Did Bill Gross, the Bond King, generate significantly positive alpha during his May 1987 through September 2014 tenure as manager of PIMCO Total Return Fund (Fund)? In their March 2019 paper entitled “Bill Gross’ Alpha: The King Versus the Oracle”, Richard Dewey and Aaron Brown investigate whether Bill Gross generates excess average return after adjusting for market exposures over this tenure. They further compare evaluation of bond market alpha for Bill Gross to evaluation of equity market alpha for Warren Buffett. Following the explanation given by Bill Gross for his outperformance, their factor model of Fund returns includes three long-only market factors: interest rate (Merrill Lynch 10-year Treasury Index), credit (Barclays U.S. Credit Index) and mortgage (Barclays U.S. MBS Index). It also includes a fourth factor that is long U.S. Treasury 5-year notes and short U.S. Treasury 30-year bonds, with weights set to eliminate coupon and roll-down effects of their different durations. Using monthly returns for the Fund and the four model factors, and monthly 1-month U.S. Treasury bill yield as the risk-free rate during June 1987 (first full month of the Fund) through September 2014 (when Gross left the Fund), they find that:
- The 4-factor model of bond returns explains 89% of the variation in monthly Fund returns over the full sample period.
- Per this model, Gross generates annual alpha 0.84% after fees, statistically significant at the 5% level.
- This finding understates actual alpha because it ignores costs of making input factors investable.
- However, fixed income securities have much higher pairwise correlations than equities, make alpha estimates 4.5 times as sensitive to observed factor returns.
- Compound annual growth rate for the Fund is 7.52%, versus 6.44% for its stated benchmark (Barclay Aggregate U.S. Index), so most of the 1.08% annual outperformance is alpha.
- Unlike Warren Buffett, whose career mostly precedes discovery of equity factors, Gross exploits sources of risk well known during the sample period.
- Gross earns essentially all his alpha in market environments favorable to his factor exposures. He exhibits significantly negative timing ability in that his factor exposures are mostly higher in months factors have negative returns than in months they have positive returns. This finding could derive from bad timing decisions or negative convexity in factor exposures.
In summary, evidence suggests that Bill Gross generates alpha over his tenure as manager of PIMCO Total Return Fund, but statistical significance of this finding is sensitive to factor model design. Accounting for factor model costs would strengthen confidence in the finding.
Cautions regarding findings include:
- As noted, accounting for costs of the Fund is easy, but fairly accounting for costs associated with model factors is difficult.
- Also as noted, determination of alpha is sensitive to factor model design.
