Gross Errors
At the start of 2011, the yield on the benchmark 10-year U.S. Treasury Note stood at 3.29%, just above its 40-year low. At that level, it was hard to imagine it could decline much further. As a result, analysts and most investors planned to avoid bonds and look elsewhere for return. That seemed the reasonable response at the time.
The most notable adherent to this this theory was none other than Bill Gross, manager of Pimco’s flagship Total Return Fund. Mr. Gross made no secret that he was actively dumping Treasuries from his $240 billion fund which placed addition pressure the bonds.
But a funny thing happened on the way to December 31, 2011: The 10-year Treasury yield continued dropping, hitting a 60-year low of 1.67% in September. At the close of the year it wasn’t much higher, yielding just under 2%. Its value, which moves in the opposite direction of its return, continued to move up resulting in a better total return than most stocks. Throughout the year, Mr. Gross stuck by his guns, leaving the Total Return Fund’s total return well below that of its benchmark as well as other funds in the category.
Mr. Gross, and those who followed him, made a classic quantitative error: They relied too heavily on the future being like the past. This is a fundamental belief of quantitative investing, but it has to be tempered with the facts of the current environment. All else being equal, Treasury yields probably would have risen had the Federal Reserve not made clear it would do everything in its power to keep borrowing rates low. Active intervention in the market through quantitative easing and then later in the year through “Operation Twist” meant all else was not equal. Bond traders have an old saying, “Don’t fight the Fed,” and in this case, that’s precisely what Mr. Gross and his followers did.
There are several lessons to be learned here. Among them is the fact that following the current market guru is no guarantee of success. Even more importantly, investors shouldn’t blindly believe the future will be like the past when there are clear indications it won’t be.
Explore posts in the same categories: Current Environment, Mutual Fund Evaluation, The Investment Decision ProcessTags: 10 year treasury, benchmark, Current Events, mutual funds, treasury yields
You can comment below, or link to this permanent URL from your own site.
