Gross caught in TIPS trap Gundlach sidestepped as bonds fell

Bernanke’s Comments

Pimco Total Return rebounded in 2012 to beat 95% of peers and has outperformed 93% of rivals over the past five years, according to data compiled by Bloomberg.

The fund’s allocation to Treasuries, a category that also includes futures, rose to 39% in April and then dipped to 37% in May, when Bernanke told Congress that the central bank’s policy-setting board could begin to curtail quantitative easing in “its next few meetings” if the Fed is confident gains in the economy can be sustained. Bernanke expanded on his comments last month, telling reporters on June 19 that the central bank will probably taper its $85 billion bond buying program later this year, as long as the economy performs in line with Fed projections.

While the yield on 10-year Treasuries soared as high as 2.66% on June 24, from a low of 1.61% on May 1, yields on inflation-indexed debt climbed even faster and further. As a result, the narrowing in the difference between yields of nominal Treasuries and TIPS, known as the break-even rate, showed that investors viewed inflation as less of a threat in the short term and thus were cutting the price they would pay for insurance against it, said Daniel Shackelford, a fixed- income portfolio manager at T. Rowe Price Group Inc. in Baltimore.

‘Worst News’

“Inflation expectations haven’t budged after three or four years of hyper-easing and now we are looking at an expectation for a Fed that will become less accommodative,” said Shackelford, who runs the $496 million T. Rowe Price Inflation Protected Bond Fund. “It was sort of the worst news that the TIPS market could receive.”

Shackelford’s fund lost 6.8% this year, trailing 76% of similarly managed funds. It beat 86% over three years and 56% over five years, according to data compiled by Bloomberg.

TIPS funds fell an average of 7.2% from the end of April through June 28, more than double the 3.3% decline in the Barclays US Aggregate Index, a fixed-income benchmark, according to Michelle Canavan, a mutual-fund analyst at Chicago- based Morningstar Inc. who follows inflation-protected bond funds.

Biggest Detractor

At Pimco Total Return, TIPS were the largest detractor from the performance during May, said Eric Jacobson, another Morningstar analyst, even though the fund’s holdings in nominal Treasuries were about 50% larger.

According to Jacobson, Pimco funds and accounts own about $100 billion of inflation-linked bonds, most of that in TIPS. The total market value of TIPS outstanding is $869 billion, not including $111 billion that is held by the Fed, according to Paul Wynn, the portfolio manager for the $837 million Western Asset/Claymore Inflation-Linked Opportunities & Income Fund.

With such a large market share, it’s difficult for Gross and other Pimco managers to meaningfully change their positions without moving prices, said a former bond manager at the firm who requested anonymity. As a result, Gross must accept short-term volatility in the fund as the price of making long-term bets in the TIPS market, he said.

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