Anyone with a dime invested knows about the emotional aspect of financial markets.
A recent investor behavior study by research firm Dalbar shows that the average equity investor has seen a return of just 2.3% annually over the past 20 years, underperforming the S&P 500 by an annual average of 4.3%.
The culprit? About half of the shortfall in returns -- 45% to 55% -- is due to psychological factors like fear of loss and following the herd, according to the study. Individual investors are notorious for emotional investing like irrational exuberance or panic selling. In fact, in 2012, investors trying to time the market guessed right just 42% of the time -- worse odds than a coin flip.
But investing in bonds is different, right? Many investors follow stocks passionately while the fixed-income portion of their portfolio sits there collecting dust. The same Dalbar study shows that the average fixed-income investor has underperformed the aggregate bond index by an annualized 5.6% over the past 20 years.
That's where Bill Gross, the "bond king," comes in.
Bill Gross' Bio
Bill Gross graduated from Duke University with a degree in psychology in 1966. After serving in the Navy, he received an MBA at the UCLA Anderson School of Management. In an interesting twist, Gross played blackjack professionally in Las Vegas before joining Pacific Mutual Life as an investment analyst and earning his chartered financial analyst designation.
Back then, the bond market was a place for buy-and-hold and used exclusively as a lower-risk alternative to stocks. Investors didn't expect their bond portfolios to return much, but the returns were safe from the ups and downs of Wall Street.
|Bill Gross has used his keen strategic ability to beat the market for almost three decades.|
In 1971, Gross, along with Bill Podlich and Jim Muzzy, persuaded Pacific Mutual to let them actively manage the bond fund in a separate account and formed the Pacific Investment Management Co. PIMCO has grown to over $2 trillion in assets under management and is the world's largest bond investor.
The PIMCO Total Return Fund, which Gross has managed since 1987, has returned an annualized 8.3% over that period, consistently beating both bond and equity indexes, and earned Gross Morningstar's Fund Manager of the Decade for 2000-2009. The company launched the PIMCO Total Return ETF (NYSE: BOND) to track the mutual fund in February 2012.
Bill Gross' Investment Strategy
Unlike many who have achieved the rank of guru in the investment community, Gross' fame isn't due to a handful of notable bets but a long track record of success. Gross has used his keen strategic ability to beat the market for almost three decades.
Gross' success revolves around developing a three- to five-year secular outlook and then structuring the portfolio to take advantage of short-term mispricings. For example, the economy's inability to strongly respond to the Federal Reserve's four-year attack on interest rates and attempts at quantitative easing (QE) has led Gross to predict that a "new normal" will persist in lower than expected returns and volatility over the foreseeable future. This has prompted him to shift his portfolio to higher-quality bonds with shorter maturities that won't react as negatively to increases in rates or inflation.
On top of this secular outlook, Gross tactically shifts the portfolio to sectors that he thinks have gotten too cheap or too expensive.
Bill Gross' Portfolio: What's He Holding Now?
Gross has made it known exactly what kind of danger bond investors are in. Recently (on April 29, to be exact), he called an end to the 30-year bond bull market but said the bear market might not yet be among us.
Gross writes a monthly newsletter that explains how his total return fund is adjusting its positions, along with what has added to or detracted from its recent performance. With his long-term view of weak markets and central bank-manipulated yields, Gross is seeking bond returns in quality names with short maturity.
PIMCO Total Return ETF's Top 10 Holdings
He has increased his exposure to emerging-market government bonds issued in the local currencies, for two reasons. First, the bonds pay higher yields because of the perceived risk though many of these large countries have a stronger financial position that their heavily indebted developed peers. Second, the bonds also benefit the dollar-based investor as the Fed continues to print money and debase the greenback. Central banks in emerging-market countries do not typically run quantitative easing programs because of the inflationary and credibility risks. This means these currencies should do better against the dollar for the foreseeable future.
Action to Take --> Investors who want to follow Bill Gross should consider two approaches.
To mirror Gross' move into emerging-market bonds, consider an ETF like the WisdomTree Emerging Markets Local Debt Fund (NYSE: ELD), which holds the local currency debt of 15 countries with 41% in Asian markets, 30% in Latin America and 27% in Europe, Middle East and African countries. Most of the debt is BBB or A-rated, and the fund pays a 4% dividend yield.
Gross has recently increased the Treasury holdings in his portfolio as he has become more vocal on the effect of the Fed's rate policy and QE program. Investors could follow this move with the iShares Barclays 20-year Treasury Fund (NYSE: TLT).