How to Find the Safest Returns in 2012

Zero interest rates and global uncertainties argue for caution, head of PIMCO investment firm advises.

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Retirement security has always been more about playing good defense than offense. At the ages of 65, 70, and older, the risks of aggressive money strategies aren't worth taking because the costs of failure are too high. There aren't enough years to recover from investment losses. There isn't enough outside income to replenish depleted investment accounts. The safe approach is to seek near-guaranteed returns of a few percentage points above prevailing rates of inflation.

[See 6 Key Money Issues for Seniors in 2012.]

This used to be relatively easy to do, but years of near-zero interest rates have made it much harder. As 2012 gets underway, are there defensive strategies that make sense, and what do they look like?

Bill Gross is the managing director at PIMCO, the big investment firm based in Newport Beach, Calif. It had $1.35 trillion in assets under management as of September. Gross has been a wizard in fixed-income markets, and his emphasis on investments in that sector is not surprising. He takes relish in contrarian views but has made so many correct calls that being a contrarian seems almost mainstream.

In his investment advisory letter for 2012, Gross moves further out on the limb, and says the risks of disruption in world credit markets are so severe that investors should be extremely cautious. Summarizing his views is hazardous; you should read them yourself.

An oversimplified explanation: The problem is that years of zero interest rates have distorted investment and business incentives but they haven't really been accompanied with any meaningful improvement in debt markets. Outstanding debt, especially at the government, or (cue the laughter) sovereign level, has soared. But it's become painfully clear to the holders of that debt that they are receiving little or no real return for taking these risks. If they act en masse on this growing perception, we will finally get some serious deleveraging. However, it won't be a calm and orderly march to the investment exits. It will be quick and ugly, and pity the individual investor caught between these institutional debt holders and the exit doors.

[See 3 Steps to Turn Nest Eggs Into Retiree Income.]

Having already left normal financial markets behind and, in his view, the "new normal" as well, Gross calls the world he sees "the paranormal," among other descriptive terms. "Investors must lower return expectations," he advises. "Two to five percent for stocks, bonds, and commodities are expected long term returns for global financial markets that have been pushed to the zero bound [of interest rates], a world where substantial price appreciation is getting close to mathematically impossible."

"It is different this time and will continue to be for a number of years," Gross writes. "The New Normal is 'Sub,' 'Ab,' 'Para,' and then some. The financial markets and global economies are at great risk."

Here are summaries of his investment advice for different asset classes. Again, PIMCO's focus on bonds is very evident.

[See Retirement Plans That Weather Economic Storms.]

Bonds:

"Durations and average maturities should be at their maximum permissible limits. Even if reflation is successful it will only be because the Fed and other central banks keep policy rates low for an 'extended period of time, he writes. In sovereign debt, focus on five- to nine-year treasury maturities, and hold them as TIPS (Treasury Inflation Protected Securities). Look for higher-rated corporate debt that is senior, not subordinated.

"U.S. municipals represent an opportunity from the stand point of valuation. Their yields of five to six percent are near historically high ratios to Treasuries. They do, however, entail risk—not only volatility but occasional default risk ... Be selective and avoid states/municipalities with pension and funding problems," Gross writes.

Stocks and Commodities:

"Stocks yield more than bonds and will tend to do better in anything but a delevering fat left tail. That, however, is what worries us. Equity allocations, therefore should favor higher yielding companies in sectors with relatively stable cash flows: Electric utilities (yes they appear overbought), big pharma and multinationals should head your shopping list ... Commodities could go either way ... Gold at $1550 [an ounce] seems pricey but it has upward legs if QEs [central bank quantitative easings] continue," he writes.

Twitter: @PhilMoeller