I saw an article on a financial planning site pointing to
the fact that 8 of the top 10 performing ETFs in 2011 were
US Government Bond funds. So I just did a quick double
check via Morningstar’s ETF screener, though the screener
doesn’t let me pick a specific year – it lets me do 1yr,
so we have a week or so shift from the article:
1. 60.74% Pimco 25+ yr Zero Cpn (ZROZ)
2. 57.98% Vanguard Extended Dur. Tsy (EDV)
3. 33.48% iShares Barclays 20+ yr Treas (TLT)
4. 29.39% SPDR BarCap Long Term Treas (TLO)
5. 29.04% Vanguard Long-Term Govt (VGLT)
6. 27.24% Pimco 15+ year US TIPS (LTPZ)
7. 24.12% SPDR Nuveen BarCap BAB (BABS)
8. 22.91% PowerShares Dynamic Pharma (PJP) — the only non-Bond ETF in the top 10
9. 22.53% Vanguard Long-Term Bond Index (BLV)
10. 22.14% Pimco Build America Bond (BABZ)
The next five also include 4 more long gov’t bond
funds plus one more Pharmaceuticals fund. The top
15 all had returns over 20%. The 16th was just under 20%
(and the 16th was also not bonds – it was US Gasoline)
As we all know, Bill Gross got 2011 wrong – he underweighted
Treasuries (eliminated them altogether for a while from
Total Return) and was beaten by the rest of the bond market
which kept their (or increased their) Treasury/Gov’t exposure.
If Treasuries looked like a bad bet last year – and it
was perfectly rational thinking — how much lower could
interest rates really go? – they look worse now.
The kind of capital appreciation which drove the very
long zero-coupon bonds to greater-than 50% returns in
2011 is not sustainable.
There are generally two reasons to have bonds in a passive
stock and bond portfolio: (a) diversification/lower volatility
and (b) income
Treasuries right now certainly aren’t doing anything for
income, so is there a justification for keeping them in place
for diversification and lowering of volatility? Perhaps,
but they sure look like they pose a lot more downside risk
than anything else right now.
This may sound like market timing, but is it really? The
equity market goes up and down but ultimately, as profits
increase, there’s potentially unlimited upside.
Bonds don’t have that same unlimited upside – for ZROZ to
repeat its performance, interest rates on 25+ year bonds would
have to go from their current level of just under 3% down to
below 1%. It’s not impossible, but it is highly unlikely. On
the other hand, if rates go up by even 1% to a still quite low
by historical standards of 4% – you’d see a loss of almost 30%
in ZROZ. That looks like a lot of risk.
Meyers Wealth Management 
Followup: Gross offered a “mea culpa” last
October and by November, he’d boosted Total Return’s
Treasury allocation back up to over 20%.
It was reported today by Bloomberg that Gross has
further increased Treasury exposure to 30%. That’s
still somewhat underweight compared to his benchmark
indices (BarCap Agg) or other similar reasonable
benchmarks (ie. int-term diversified bonds indexes).
Of course, like all fund managers, beating his index
will require not just having a better performing
portfolio, but having that portfolio beat the index
by enough to overcome management expenses as well.
That’s quite a trick to pull off in any actively
managed investment-grade bond fund. Total Return
institutional shares have 46bp expenses. In a world
where Treasury bonds are yielding only 2%, that’s a
huge hurdle. Unless treasury yields drop a lot,
and an active bet is made on that by extending duration,
it’s highly unlikely that any portfolio with a big
swath of treasuries is going to overcome those expenses.
And that active bet adds a lot of risk.
It’s hard to see Gross’s logic in making the treasury
bet *after* they’ve risen so much. Nevertheless, folks
have given him hundreds of billions of dollars to manage.
And further, an ETF version of Total Return is set to
debut in a month or two. Part of the appeal, though, of
Total Return lies in that many folks with 401k accounts
just don’t have a lot of choice in fixed income. If they
have an index at all, it’s likely to be the BarCap agg,
and a huge number have little beyond such an index and
perhaps this very Pimco fund.
Nevertheless, even with the recent underperformance, Pimco
total return has, long-term, done better than the agg, and
even now is still underweight treasuries vs. the agg – a
position which seems like a smart move given the environment.
[As usual, nothing contained in the above notes is intended
as investing advice or a recommendation for or against any
particular investment.]