Guru Gaffe: Investors Losing Faith in ‘Bond King’

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Andrew Harrer / Bloomberg via Getty Images

For heralded bond fund manager Bill Gross, 2011 was one of his worst years on record.

Bill Gross, a legendary bond fund manager, is about to close the books on a terrible year for his $241 billion PIMCO Total Return Fund. His missteps underscore the risks of a concentrated investment and in staying too long with a flawed strategy.

Gross is known as the bond king and has been likened to both Peter Lynch and Warren Buffett. That’s how good he’s been at buying and selling bonds over the years. But earlier this year he made a big bet that interest rates would rise, and when rates fell instead his fund began to lag badly.

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The fund is up less than 4% this year, about half the gain of the average comparable bond fund in what has been a good year for most bond investors. In the bond world, where yields typically drive returns, such underperformance is epic. Gross ranks in the bottom 10% of bond fund managers this year.

His long-term record remains stellar. But in a what-have-you-done-lately world, investors have begun to exit his fund. Last month, his fund had net outflows of $500 million as the universe of comparable funds enjoyed net inflows of more than $10 billion. Gross likely will record his first calendar year of net outflows when 2011 draws to a close. His fund was launched in 1987.

What went wrong? Gross underestimated the European debt crisis and the punishing effect of last summer’s Congressional wrangling over the debt ceiling. These events eroded confidence in the global economy and sent interest rates plunging. Gross had been positioned for higher rates, evidently thinking that the economy would soon show signs of recovering.

He apologized to his investors for the misread—but not necessarily for the outsized gamble. Indeed, in an effort to get ahead of the next trend he has been loading up on mortgage-related securities that should rise if the Federal Reserve ramps up a program to buy mortgages in an attempt to prop up the U.S. housing market, as some believe the Fed plans to do.

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That’s how Gross earns his millions. He makes bold bets and is right often enough to keep getting more chances. But his misstep this year is eerily reminiscent of another guru gaffe—stock picker Bill Miller’s bad bet on financial shares in 2008, which caused his stock fund to lose 55% of its value and sent loyal investors fleeing from his Legg Mason Value Trust fund. Despite years of outperforming, Miller retired last month with a diminished reputation.

No one is saying it’s time for Gross to hang it up. Gross has said that “the competitive fire burns even hotter.” Odds are he’ll rebound. But Gross’s near-term troubles are one more example of how a concentrated bet (Do you have too much company stock in your 401(k)?) and staying with a flawed strategy too long (Are you saving too little and counting on unrealistic returns?) can damage your portfolio and maybe your retirement dreams.