global financial markets that have been pushed to the zero bound, a world where substantial real price appreciation is getting close to mathematically improbable."

Of course, Gross has forgotten more about bond trading than I'll ever know, so his long-term record is worth respecting. His cautions are still valid. But actively managing money becomes nettlesome because the future is as slippery as a politician's promise. What's predicted doesn't always transpire; if you make big bets, you can suffer big losses.

The larger question for investors is should you even bother with an active manager making periodic wagers based on theories that may not hold water?

Would you be better off in passive bond-index funds like the Vanguard Total Bond Market ETF or the iShares Barclays Aggregate Bond fund, which I hold as a U.S. broad-market bond proxy in my 401(k) portfolio?

Passive investing usually makes more sense since you avoid the high costs and frequent missteps of active managers. As of the last Lipper research report, Gross's PIMCO Total Return fund finished in the bottom 12 percent of its category, posting a 4.15 percent return. That's compared to a 6 percent average performance for its peers.

That's why a passive strategy still makes sense. The Vanguard fund, for example, samples a fairly static basket of U.S. government-based mortgage bonds, Treasuries, corporates, utilities and a touch of non-U.S. paper. It charges 0.11 percent annually for management. The PIMCO fund has an expense ratio of 1.15 percent annually with a costly 430 percent turnover rate, indicating high trading costs that are passed along to investors.

As for predicting the market going forward? Be cautious and hedge any large position in bonds (European or American), stocks and metals. The only guarantee is that big financial events often follow an abnormal course.

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The author is a Reuters columnist. The opinions expressed are his own.

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