Performance Results and Measures of Greatness

This posting serves as a coda to the earlier series about The Bond King, a book by Mary Childs about Bill Gross and Pimco.  The previous chapters:

“Cult and Culture in the Bond Kingdom.”  The key personalities and organizational dynamics.

“Hunting for Edges that Others Didn’t See.”  Tools, tactics, and structural alpha.

“Challenges and Quandaries in Manager Research.”  Questions for manager research analysts based upon the Gross/Pimco story.

Performance

Any discussion of the performance of a fund involves complications, but let’s start with a simple chart of Pimco Total Return since its inception:

The return in the top panel is the relative performance of the institutional shares (PTTRX), which have been in existence the longest.  At the bottom are the total assets across all share classes.

Gross managed the fund from its beginning until that vertical line signaling his departure.  As you can see, the performance and assets were mostly up and to the right.

Some of the zigs and zags in the lines are illuminated by the happenings described in Childs’s book, particularly the strong performance (and growth in assets) coming out of the financial crisis — and the noticeably sharp bout of underperformance during 2011.

That was attributable to a significant, misguided bet against Treasuries. As was his style, Gross had widely promoted it.  But, wrote Childs, “Five months after he made it, Gross’s bold call was publicly, exceptionally wrong.”

Among the complications when considering performance is what the benchmark ought to be.  A long-standing issue with many of the leading bond funds is that they didn’t match up very well with the Bloomberg Aggregate (and its variously-named predecessors), yet it is the standard by which they have been measured.  The funds took on more risk than the index — by overweighting certain areas and investing in vehicles that weren’t in the index — which paid off given the bond-friendly environment that lasted for decades.

Notions of alpha

In 2019, Richard Dewey and Aaron Brown published a paper entitled “Bill Gross’ Alpha: The King Versus the Oracle.”  The “oracle” referenced in the subtitle was Warren Buffett.

The authors explained that determining the alpha delivered by Gross is different than doing so for an equity portfolio, because “fixed-income securities have much higher correlations with each other than equities, [making] alpha 4.5 times as hard to measure for Gross than Buffett.”

Using the Bloomberg Credit Index rather than the Aggregate, they found that Total Return “generated 1.33% per year of alpha, with a t-statistic of 3.76” during the time Gross managed it, although analyses by others show less robust results.

The paper is worth reading for its general points about the difficulties of judging alpha when it comes to bond portfolios.  For starters, the publicly-available information on portfolio holdings is usually incomplete.  Furthermore, the attributes of an index of bonds change over time in ways that stock indexes don’t — and the prices used (for an index and for a portfolio to be judged against it) “necessarily contain a mix of opinion and observation of arms-length transactions.”

Gross to Janus

After leaving Pimco just before he was pushed out, Gross moved to Janus to manage an unconstrained fund that had been started just four months before.  Here’s that fund (shown in a similar fashion to the chart above; it is now named the Janus Henderson Absolute Return Income Opportunities Fund):

The good performance did not carry over to his new firm, at least in terms of this benchmark comparison.  Gross did attract some assets, although the Wall Street Journal reported that half of the $1.4 billion of assets in the fund after Gross had been at the helm for a year were his own.  The underperformance of the fund in 2018 triggered strong outflows, and Gross retired for good in February of 2019.

The Total Return ETF

It was big news in 2012 when Pimco started an ETF with the same strategy as its widely-popular Total Return mutual fund.  (The original ticker, TRXT, was changed to the more iconic BOND after a month, and the Total Return name was changed to Active Bond in 2017.)  An interesting part of the book details the desire to have the ETF come out of the gate quickly.

This chart shows how successful the tactics were (there is more on that in the second posting in this series) by plotting the relative performance versus AGG (its natural competitor as the ETF that tracks its index) and the two main classes of the mutual fund.  After the sharp early rise, BOND has had minor changes versus each of them from then until now.

Gross in his own words

The monthly “Investment Outlook” pieces by Gross that drew so much attention from market participants have been removed by Pimco and Janus, but he has made many of them available online.  He has also written a book, which he rushed out shortly before The Bond King was published.

An article, “Consistent Alpha Generation through Structure,” was written by Gross for the Financial Analysts Journal in 2005.  While the phrase “structural alpha” didn’t appear within it, he detailed some of the elements of that concept.

They included “the use of financial futures or future-related investments and the successful placement of the residual cash into higher-yielding, slightly longer-dated investments,” which could add “20 bps a year without even breathing hard.”  Additionally, there were various categories of “selling of unlevered volatility,” including a greater use of mortgages (capturing the mispricing of the prepayment options embedded within them; 10 bps a year), options on Treasury futures and swaps (5-10 bps), and overweighting the front end of the yield curve versus an index (the value added from that was not specified).

At the root of those structural opportunities was that there are market participants who,

because of their inherent character or the role they play, provide profits to structural investors taking the other side of the bet.

Measures of greatness

Gross built Pimco and managed its lead portfolio during an unusual time in the markets.  The environment for bonds was benign, except early on in Gross’s career, before the Total Return Fund came into existence.  So was he a product of the times or a unique talent?

Both.

An important reminder, however, is that despite the fact that Gross is seen as the owner of the track record, the returns were the product of an organization, not one person.  The results at Janus may be evidence of what happens when you take the man out of the ecosystem.

That said, it in no way diminishes his accomplishments.  In their paper cited earlier, Richard Dewey and Aaron Brown said this of Gross:

He acquired investors and leverage, he ran his fund efficiently, he stuck with his high-risk principles even when they were going through bad periods, and he communicated so that his investors not only stuck with him, but gave him the funds to build the largest bond fund in the world.

Along the way, he and his firm changed how markets and the investment industry were structured, as others adopted the methods they pioneered.

That’s quite a legacy.  The Bond King is an important book, because it goes behind the scenes at Pimco, revealing plenty of drama even as it prompts questions for the asset managers of tomorrow (and those who evaluate them) regarding the best ways to build portfolios and organizations that succeed.