NEW YORK (Reuters) - Bill Gross, manager of the world's largest bond fund at Pimco, said Wednesday his firm estimated the Federal Reserve's long-term neutral policy rate at 2 percent, which would indicate lower returns on assets but a lack of financial bubbles.
Gross, whose Pimco Total Return Fund has $232 billion in assets, said the focus on the future "neutral" federal funds rate would be critical for finding value in all assets.
"At PIMCO, we believe that this focus on the future 'neutral' policy rate is the critical key to unlocking value in all asset markets," Gross said in a monthly letter to investors titled, "Achoo!"
Gross's prediction of a 2 percent neutral long-term fed funds rate is half the 4 percent median forecast of Federal Reserve policymakers for the rate in both March and December.
The co-founder and chief investment officer at Pimco said that while a 2 percent neutral long-term fed funds rate would result in lower returns on financial assets in future years, it would also suggest lower volatility in bonds and a lack of financial bubbles across asset markets.
"PIMCO believes 2 percent neutral is closer to the mark," Gross said. "If so, asset markets are not bubbly, just low returning."
Financial bubbles are created when asset prices surge above their underlying fundamentals, risking a freefall as the bubbles burst.
He said bonds would be "attractively priced" rather than "artificially priced" if the long-term neutral policy rate is 2 percent.
Bond investors, in particular, could draw comfort from the likelihood of a 2 percent neutral long-term policy rate, Gross said, partly because such a rate would keep inflation fears muted.
"Instead of facing a nearly 100-percent certain bear market currently forecast by market mavens, bond investors could draw some comfort from a low returning yet less volatile future," he said.
Investors with an appetite for higher returns should seek alternative assets, hedge funds, levered closed-end funds, and a higher proportion of stocks versus bonds in a personal portfolio, Gross said. He added Pimco could also turn a total return bond portfolio into a higher-returning asset.
"Portfolio managers at PIMCO who understand this can also transform a total return bond portfolio into a higher returning asset," Gross said.
The Pimco Total Return Fund is up just 1.85 percent this year, trailing 83 percent of its peers, according to Morningstar data. Analysts have said the fund's overweight position in shorter debt and its underweight position in long-dated bonds have hurt performance this year.
The Federal Reserve will announce its latest policy decision at 2:00 p.m. EDT (1800 GMT). It is expected to maintain its reduction in monthly bond purchases that have kept rates low for several years, and signal that rate increases are still far off in the future.
Pacific Investment Management Co, a unit of European financial services company Allianz SE, had $1.94 trillion in assets as of March 31, according to the firm's website.