NEW YORK Pimco's Bill Gross, manager of the world's largest bond fund, said on Thursday the global economy has become difficult to stabilize and that investors should seek safety in shorter-dated bonds and inflation-protected Treasuries.
In his September letter to investors, Gross said central banks' easy money policies have become less effective in generating economic stability, and that zero-bound interest rates have threatened finance and investment in the "real economy."
"Why invest in financial or real assets if bond prices could only go down, and/or stock prices could no longer be pumped up via the artificial steroids of QE?," Gross said, in reference to stimulative policies like the Federal Reserve's $85 billion in monthly purchases of Treasuries and mortgage-backed securities.
Gross added that liquidity will be "challenged" when policymakers start to tighten easy money policies and stocks may also be "at risk" when the Fed ends its bond-buying program.
The Fed's stimulus, which is being implemented in an effort to spur U.S. economic growth and keep interest rates low, has been a major source of support for stock and bond markets. The benchmark S&P 500 stock index has risen about 16 percent this year.
The release of the latest minutes of the Fed's July 30-31 meeting offered few clues on the timing of a reduction in stimulus. Four Fed presidents said in August, however, that the central bank could begin reducing its bond-buying soon.
In the letter entitled "Seventh Inning Stretch," Gross said that the end of central bank stimulus challenges liquidity since mutual funds and exchange-traded funds, no longer benefiting from easy money policies, will "have only themselves to sell to."
Gross also said that, in light of economic instability and central banks' focus on "forward guidance," or the likely path of future interest rates, shorter-dated bonds are the most reliable investment. The Fed has held the benchmark federal funds rate in a zero to 0.25 percent range since December 2008.
"If unemployment and inflation rates can be at least closely guesstimated, then front-end yields become the most reliable bet in the ballpark," Gross said in the letter.
Fifteen of the Fed's 19 policymakers in June had not expected to start raising rates until 2015 or later. Gross, however, wrote on social media platform Twitter in mid-July that the fed funds rate - the U.S. central bank's benchmark short-term borrowing rate - is likely to remain at its current level until 2016 and is the "key to value."
Gross, whose flagship Pimco Total Return Fund is the world's largest bond fund with $251 billion in assets, said investors should seek shorter-dated Treasuries or credit, while also seeking longer-dated TIPS to protect against future inflation.
"Bond investors should focus on 'safer' front-end positions in Treasuries or credit space because of the Fed's shift to forward guidance," Gross said.
Assets in Gross's flagship bond fund have shrunk 14 percent in the past four months as a result of investor withdrawals and price losses, according to data from investment research firm Morningstar.
The fund has seen its assets fall from $292 billion at the end of April to $251 billion at the end of August. Investors have pulled about $26 billion from the fund since the start of May, while portfolio losses have amounted to roughly $15 billion over that period, according to Morningstar.
The price losses have come amid a selloff in the bond market on fears of an upward spike in interest rates once the Fed reduces its bond-buying.
On Thursday, the yield on the safe-haven 10-year U.S. Treasury note rose above 2.95 percent, its highest in more than 25 months. As yields rise, prices fall. That marks a sharp rise of well over a percentage point since May 2, when the yield stood at 1.62 percent.
Gross's big bet on U.S. government securities has hit his flagship bond fund, which is down 4.13 percent so far this year, according to the Pimco website. The fund had 39 percent of its holdings in U.S. government-related securities as of July 31.
The fund fell 1.07 percent in August alone, putting its performance above just 8 percent of peers, according to Morningstar.
The Pimco Total Return Exchange-Traded Fund, an actively-managed ETF designed to mimic the strategy of the flagship mutual fund, fell 0.68 percent in August, ahead of 24 percent of peers, Morningstar added.
Along with the limitations of banks and government in stabilizing the economy, Gross said in the letter that regulatory restraints such as Basel III, Securities and Exchange Commission fines, and criminal investigations have been negative for the economy.
The Basel III accord was drawn up to make banks more stable and reduce their risk after the 2007-09 financial crisis.
Gross is a founder and co-chief investment officer at Pacific Investment Management Co, a unit of European financial services company Allianz SE.
The Newport Beach, California-based firm had $1.97 trillion in assets as of June 30, according to the company website.
(Reporting by Sam Forgione; Editing by Nick Zieminski and James Dalgleish)