NEW YORK The world's largest bond fund has gone ultra bearish on the United States, dumping all of its U.S. government-related debt holdings.
The move by Bill Gross's $236.9 billion PIMCO Total Return fund completed last month comes in the wake of a vicious Treasury market sell-off and just days after he questioned who will buy Treasuries once the Federal Reserve halts its latest round of bond purchases in June.
Gross, who also helps oversee a $1.1 trillion investment portfolio as PIMCO's co-chief investment officer, has repeatedly warned against U.S. deficit spending and its inflationary impact, which undermine the value of government debt and push up yields as investors demand more compensation for risk.
Over the last five months, worries over the ballooning U.S. budget gap estimated at $1.645 trillion for 2011, political stalemate in Washington over how to narrow it and inflationary fears have all contributed to a steep sell-off in Treasuries. The benchmark 10-year note has seen its yield, which moves inversely to price, rise more than one percentage point since early October to 3.46 percent by Wednesday's close.
Gross expects further carnage. Just last week, he told Reuters Insider that a 4.0 percent yield for 10-year notes is a "rational expectation" if the Fed "disappears as the buyer of last resort."
Gross, as with many other investors, has raised red flags over demand for Treasuries when the U.S. central bank ends its controversial quantitative easing program. This week, he posed the following in his widely read monthly report: "Who will buy Treasuries when the Fed doesn't? The question really is at what yield, and what are the price repercussions if the adjustments are significant."
Already, bond prices have taken a massive beating on that possibility and as the U.S. economy recovery strengthens. The 10-year Treasury yield hit a 9-1/2 month high of 3.77 percent on February 9, rising 40 basis points in the short period from the end of January.
Gross sold all of its U.S. government-related securities, including U.S. Treasuries and agency debt, from its flagship Total Return fund, as of the end of Feb. 28, according to the firm's website on Wednesday.
That's down from when the portfolio held 12 percent government-related debt at the end of January. The last time PIMCO was this negative on U.S. government-related debt was in January 2009.
A PIMCO spokesman declined to comment.
INTEREST RATE RISK
Gross's latest move reflects his defensive positions against higher rates and higher inflation, said Eric Jacobson, director of fixed-income research at Morningstar.
"The even bigger story is the net effect of his government bond sales and derivatives positioning, which takes the fund's overall duration to 3.9 years versus 5.1 years," for the bond market's benchmark, Jacobson said.
Duration is a bond's sensitivity to interest rate fluctuations, and going short duration is an investment strategy when rates are expected to rise. The Total Return fund has an excellent track record in timing the market.
It performed better than 93 percent of its intermediate investment-grade peers over the last three years, posting annualized returns of 8.67 percent, according to Jeff Tjornehoj, head of Americas research at Lipper.
Hence, his holdings are closely followed. However, the bond market was unmoved by the PIMCO news on Wednesday, perhaps because Gross long has telegraphed publicly his distaste for U.S. Treasuries.
In fact, in January, Pacific Investment Management Co's Total Return fund had slashed its U.S. government-related debt holdings to the lowest level in at least two years and increased cash and debt holdings from other developed nations.
Wednesday, U.S. Treasury prices rose, even digesting a $21 billion 10-year note auction, on a safety bid over peripheral European debt concerns. The 10-year notes yield closed at 3.46 percent, down from 3.55 percent late Tuesday.
Overall, the Total Return fund is now mostly made up of mortgage and cash.
Cash and cash equivalent holdings surged to $54.5 billion as of Feb. 28 from $11.9 billion at the end of January, comprising 23 percent of the PIMCO Total Return fund. Cash is defined as anything that has a duration of less than 1 year -- which can include Treasury bills.
Mortgage holdings stood at 34 percent at the end of February, down from 42 percent at the end of January. Investment-grade credit made up 18 percent of the portfolio; emerging markets at 10 percent; high-yield credit at 6 percent; non-U.S. developed 5 percent and municipal bonds at 4 percent.
Government-related securities include Treasuries, Treasury Inflation-Protected Securities, agencies, interest rate swaps, Treasury futures and options, and corporate securities guaranteed by the U.S. Federal Deposit Insurance Corp.
PIMCO may have plans for how it will put its cash holdings to work. In a December regulatory filing the Total Return fund said it may start investing up to 10 percent of its assets in "equity-related" securities, such as convertibles and preferred stock, after the first quarter of 2011.
(Additional reporting by Emily Flitter; Editing by Stella Dawson)