Wisdom from the Bond King

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

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An investor probably has to look forward to higher inflation. Slower growth and higher inflation—that's not a positive, by any means. Individuals would want it to be just the reverse. The de-levering and the check-writing on the part of central banks, that's really what produces the situation.

Are you worried about debt in the United States and Europe?

Slow growth and inflation have a tendency to accompany large deficits and increasing debt as a percentage of GDP. Unless we begin to reverse that course, we could resemble Greece within a decade.

So where are the investment opportunities for individuals?

Both from the standpoint of stocks and bonds, an investor wants to go where the growth is. There are countries that should grow faster than Euroland countries, and countries that should grow faster than the United States. They would be the big obvious ones: China and Brazil, and even Mexico.

In terms of the bond market, there are opportunities in what are known as closed-end funds, [which issue a fixed number of shares and] trade like stocks. The magic to them is that many of them are slightly levered: They borrow basically at zero percent or close, and then reinvest back into their asset class. Municipal closed-end funds with bonds that yield typically 4 to 4½ percent can be turned into a 6 to 7 percent tax-free investment on the basis of this borrowing and the mild leverage. Many PIMCO funds, many BlackRock funds, many Vanguard—they're all over the place—you can buy them at 6 percent yield, tax-free, and they provide the opportunity for investors to get those historic 6, 7, 8 percent returns that I said at the beginning were not available through generic types of investments. So I say buy these closed-end funds, because they yield 6 to 7 percent and there's basically the same risk as in the generic universe.

The Total Return Fund holds a hefty percentage of mortgages. Several years before the subprime mortgage crisis, you seemed to see it coming and time your moves accordingly. How do you do it?

PIMCO's foundation is one that attempts to analyze what we call the secular outlook, which means, for us, the next three to five years. When it came to 2007 and 2008, we were exploring the long-term metrics of housing and debt accumulation.

One of the things we did in 2006 was we took 10 of our credit analysts that were analyzing individual companies and we turned them into real-estate buyers. We said, instead of visiting Coca-Cola and IBM, we want you to go to Las Vegas and to Miami and to Des Moines and to Cincinnati. Get us an on-the-ground feel for what the housing market was doing because we were suspicious of many of the things that were taking place. [As a result, we] sold lots of lower-quality bonds in anticipation of a large recession. It was just a common-sensical shift, I guess, from corporate credit to exploring the housing market.

So I think why PIMCO's been successful has been, one, we look at the longer term; and two, we just employ a lot of common sense, with an understanding that things don't go on forever. The critical element, of course, is how do you know when? The fact is that nobody knows when. So far, so good, I guess.

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Is that kind of combination something that investors should really take to heart?

Oh yeah. An investor has to have a longer-term view and shouldn't be day trading the market. It just can't be done. Returns are not what they used to be.

Because of that, they've got to watch their fees. If you're in a 4 or a 5 percent world and you're paying 1 percent or whatever it is that you're paying, that's my point. You can't afford to give much to the manager. Make sure that your fees are reasonable relative to the returns and make sure that you're looking at long term and forget about the day trading. It only makes money for Wall Street as opposed to Main Street.