The King of Bonds, Bill Gross, talked to Barron's recently, which yielded some very interesting and practical investing advice predicated on the reigning zero interest rate environment we are experiencing in today's market. They include some unconvential plays, including closed-end funds, but also three straightforward common stock investments.
- Engage in M&A plays because they are highly likely to close with acquirers being able to borrow very cheaply. Gross gives SABMiller (SBMRY, Financial) as an example, but in the Janus Unconstrained Bond Fund, which he manages, I can’t find any other equities of companies that will soon be acquired. Gross likes the M&A game because this way you indirectly benefit from low borrow rates, while not being exposed to that risk to the same extent.
- Buying closed-end funds that lever assets under management a moderate amount, between 35% to 50% works as well. Gross poured between 8% to 9% of assets in closed end funds that trade at discounts to NAV. He mentions the Nuveen Preferred Income Opportunities (JPC, Financial) and the Duff & Phelps Global Utility Income (DPG, Financial) fund. The risk with these funds is that the discount never closes or they blow up due to the leverage, which is less likely at such low rates.
- Buy mortgage REITS. Mortgage REITS like Annaly Capital (NLY, Financial) and American Capital Agency (AGNC, Financial) levered up their balance sheets about 4x to 6x. They borrow money in the overnight repo markets and put it in mortgages guaranteed by the government.
"It yields about 11% because of leverage, not risky assets. The concept, again, is letting corporations borrow for you to produce a return higher than the 1% to 2% return the bond market gives you today." - Sell volatility. Most of Gross' return is generated by what he calls “selling volatility” with options. I’ll quote him to explain because, although fascinating, it isn’t exactly smack dab in my circle of competence:
Years of easing by central banks mean that interest rates in most of the developed world will fluctuate narrowly. That offers an opportunity to sell volatility to create return. If you bought a 10-year Treasury bond today and nothing changed, you would get a 1.9% yield. If you bought a seven-year German Bund, you’d get zero. If, however, you sold a three-month call or three-month put on that same Treasury with a 20-basis-point [hundredths of a percentage point] variation—in other words, the yield stayed in the range of 1.7%-2.1% for three months—the trade would produce an annual return of 6%, as opposed to 1.9%.
The risk is that interest rates will go up or down by more than 20 basis points over a three-month period. But my premise is that central bankers will do anything possible to contain interest-rate fluctuations. The sale of volatility is producing the predominant amount of return in my fund.
- Use leverage. Gross doesn’t exactly come out and say it, but he is levered up to about 150% on average, so that suggest he likes it. It is critical to be right and very confident when practicing Gross' style because apparently he levered his fund but also seeks out levered investments.
