A prolonged low interest rate environment will start pushing investors into choices they wouldn't normally make, Pimco's Bill Gross said in his latest letter to investors.
In a highly debt-laden world where the Federal Reserve will have no choice but to keep rates low, Gross said investors looking to fixed income and cash investments will find their returns going forward low by historical standards.
As a result, they'll have to go outside their normal choices and traditional allocations to find opportunities.
He expects a world in which 2 percent is considered the "neutral" interest rate that helps keep debt costs low while staving off inflation. That's good for debtors but rough on those—such as pension fund managers and savers—who look for higher cash returns to meet their objectives.
According to Gross:
Most pension funds assume 7–8 percent total returns in order to fund future retirement liabilities. Investors want their "cake," priced at current market prices, but they want to "eat" future returns of near double-digits. That won't happen with a 2 percent neutral policy rate.
Consequently, they'll start looking beyond normal portfolio parameters and seek higher returns elsewhere.
Still there are ways to fight back – most of which involve taking different risks than you may be commonly used to taking: alternative assets, hedge funds, levered closed-end funds, a higher proportion of stocks vs. bonds in a personal portfolio...All of these alternatives are potentially higher returning assets in a world of 2 percent policy rates where cash is a poor performing asset, but likewise a cheap liability that can be borrowed to an investor's advantage.
Gross has become all too familiar lately with performance problems in a low-rate environment.
Pimco's flagship Total Return mutual fund—with $232 billion in assets the largest in the world—has returned just 1.2 percent in 2014, below the 1.84 percent from the benchmark Barclays U.S. Aggregate Bond index. The fund also has seen heavy investor outflows
For the full Gross letter—it opens with a 447-word riff on sneezing—go here.