If you can’t beat ’em, join ’em

Bill Gross has been somewhat anti-hedge fund over the years.  For example, in his August 2004 commentary, he criticized hedge funds’ high fees and their use of leverage:

“..if you’re thinking about a hedge fund to bolster your portfolio returns, give it a long think. They’re risky and they’re generally overpriced…the growing fascination with hedge funds and indeed the ability to lever almost any asset at minimal borrowing costs which was the heretofore province of strongly regulated banks…the world’s economy is unstably founded on a base of cheap money used as leverage to support certain asset prices of dubious value. If and when the cost of those funds moves sharply higher for any reason…then the flaws of a levered economy will be quickly exposed. It is then that many hedge fund managers will wish they had stuck to selling lemons, instead of lemonade and that they could return to their staid old jobs centered around active money management.”

But faced with what Gross now calls “Alpha/Beta Anemia” caused by a secular decline in volatility, he seems to be coming around to the use of leverage to enhance active returns.  In his November 2006 commentary, after arguing that markets will remain anemic for the foreseeable future, he says:

And so the anticipated future Beta anemia leads in turn to a willingness to assume more risk, to drive the prices of risk assets higher – and risk premiums lower – and at some point (like now) to produce an Alpha anemia as well.”

“I and we at PIMCO accept many of the realities/fundamentals of this new world low nominal GDP growth. Financial innovation, central bank transparency, and even globalization’s great moderation of economic volatility are powerful arguments suggesting the old days of copious Alpha and Beta are over because 5% GDP growth and compressed risk spreads are not likely to permanently return to historic levels.”

With permanently reduced alpha-generating opportunities, Gross now reluctantly acknowledges a renewed importance for leverage and recommends PIMCO “scale up its most confident strategies (sic)”:

“Playing by the new rules which in part require an assumption of levered risk spreads at historic lows could likely lead to low absolute returns and/or negative Alpha should instability return.”

“Closet indexers will not prosper in this new worldDoes this mean that PIMCO wants to turn itself into a hedge fund on the cheap? Hardly. But it does mean we should be willing to scale up our most confident strategies in a way that could lead to additional Alpha for you the client at the temporary expense of increased volatility.”

Whooah.  Hold the phone!  Levering up active bets and reducing beta exposure sounds a lot like a hedge fund.  And given Gross’s apparent pride in PIMCO’s low fee structure, we would assume PIMCO does indeed want to be a “hedge fund on the cheap”…Which is a good thing.

Welcome to the hedge fund industry, Bill!

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