Lessons from Bill Gross's "Mistake"
Bill Gross, manager of the world's largest bond fund at Pimco, engaged in a bit of self-flagellation this week, acknowledging that his highly publicized bet against Treasury bonds early this year was, in hindsight, a "mistake."
When 10-year Treasurys were yielding 3.5 percent in January of this year, Gross said that they were "the most overvalued bond in the universe" as he made a well-publicized decision to bet against U.S. debt going forward. Since then, Treasury bonds have rallied, and their rising prices have pushed yields even lower -- falling briefly below 2 percent this month -- which has caused the year-to-date return of his Total Return Fund to rank near the bottom of its peers. Over the past three months, the fund has trailed its benchmark by nearly three percentage points.
So what lessons should investors draw from Gross's experience?
- It's hard to know more than the market does. Gross was far from alone in expecting interest rates to rise. Investors could scarcely turn on the television without hearing some discussion of a bond market bubble. And indeed, with interest rates near historic lows, it seemed logical to assume that they had nowhere to go but up. But the economy stumbled, forcing the Federal Reserve to keep rates lower much longer than anyone anticipated a few months ago. Further, stock market volatility caused more investors to seek the shelter of Treasury bonds, which further reduced their yields. It's tempting to give in to your gut when all logic seems to dictate something is inevitable. But as John Maynard Keynes said, the market can remain irrational longer than you can remain solvent.
- Don't be afraid to admit mistakes. When handed a defeat such as Gross's, it's tempting to come up with a rationale that explains away our failure. For instance, a gambling friend of mine has never made a lousy football bet in his life -- all of his losses were attributable to fluke plays that he's never seen before in his life or horrible calls by the referees. Of course, that's just our way of protecting our ego. As my colleague Larry Swedroe has said, when we hit on these bets, it's because of our wisdom. When we don't, it's because we were undermined by something that was completely unknowable beforehand. But an ability to acknowledge our fallibility -- as Gross did -- can provide some much-needed temperance the next time we're ready to load up on a sure thing.
- You never know when active management will cost you. Bill Gross is paid handsomely to make these sorts of bets, and his track record indicates that he's been right more often than he's been wrong. But when you choose to bet on active management, you're wagering that a manager's past record is indicative of his future performance. Now is Gross's recent stumble a mere speed bump in an otherwise stellar career? Perhaps it is. But investors who made the same bet on Legg Mason's Bill Miller -- who had a similarly long and impressive record of performance -- three years ago have watched as that speed bump morphed into a career-derailing period of woeful underperformance. You never know when you manager's skill will desert him, but the truly scary part is that it's the rare manager who retires with his reputation -- and stellar track record -- fully intact.