PIMCO Still Piling into Mortgages

by REIT Wrecks on May 24, 2008

In April I posted Bloomberg’s report that had PIMCO more than doubled the mortgage holdings in its flagship Total Return Fund from 23% of assets in March of last year to almost 50% of assets in March of 2008.

Now the FT is reporting that PIMCO has continued to build its position. Bill Gross, the manager of the world’s biggest bond fund, has now almost tripled his mortgage debt holdings to more than 60% of the fund.

According to the FT, the Total Return Fund fund pulled sharply ahead of rivals in the past year after Gross predicted a housing downturn and sold out of housing-related securities and corporate bonds. The fund has returned 12.6% over 12 months, beating 99% of its peers, according to fund tracker Morningstar.

Mr Gross said his decision to raise exposure to mortgage debt in recent months was based on the US government’s implicit guarantee of Freddie Mac and Fannie Mae, the government-sponsored mortgage agencies. “Government policy is moving to sanctify the status of the government-sponsored agencies . . . it became a question of which institutions would be sheltered by the government umbrella,” he said.

So far, the bet appears to be paying off. In the first four months of this year, the fund returned 3.8%, twice the return of its benchmark index and its best start to the year in at least eight years. Mr Gross said Pimco was buying primarily mortgage agency debt and “not the subprime garbage”. The Total Return fund is now invested about 61% in mortgage debt. Such debt comprises only 43% of one of the fund’s benchmarks, the Lehman Aggregate bond index.

Mr Gross, who is also Pimco’s co-chief investment officer, is known for his macro-economic style of investing, which has seen him take big bets on bond classes depending on where he thinks financial markets might be moving. Mr Gross was heavily overweight US Treasury bonds in the early 2000s but is now scornful of them and the fund is using derivatives to gain from any downturn in Treasuries.

He called Treasuries “the most overvalued asset”. “If there was a bubble, the popping has produced a counter-bubble in quality securities. The safe haven has been way overdone. Treasuries are yielding 2 to 3%, there is no real return on that at all,” he said. “This is an asset class that is held by sovereign wealth funds and central banks . . . but that is not any reason to follow them.”

There may be no reason to follow the herd into Treasuries, but apparently there is still plenty of reason to take a closer look at the disconnect between price and value in Mortgage REITs. Click here for an updated list of Mortgage REITS”, including current yields.

REIT Investment

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