Bill Gross: Highest Level Of Market Risk Since 2008

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About: Janus Henderson Global Unconstrained Bond Fund A (JUCAX), Includes: BAC, C, JPM, USMV, VNQ, WFC
by: Bram de Haas
Summary

Bill Gross warns about market risk at the Bloomberg Investment Summit.

He believes the level of risk in the markets is high due to central bank created money seeking returns.

Money is pushing up bond and stock prices.

Gross portfolio reflects his views on Yellen's next moves.

With Bill Gross warning us market risk is at the highest level since 2008 it seems to be an opportune time to revisit a review of Gross' portfolio, managing the Global Unconstrained (JUCAX), I did in the beginning of this year. Here's a short clip from the Bloomberg Investment Summit:

In January I summed up Gross approach as follows:

-Keep an extremely safe core (10% cash and very short term high quality corporate/agency bonds)

-Avoid/underweight medium term bonds

-Aim for low duration because of the level of interest rates

-Accompany a very secure core with very risky investments

-If you think interest rates won't rise or rise much slower than anticipated borrow heavily in a way that's non-recourse to your portfolio

The graphic below shows a breakdown of the bond maturities in his portfolio around January 2017.

Source: Morningstar / JUCAX 2017

Back then Gross heavily overweight short maturities to the tune of having 64% of bonds in the 1-3 year category compared to the 17.9% average. His portfolio clearly reflects Gross has updated his views as well as his competitors:

The Morningstar data shows a decline in the 1-3 year allocation but that's been accompanied by what's now a 32.2% cash position. Cash yields pretty much nothing so you have to understand this is an extremely brave position for a portfolio manager. The easiest thing is to just stick your investors into bonds to ensure you don't underperform peers to much. Gross did tell Bloomberg he feels required to stay invested. That suggests he would rather hold even more cash...

The unconstrained category is where managers have a lot of freedom to do what's best in the current climate as opposed to what's within their mandate. It's very interesting to see the entire category aggressively shifting towards short maturities.

Gross is ahead of the pack. The effective duration of his portfolio went down from 0.6 to -0.17. A duration of 1 indicates a portfolio will lose 1% of value when interest rates move up and gain 1% in value when interest rates move down. Gross would now be gaining if Yellen moved up rates. That's not to mention the advantage 32.2% of cash would give him after bond prices at longer maturities go down. This seems like a clear pivot from "interest rates will remain low for longer" to "interest rates hikes may well surprise to the upside".

Understanding and anticipating possible interest rate moves is an important part of being a bond fund manager. Gross managed an enormous bond fund at Pimco and did so very skillfully.

Takeaways

It looks like positioning for interest rates hikes is becoming a very pressing matter right now. In this environment I would be very careful about REIT type exposures like the Vanguard REIT ETF (VNQ), got rid of any utilities some time ago and shorted European sovereign bonds at all maturities as well as shorting a low volatility ETF, like the iShares Edge MSCI Min Vol ETF (USMV) but which ticker isn't available on Seeking Alpha. It functions as a bond equivalent. Once the longs discover these low yielding stocks are NOT bond equivalents there will be a self-reinforcing cycle downwards as people will get rid of them in short order.

The most important thing is to avoid some of the most vulnerable holdings.

Buying Bank of America (BAC), Citigroup (C), JP Morgan (JPM) and Wells Fargo (WFC) is a more positive way of expressing a view interest rates will continue to go up. Also read: Buy Big Banks Now.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.