Wisdom from the Bond King

In a slow-growth environment, the bond king points to opportunities in closed-end funds.

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When Bill Gross tweets, investors listen. After getting his start playing blackjack in Las Vegas upon graduation from Duke University in 1966, Gross turned to investing, and over the last 40 years has made a name for himself as a prescient strategist and market mover (not to mention an avid yoga enthusiast and stamp collector). Today, Forbes estimates his net worth at $2.3 billion and puts him at No. 206 (in a 12-way tie) on its list of the country's 400 richest people.

Since 1971, Gross, 68, has deftly steered PIMCO, the Newport Beach, Calif., investment firm that he cofounded and where he is currently co-chief investment officer, overseeing some $1.8 trillion in assets. He manages PIMCO Total Return Fund, the world's largest mutual fund and a stalwart of the fixed-income world that has returned more than 7.3 percent annually over the past 15 years, helping to earn Gross the unofficial title of "bond king." Gross recently spoke with U.S. News about what he sees as a "new normal" for the markets and for investors. Edited excerpts:

[Read: The 10 Most Popular Mutual Funds of 2012.]

What have you done that has accounted for the Total Return Fund's impressive and continued success?

To be fair, the near double-digit returns are a function of falling interest rates more than anything else. It's sort of like a teeter-totter; when interest rates go down, prices go up. So the Total Return Fund, [just] as all bond funds, has done well in part because interest rates have gone down, down, down. We've also outperformed the [investment-grade bond] market by close to 2 percentage points a year. Individual strategies in terms of trading hopefully account for the track record. That leads, I guess, to another question: Can those returns be duplicated going forward?

I imagine that's on a lot of investors' minds. What should they expect?

You start with the obvious: The Federal Reserve has lowered short rates to close to zero. The investment-grade bond market, which includes treasuries and corporates and mortgages, all in one big pot, yields 1¾ percent. It's hard to manufacture near double-digit returns from that. It's the metaphorical concept of squeezing juice out of an orange; almost all of the juice has been extracted, so to speak.

So investors looking for a repeat of historical performance are bound to be disappointed, and that's why I wrote several months ago—which caused a ruckus in the market—about the [dying] cult of equity. It was the same thing with the cult of bonds, the "cult" meaning that there was a belief that historical returns could be projected into the future. They can't. They can't for bonds and they can't for stocks either, in my opinion.

The PIMCO Total Return Fund starts with a universe that yields 1¾ percent. If we can outperform the market by 1 to 2 points a year and things stay the same, then investors can get a 3 to 4 percent type of return. But they shouldn't expect a 6 or an 8. A 10 percent return, it's nearly impossible, at least from a generic [investment-grade] type of universe. We can speak to high-yield and we can speak to opportunities elsewhere, but they, of course, involve risk-taking. [Now we are concentrating on] more short- and intermediate-term bonds, mainly mortgages and, in some small percentages, bonds in Italy and Spain.

What's your economic forecast for the months and year ahead?

In terms of economic growth, PIMCO originated the famous phrase the "new normal." That was us three years ago, and it's the same today: The growth is much slower than what it was, not just in the U.S., but in Europe, obviously, and even in China. That's because in 2008 the world was too highly levered and ever since it's been in the process of de-levering, which means that consumers and businesses cannot take on the same amount of debt that they did in the past. Don't think that anytime soon we're going back to the "old normal" because these cycles of de-levering are biblical in nature.