Bill Gross Explains Why He Is Now Shorting Credit
By Tyler Durden
One week ago, in an interview with Bloomberg, Bill Gross made a surprising announcement when he said that he was starting to short credit. As he said at the time, “It’s really hard to change your psychological makeup and to be a hedge manager that is comfortable with being short,” he said during his interview. “I’m working on it, because I’m an investor that ultimately does believe in the system, but believes that the system itself is at risk.“
In his just released monthly letter, “Bon Appetit!”, he provided some additional insight on why he has become so bearish on credit instruments. In short, as he says that since the inception of the Barclays Capital U.S. Aggregate or Lehman Bond index in 1976, investment grade bond markets have provided conservative investors with a 7.47% compound return with remarkably little volatility.
He then says that his take from these observations is that this 40-year period of time has been quite remarkable – “a grey if not black swan event that cannot be repeated.”
He attributes this tremendous performance to the “carry” trade, facilitated by ever higher debt, and ever lower interest rates over the past 30 years, a condition he thinks will not repeated again.
What does this mean in practical terms? Gross summarizes his thesis in more compact form, noting that anyone seeking such historical returns, will not find them on earths: perhaps on Mars.
“For over 40 years, asset returns and alpha generation from penthouse investment managers have been materially aided by declines in interest rates, trade globalization, and an enormous expansion of credit – that is debt. Those trends are coming to an end if only because in some cases they can go no further. Those historic returns have been a function of leverage and the capture of “carry”, producing attractive income and capital gains. A repeat performance is not only unlikely, it is impossible unless you are a friend of Elon Musk and you’ve got the gumption to blast off for Mars. Planet Earth does not offer such opportunities. “
He then goes on to explain why the “carry” trade will no longer provide the kind of returns investors are used to.
- Duration is unquestionably at risk in negative yielding markets. A minus 25 basis point yield on a 5-year German Bund produces nothing but losses five years from now. A 45 basis point yield on a 30-year JGB offers a current “carry” of only 40 basis points per year for a near 30-year durational risk. That’s a Sharpe ratio of .015 at best, and if interest rates move up by just 2 basis points, an investor loses her entire annual income. Even 10-year U.S. Treasuries with a 125 basis point “carry” relative to current money market rates represent similar durational headwinds. Maturity extension in order to capture “carry” is hardly worth the risk.
- Similarly, credit risk or credit “carry” offers little reward relative to potential losses. Without getting too detailed, the advantage offered by holding a …read more
Source: Bill Gross Explains Why He Is Now Shorting Credit
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