The Black Box

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Speak of the devil: PIMCO's Gross Says Investors Should Shun Index Funds,Dlr

03/29/2006
Dow Jones News Services
(Copyright © 2006 Dow Jones & Company, Inc.)



By Eduardo Kaplan
Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--It's a rough world of low returns and flat yield curves for bond traders, even those in charge of the largest bond fund in the world.

But there is hope, says Bill Gross, managing director of PIMCO, for investors who understand that a new approach is required to deal with the changed investment landscape, namely staying out of indexed funds and dollar-denominated assets. PIMCO is one of the world's largest bond fund managers with over $500 billion in total assets under management

In his latest investment outlook, Gross says moving out of the known territory of index funds could create anxiety for investors, but it's a necessary step to find returns.

In a global bond market "devoid of historic risk premia", Gross says that "avoiding the tyranny of an index can in effect produce a higher return with less risk.

While Gross applauds the "democratization" and expansion of bond market, he also recognizes that competition from large participants such as central banks and hedge funds has made it much harder to find returns higher than 5% or 6%, and presents "investors with a rather diminished array of future returns upon which to feast."

"Successful money management has always depended on riding the wave of the crowd until it crests and crashes to the ocean floor," Gross writes, and the timing of such cycles is tricky.

"If an investor is being paid little to await his eventual demise then it seems he should rethink the proposition. If you're going to hell in other words, you might as well get paid for it and bond investors for the most part are not being paid today," Gross says.

"The restrictiveness of plan sponsor index guidelines should perhaps give way to a more flexible focus on divergent strategies that break the tyranny of adhering to the index mean," Gross writes.


End Of Carry Trade

The gradual but persistent rise in interest rates in the developed economies is draining some of the ample liquidity available to investors, prompting a change in strategies. One of the more well-telegraphed changes involves the so-called carry trade, where investors borrow in a low yielding currency such as the yen to invest in riskier assets with better returns such as emerging market assets.

Gross believes that the end of the quantitative easing by the Bank of Japan means that "the carry trade and importantly the existing level of the U.S. dollar versus the yen and almost all currencies is at risk. As global real interest rates converge, the export potential of comparative economies should begin to dominate exchange values and it is there, of course, where the U.S. is so critically deficient," Gross says.

The biggest potential loser in this new environment is the U.S. dollar, a point that investors should consider when comparing assets. Gross says a "blanket" acceptance of dollar-denominated assets seems excessive.

"The real long-term risk in my opinion, is in holding dollars, and if so, absolute returns in global purchasing power will suffer if they are held," Gross writes.

-By Eduardo Kaplan; Dow Jones Newswires; 201 938 2161; [e-mail]


(END) Dow Jones Newswires

03-29-06 1311ET

Copyright (c) 2006 Dow Jones & Company, Inc.