Bond King Bill Gross to Bond Funds: Drop Dead

Former bond king Bill Gross wants you to know bond funds are dead.

That may be a bit rich coming from a man who became a billionaire peddling bond funds to the masses. But it doesn’t mean he isn’t right.

Gross, who parted ways with long-term home Pacific Investment Management Co. in 2014 and retired from Janus five years later, takes particular aim at the notion of “total return.” The idea, which Pimco helped popularize, is that bond investors should focus not just on interest, but also on capital appreciation, much like stock investors focus both on dividends and stock prices.

The problem, says Gross in a recent essay on his personal website, is that the math is no longer in investors’ favor. When Gross popularized the total return idea in the 1980s, long-term Treasury yields were 15%. Since bond prices rise when interest rates decline, there was huge scope for price appreciation once rates started coming down.

These days, 10-year Treasuries are yielding 4.4%. That leaves a lot less room for error.

At the same time, bond investors have suffered significant losses in recent years as rates have increased. Gross says that while bond bulls have been arguing that rate cuts by the Federal Reserve will soon reverse the trend, investors shouldn’t count on that outcome.

One key reason is the growth in outstanding public debt, which increased by 10% last year. Ultimately, he argues, the fast-growing supply of Treasuries will make it difficult for long-term bonds to sustain a price rally, no matter what the Fed does.

“Those that argue for lower rates have to counter the inexorable upward climb in Treasury supply and the likely Sisyphean decline in bond prices,” Gross writes. “Total Return is dead. Don’t let them sell you a bond fund.”

Gross, who has always had a talent for being provocative and no longer has to worry about pitching his own bond funds to investors, has a point.

As he mentions, the Vanguard Total Bond Market Index Fund—a popular and representative fund—hasn’t just had one or two bad years. Its average annual total return is negative over the past five years. Half a decade is a long time to wait for retirees, especially considering bonds are supposed to be the most reliable part of a conservative investment portfolio.

Of course, most income investors probably aren’t sticking with bond funds because of their strongly held views on the yield curve or the pace of Treasury issuance. Instead, they have no other good options. Stocks remain volatile and offer measly average dividend yields of well below 2%. Alternatives tend to be expensive and illiquid.

One solution: Keep income-producing assets, including bonds, but do ditch the total-return mentality that Gross pioneered. To accomplish this, try to look past your portfolio’s overall performance numbers. Instead, simply invest enough of your assets in bonds and instruments like certificates of deposit to cover emergencies and coming living expenses. Put the rest in the stock market for the long term.

A bond or CD ladder, which involves buying a series of bonds with successive maturities, should help investors handle the fixed-income investments effectively. Short-term bonds—like the six-month Treasury bill, currently yielding 5.4%—will let you capture the highest possible rates. Longer-dated notes, like the five-year with a 4.6% yield, pay a bit less but offer several years of security in case rates fall or stocks enter a bear market.

In other words, think about bonds the way many investors did before Gross came along. Consider them not as an opportunity to squeeze a few extra performance points from your portfolio, but as a financial planning tool: a way to protect your savings and lock in income you need to cover your budget.

Write to Ian Salisbury at [email protected]