How Gurus Generate Income: Bill Gross

We live in a world of low yields and have for a while. Investors are finding it increasingly difficult to generate income, so invariably they have to choose between higher volatility or higher risk in their portfolios. I thought I would take a look at approaches of some well-known guru investors to see what lessons we can learn. First on my list is Bill Gross.Â

Bill Gross

Gross is the well-known co-founder of Pacific Investment Management (PIMCO), running the firm’s $270 billion Total Return Fund (PTTRX). After disagreements that were widely chronicled in the industry, he left to join Janus and manage Janus Unconstrained (JUCAX) in 2014.

While the returns on this safe core are modest, once interest rates change and his managed assets are not locked up for the medium to long term in depreciated bonds, he will be well-positioned. At that point, he can buy aggressively and outperform peers.

Gross used to bet heavily on interest rates remaining low, which is in keeping with Trevor Cowen’s “great stagnation” thesis. He employed a lot of non-recourse leverage through mortgage real estate investment trusts (REIT) like Annaly Capital Management Inc. (NLY, Financial) as well as closed-end funds like Gabelli Dividend & Income Trust (GDV, Financial) and Cohen & Steers Infrastructure Fund Inc. (UTF, Financial). Those bets seem to have been dialed down a bit.

Portfolio

Gross' portfolio is actually extremely defensively positioned as far as interest rate risk goes, with the majority of the portfolio in bonds that mature within three years:

In order to keep up with returns generated by peers, Gross is taking more credit risk. Note he owns virtually no AAA-rated bonds:

Finally, his sector weightings are interesting with almost no government bonds whatsoever and the fund heavily invested in short-term corporate credit:

Gross' entire portfolio is below, but a few things that stand out to me are the presence of lots of auto, financial and energy companies. It also looks like he is leaning toward companies with lots of free cash flow.

Here are what I identify as overarching portfolio themes:

• Maintain a safe core comprising approximately 11% cash and very short-term, high-quality corporate and agency bonds.
• Avoid medium-term bonds that are underweight.
• Select low duration bonds (because of interest rates).
• Balance your secure core with risky investments (barbell portfolio style).Â
• Borrow heavily if interest rates are unlikely to rise much.

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Disclosure: No positions in any stocks discussed.