UPDATE 1-Pimco Total Return cuts mortgage, U.S. gov't holdings on Fed outlook

Tue Mar 11, 2014 8:34pm EDT

(Adds detailed background of portfolio, Gross tweet, analyst comment, byline)

By Sam Forgione

NEW YORK, March 11 (Reuters) - The Pimco Total Return Fund, the world's largest bond fund, slashed its holdings of mortgages in February to the lowest level since at least late 2011 on bets that the Federal Reserve will conclude bond purchases this year, data from the firm's website showed on Tuesday.

The fund, which has $236 billion in assets and is managed by Pimco co-founder and co-chief investment officer Bill Gross, cut its mortgage holdings to 29 percent in February from 36 percent in January, and trimmed its U.S. government-related holdings to 43 percent in February from 46 percent in January.

On March 7, Gross tweeted that investors should "Sell what the Fed has been buying because they won't be buying them when Taper ends in Oct," he said.

The Federal Reserve, responding to a broad drop in unemployment and a pick-up in economic growth, is now buying $65 billion in bonds each month to reduce longer-term borrowing costs and stimulate investment and hiring. The stimulus program started in 2012 and continued until December 2013 at an $85-billion pace.

The Pimco Total Return Fund's asset allocation is important because Pimco manages roughly $1.9 trillion and is one of the world's largest bond managers.

More importantly, several U.S. institutional investors said they are closely monitoring the overall developments at Pimco in the wake of Mohamed El-Erian's abrupt resignation as CEO and ensuing acrimony between him and Gross.

In February, Gross's flagship Pimco Total Return Fund had $1.6 billion of net outflows, its 10th consecutive month of outflows, and it lagged 69 percent of its peers with a return of just 0.52 percent last month, according to final figures from Morningstar. In 2013, it suffered a negative total return of nearly 2 percent.

The Total Return Fund left its U.S. credit exposure, which may include both high yield as well as investment grade securities, unchanged at 9 percent.

Eric Jacobson, Morningstar senior analyst, said: "As usual, the fund was very underweight U.S. investment grade corporate bonds. That would have been a detriment given that the overall investment grade corporate index returned 104 basis points for February, and returns were better the farther down you went on quality."

The fund also cut its effective duration to 4.71 years in February from 5.05 years. Jacobson said the fund's shortening of duration and meaningful underweight to bonds maturing in more than 5 years and all the way out the yield curve "would probably have been a very meaningful detriment to returns because the 20-plus sector of the Treasury index returned 85-plus basis points for February."

In February, benchmark bond prices stabilized, with the yield on the 10-year U.S. Treasury note ending the month roughly unchanged at 2.66 percent on some weak U.S. economic data and geopolitical tensions in Russia and Ukraine.

Pimco said on its website that its holdings of U.S. government-related securities may include nominal and inflation-protected Treasuries, Treasury futures and options, and interest rate swaps.

The fund also showed zero exposure to money market and net cash equivalents in February after showing a negative 8 percent exposure to the category in January. Pimco defines money market and net cash equivalents as liquid investment grade securities with duration less than one year.

In having a so-called negative position in cash equivalents and money-market securities, it is an indication of using derivatives and short-term securities as collateral in order to boost the fund's buying power with leverage.

The fund increased its holdings of non-U.S. developed market securities, to 9 percent in February from 7 percent in January, the highest since April of last year.

The fund kept its holdings of emerging markets securities unchanged at 6 percent in February and its holdings of "other" securities unchanged at 4 percent.

The firm said "other" securities may include municipals, convertibles, preferreds, and Yankee bonds.

Gross said in his March letter to investors that returns on risk assets will depend on whether central banks such as the Federal Reserve can sway investors that their easy money policies are stimulating economic growth. He said the success of the Fed's recent move toward more "qualitative" guidance on the economy would be critical. [ID: nL1N0M11FY]

The Newport Beach, Calif.-based Pacific Investment Management Co. is a unit of European financial services company Allianz SE. (Reporting by Sam Forgione; Editing by Jennifer Ablan and Ken Wills)