As Bill Gross sees it, investors face a tough time ahead trying to pick places to put money in a world where basically everything is mispriced.
Central banks that have kept rates low have helped boost asset prices, but the landscape will be different now that stimulus from the Federal Reserve and elsewhere is losing its impact, the Janus Funds portfolio manager said in his latest missive to clients.
Investors need to determine where the Fed and other central banks will keep rates in balance with economic growth—a number that Gross calls the "new neutral" and which he expects to stay around 2 percent from its current zero peg for the foreseeable future.
"The lower real rate/capital gains ocean liner has taken us into uncharted waters, but waters, which we must know, that are hostile to investors," he wrote in an examination of what future policy rates will have to be in light of the outlook for slow growth. "Knowing how to maximize return versus risk in these new waters will be key. There are at least several approaches, any one of which may be the correct one."
Gross himself knows how tough things have become.
The $1.4 billion Janus Global Unconstrained Bond Fund has languished since he arrived at the Denver-based firm, to much fanfare, to run it a year ago.
In 2015, the fund has gained about 1.09 percent, trailing the Barclays U.S. Aggregate Bond Fund, which is up 1.61 percent. That's a little better than the , which turned negative for the year in Wednesday's decline, but only around the middle of the rest of his competitors. By comparison, the $124.7 billion Pimco Total Return Fund, which has been hemorrhaging investor money since Gross left—its assets under management are down from the April 2013 peak of $292.6 billion, according to Morningstar—is up 2.12 percent year to date.
On the road ahead, Gross suggests fixed income investors bet against volatility in interest rates. For instance:
The most attractive opportunity to me rests with the notion that (European Central Bank President Mario) Draghi's 18-month (quantitative easing program), which roughly purchases 200 percent of sovereign net new issuance during that time, will keep yields low in Germany and therefore anchor U.S. Treasuries and UK Gilts in the process. I would not buy these clearly overvalued assets but sell "volatility" around them, such that much higher returns can be captured if say the German 10 year Bund at 20 basis points doesn't move to –.05 percent or up to .50 percent over three months' time.
However, even this strategy has its risks. Gross said his Janus fund is close to what Ray Dalio is doing at Bridgewater Associates—believing that if borrowing costs were going to remain cheap, then investors can continue to use leverage to generate returns:
Cheap leverage is an alpha generating strategy as long as short rates stay low and mimic the 0 percent real new neutral.
Of course if an investor borrows short term to invest longer and riskier, the potential alpha necessarily demands choosing the correct assets to lever. That is not easy these days since almost all assets are artificially priced. The challenge is to purchase the ones that might remain artificially priced over one's investment horizon.
For 2015, though, Gross would have better off making a bet on plain-vanilla long-duration Treasurys. The exchange-traded fund is up 4.21 percent this year, making it one of the year's better investment choices.