It was not long ago that Pimco Total Return Fund (PTTRX; PTTDX) had a pretty hefty position (18% or so of the portfolio) in debt or debt futures from developed countries. Most of this was in countries such as Germany and Canada. In his monthly investment commentary, portfolio manager Bill Gross discussed avoiding countries that were in what he dubbed 'the Ring of Fire' (see chart below). Gross was writing about national debt and the ‘ring of fire’ analogy comes from this section in his February Investment Outlook [emphasis added]:
The Ring of Fire (PIMCO, Feb. 2010, Bill Gross)
…The most vulnerable countries in 2010 are shown in PIMCO’s chart “The Ring of Fire.” These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years’ time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth…
In that February letter Gross went on to praise Germany:
…Germany is the safest, most liquid sovereign alternative, although its leadership and the EU’s potential stance toward bailouts of Greece and Ireland must be watched…
A few months later, Pimco Total Return and Gross seem to have changed the tune from Ring of Fire to Born on the 4th of July. In fact, the giant bond fund has come back to the USA. The developed country holdings are down considerably from the high double digits to single digits. What’s up?
European debts & doubts
I suspect this move on the part of Pimco is really just a move away from Europe. The big issue is that the euro looks weak and the European Union and European Central Bank have not dealt with the problems of sovereign debt in a way that portends progress.
From Pimco’s web site, here is an excerpt from a Q&A with Pimco’s head of European portfolio management [emphasis added]:
Q. How does PIMCO’s secular outlook for the eurozone translate into investment strategy?
A. …Given the range of possible outcomes, we remain cautious on European sovereign risk. The government interventions may eventually be successful in bailing in private sector investors. But because these interventions have been focused on liquidity provision and also given the multiple challenges and the wide range of possible outcomes, we think it is prudent to remain underweight European sovereign risk and to wait for evidence that countries with stressed debt dynamics can deliver on fiscal consolidation without undermining growth in their economies.
We will look both within and beyond Europe for higher-quality securities where we think we can achieve similar or superior risk-adjusted returns. We remain positive on core duration and German bunds. But given the potential for eurozone governments or the ECB to be drawn deeper and deeper into providing support, we do not see German bunds as offering significant advantages over the secular horizon compared with U.S. Treasuries…
That seems pretty clear to me. Even the best of Europe’s bonds (German bunds) don’t look all that good compared to U.S. Treasuries, government agency bonds, and so on. In addition, I suspect the Pimco brain trust still thinks there is more weakness ahead in the euro.
Disclosure: Kurt Brouwer owns shares in Pimco Total Return [PTTRX].