Big changes are afoot at Pimco Total Return Fund. As the latest report (August 31, 2011 see link below) indicates, Pimco is changing course to go long and to go home to government securities. Both are big changes from earlier this year.
This report from one of my favorite blogs, Zero Hedge, fleshes out the details [emphasis added]:
…As the just released latest monthly Total Return Fund data indicates, PIMCO now has a substantial net long position in Government Related securities, at $51.5 billion (net of swaps), a more than 100% increase from the $22.1 billion in July (and a far cry from the $9.6 billion short in April).
That’s a big boost in government securities. The question is why are they doing this? The ZH folks believe this is a ‘tell’ or an indication that Gross believes the Fed is going to intervene in the bond market in a big way by buying long maturity bonds. That makes sense, but there may also be a simpler explanation, which I’ll get to in a moment. ZH continues with thoughts on what the latest Fed intervention — Operation Twist or Torque or whatever it will be called — will do:
…the Fed is about to re-enter the securities market to prevent the latest re-depression with Operation Twist if not much more. So while it no longer makes sense to be short bonds (as Gross has figured out the hard way), what makes sense is to be very, very long duration, since this is what the Fed will be buying in Operation Twist/Torque.
Earlier this year, Gross openly moved out of U.S. Treasury holdings and made a bet on higher interest rates. That did not happen. However, as all good portfolio managers do, when he’s wrong, he changes course. Now, he has done that in a big way by going long and going back into government securities. ZH continues with a discussion of changes in the duration or average weighted maturity of the portfolio:
…average holding duration, which from 4.56 in July, has soared to 6.27 in August, the highest since 6.23 in October, and possibly the highest on record (that said our records only go back to 2007)…
Pimco Total Return is changing its portfolio in two ways:
- Duration: First, it is extending the duration to go long. And, make no mistake, a duration of 6.27 years is at the long end of the range for this fund. I chatted with Kevin Winters of Pimco to get some clarification about the fund’s duration policy. The policy is to operate in a range of up to two year over (or under) the Barclays Capital Aggregate Bond Index. Currently, the BarCap Aggregate is about five years, so Pimco could actually go up to seven years duration.
- Government securities: The second portfolio change is that the fund is moving more aggressively into U.S. government securities.
Both lengthening duration and moving strongly back into government securities are big changes from earlier this year. The question I asked myself is why are they making these changes? The ZH folks believe this is a ‘tell’ that Gross believes the Fed is going to intervene in the bond market in a big way. That makes sense, but there may also be a second and more important explanation.
Fed intervention for a weak economy
Why would the Fed intervene in a big way? Because the economy is slowly grinding to a halt. I disagree with the Fed’s past interventions, so I am not a fan of QE I, II or a potential QE III. Nonetheless, the only reason I can see for a potential Fed intervention is to shore up a weak economy.
I suspect that Pimco and Gross are not just thinking about Fed intervention, but rather they are changing their economic outlook. In other words, with the economy weakening, inflation is likely to remain constrained and interest rates will be soft. Therefore, both scenarios — Fed intervention and a weakening economy — warrant a longer portfolio duration.
Here is a link to Pimco Total Return’s stats through August 31, 2011.
Disclosure: Kurt Brouwer owns shares in Pimco Total Return (MUTF:PTTRX)