Question for Bill Gross

Chidem Kurdas

If PIMCO Total Return Fund, in which I’m an investor, were a hedge fund, I would call the manager to ask about a topic that’s on my mind. But Total Return is a mutual fund and as a little denizen of the mutual fund world, I don’t think I’ll get Bill Gross on the phone. Hedge funds cater to clients in a way mutual funds don’t. Of course, hedge fund clients are large investors and there are relatively few of them.

Anyway, my question arose from looking at the most recent data on debt and realizing how drastically Mr. Gross has cut Total Return Fund’s holdings of US government paper, which accounted for nearly one-fourth of the fund only a few months ago.  

What are you buying now? That’s the question and I did get hold of a hedgie and asked him. He said he does not buy and hold debt in the sense Total Return does. The hedge fund has an arbitrage strategy. Well, maybe arbitraging between durations, etc. is the best way to go in the current market.

But I’m not sure that a giant fund like Total Return can arbitrage successfully, except around the edges. Its $237 billion assets are orders of magnitude larger than even the largest hedge fund. In any case, millions of Americans nearing retirement will need to hold increasing amounts of bonds so as to reduce their exposure to stock market gyrations.

So what is Mr. Gross buying? Mostly corporate bonds, I’d say, since there is not much of an alternative. Commercial mortgages and commercial paper are shrinking. But there is a lot of corporate bond issuance. Household debt, including mortgage debt, continues to shrink as families de-lever.

Government issuance, of course, is still growing phenomenally—just in fourth quarter 2010, federal debt rose 14.5% and state and local government debt went up by 8%.  Those numbers show why Mr. Gross has a highly uncertain view of the future.

“A successful handoff from public to private credit creation has yet to be accomplished, and it is that handoff that ultimately will determine the outlook for real growth and the potential reversal in our astronomical deficits and escalating debt levels,” he writes. “If on June 30, 2011 (the assumed termination date of QE II), the private sector cannot stand on its own two legs … then the QEs will have been a colossal flop.”

If that happens, will corporate bonds provide a sanctuary? I ask the hedgie, but he’s already turning away, muttering something about arbitrage.

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