Over almost half a century, Gross, the “Bond King,” transformed the fixed income market. His Pacific Investment Management Company, LLC (PIMCO) flagship Total Return Fund peaked at close to $300 billion, and during his tenure he outperformed his benchmark by 140 basis points.
After Gross abruptly left PIMCO at the end of 2014 in a mutinous coup, he joined Janus Henderson Group. That’s when his mastery started to fade.
At Janus, Gross was given carte blanche to run a Global Unconstrained Bond Fund. He wasn’t shackled by any benchmark and was free to roam anywhere to capture returns.
His big bet was that the gap between the U.S. 10-year Treasury bond and the German Bund would narrow. It remained wide, and he remained stubborn.
After four years of underperforming his peers and even lagging cash, investors were withdrawing funds. He was quickly reduced to only managing his own money.
Here’s how it all went wrong.
Global Unconstrained Averaged -0.17% over Cash Averaged 1.02%
Source: Janus Henderson, Fund Facts January 2019
Don’t Forget What You Know
Gross’ first big mistake was that he forgot what he learned early on from Ed Thorp.
Thorp, a Massachusetts Institute of Technology (MIT) mathematician, applied blackjack strategies to investing in his book, “Beat the Market.” His main thesis was that solvency depends on not over betting. The rule of thumb was to keep single bets under 2% of capital. A young Bill Gross was enamored, and validated the guidance first hand by winning at Vegas blackjack tables.
At PIMCO, Gross’ risk management approach was to keep single credit exposures under 2%. He was also tethered to a benchmark with internal controls, which kept his mismatches within reasonable tolerances and helped to avoid ruin.
But when he moved to Janus, Gross had no constraints. A risk budget seemed pedantic when asking the Bond King to find the best opportunities. Investors were queueing up to have a slice. George Soros, the legendary investor, kicked in $500 million!
Besides the bet on Treasury and Bund convergence, Gross was confident that interest rates would quickly rise. While the average global bond fund had a duration of positive seven, Gross was positioned at a negative four. When rates stalled and started to drop, his losses were extreme.
The Odds Are Against A Star’s Second Act
Janus’ stock surged 40% on the news that the Bond King would be joining the firm. But hiring stars is a tricky business.
Boris Groysberg, of the Harvard Business School, looked at the transition of 1,000 star equity analysts across firms (a group whose performance is profoundly transparent as they make public stock recommendations). A star was defined as a sector analyst ranked in the top four by Institutional Investor.
He found that not only does the star’s performance drop when they change firms, but so does the performance of their new associates. Groysberg concluded that skill includes some company-specific abilities, and until the transplant learns to work the new system their competency falls. That can take years.
At PIMCO, Gross was within earshot of experienced voices he’d known for years. Voices who weren’t afraid to tell him when he was wrong. At Janus, he didn’t move into their offices or assimilate with their teams, but set up in a remote office down the road from PIMCO. Sitting alone with your ideas certainly limits peer review!
Post-Crisis Macro Relationships Are Still Evolving
Gross had an uncanny ability at PIMCO to adapt and stay ahead of the markets. PIMCO’s macro view helped see through the noise and divine trends. But some of the old economic models and expected convergences have stalled since the financial crisis.
In today’s market structures, central banks are playing an oversized role: negative interest rates have become sticky, inflation remains muted even as unemployment hits lows, and Populism is becoming mainstream in many developed economies. There is even serious consideration that fiscal deficits don’t matter as Modern Monetary Theory (MMT) gains air time.
Gross bet heavily that sovereign bond relationships would start to revert. However, it is not happening quickly and as John Maynard Keynes said, “markets can stay irrational longer than you can stay solvent.”
In the old days Gross would have adapted and shifted from macro tilts to more micro trading of individual securities. However, his conviction didn’t wane until it was too late.
Gross’ final act is a sobering reminder for investors. Don’t compromise on risk management, grow your own talent, and stay alert as key macro relationships may have a new playbook. Even great investors can spectacularly misfire sometimes.
This material contains opinions of the author, but not necessarily those of Sun Life or its subsidiaries and/or affiliates.