Bill Gross, fund manager of Janus Capital Management LLC, smiles during a Bloomberg Television interview on the sidelines of the Milken Institute Global Conference in Beverly Hills, California, U.S. (Photographer: David Paul Morris/Bloomberg)

What Is Bill Gross’s Bond Fund Even Betting on Anymore?

(Bloomberg Opinion) -- When is a self-described “bond fund” no longer a bond fund?

That’s my question after looking at the recent performance of Bill Gross’s Janus Henderson Global Unconstrained Bond Fund, which saw its net asset value drop on Wednesday to match its lowest level ever. The kicker, of course, is that the latest bout of stock-market volatility has been great for fixed-income investors as a whole. On Oct. 11, the Bloomberg Barclays U.S. Aggregate Bond Index gained the most since late May. It’s currently on a three-day win streak.

What Is Bill Gross’s Bond Fund Even Betting on Anymore?

Loyal trackers of Gross’s performance will recall that late May was when he had a really bad day (to put it mildly). So it’s only fitting that on that strong day for the bond market earlier this month, the Janus fund tumbled the most since June. At this point, anyone investing with Gross should have their eyes wide open to a core element of his fund — an extremely negative effective duration, a measure of a portfolio’s sensitivity to interest rates. It was minus 3.67 years as of Sept. 30, compared with minus 3.14 years as of June 30. That means Gross’s fund generally gains when yields go up. 

But there seems to be more going on with the fund than just a bet on higher interest rates. For one, documents on Janus’s website show 23 percent of its assets are invested in “equity-related” securities, with the fund holding seven stock issues. And according to data compiled by Bloomberg as of June 30, the fund’s two biggest positions were in shares of Aetna Inc. and AT&T Inc.

Part of the fund’s appeal, according to the website, is that it “allows access to sources of returns that are intended to be uncorrelated to traditional risk assets.” One of those wagers, which my Bloomberg News colleagues and I have chronicled extensively, is that the yield spread between 10-year U.S. Treasuries and German bunds will converge as the European Central Bank catches up on tightening monetary policy. Instead, the difference has only gotten larger. Gross did say in July that he “scaled back” that positioning. But if he still has that bet on at all, it should have been strongly positive on Wednesday — the spread narrowed by 5 basis points, the most since June 7. 

Maybe the negative duration simply drowned out that move. What’s more likely is that Gross has been short volatility — for example, selling out-of-the-money put or call options and collecting the upfront premium, betting that a stable market keeps them worthless — to boost returns, and that backfired as the stock market tumbled. Bank of America Corp.’s MOVE index, which tracks price swings on U.S. Treasury options, is at the highest level in more than four months. The Chicago Board Options Exchange Volatility Index, or simply the VIX, spiked both on Wednesday and on Oct. 11, lining up exactly with the Janus fund’s losses.

Taken together, it’s difficult to understand exactly what Gross is positioning for in the months ahead. He has long expected Treasuries and bunds to converge, yet on Oct. 3 observed that skewed hedging costs make it uneconomical for long-term investors in Europe and Japan to purchase American debt. As I wrote in June, that phenomenon is a key reason why the yield spread can stay historically wide for a long time. Yet just a day later on Twitter, he again came back to thinking in absolute terms:

And what about that extreme negative duration? Gross said this month that the 10-year Treasury yield should stay around 3.2 percent, and might get up to 3.4 percent. That’s not a lot of room to run, and sounds like a lot of the easy money has been made. Even Michael Hasenstab, the Franklin Templeton bond chief who has said the global benchmark could rise past 4 percent, still has an average duration of just minus 1.34 years in his $35 billion Templeton Global Bond Fund.

If he’s selling volatility, that only makes the calculus more challenging. The best-case scenario, it seems, would be for Treasury yields to rise, but not as fast as those on bunds. Additionally, those higher interest rates wouldn’t cause market turbulence, creating a favorable environment for the two-thirds of the fund that’s invested in equities and U.S. corporate bonds, both high-yield and investment grade. This month’s experience should tell you all you need to know about such a rosy scenario playing out.

I’ve said it before: There’s such a thing as being too unconstrained. And with sizable equity holdings and such a large bet against duration, a bedrock of fixed income, is it really fair to be considered a bond fund? It’s more appropriate to say that the remaining investors in the Janus Henderson Global Unconstrained Bond Fund are simply buying into Gross’s worldview.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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