Bill Gross: ‘De-Risk’ Your Portfolio

Bill Gross, the famous bond investor who founded Pimco and today is lead portfolio manager at Janus Capital, has a message to investors today: Trim your exposure to risk assets as you head into 2016.

Comparing current global monetary policy to a casino, he said in his latest market commentary that central banks “bluff or at least convince investors that they will keep interest rates low for extended periods of time, and if that fails, they use quantitative easing with a Martingale flavor.”

“Martingale,” as he puts it, is a gaming theory that says if you lose a bet, double the next one to get back to even, and do that indefinitely. This is the core of his concern, the idea that central banks can’t go on artificially pumping the economy—and printing money—forever.

Riskier To Own Risky Assets

To investors, the takeaway is that eventually the music will stop, and it’s getting riskier to own risk-type assets such as stocks and corporate bonds.

So far this year, investors have piled into risk assets even though the S&P 500 has barely eked out returns of 1%. More than $132 billion has flowed into equity ETFs year-to-date—or more than 65% of all net inflows into U.S.-listed funds. As of Dec. 1, eight out of the top 10 most popular funds this year were equity ETFs. Appetite for risk is alive and well.

"Much like time is relative to the speed of light, the faster and faster central bankers press the monetary button, the greater and greater the relative risk of owning financial assets,” said Gross.

“I would gradually de-risk portfolios as we move into 2016: less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money," he said.

There’s no single way to de-risk a portfolio, and investors should always keep sight of their long-term asset allocation. But here are a few ideas:

• De-risking your equity allocation could be as simple as trimming exposure to cyclical stocks, and tilting toward defensive sectors such as utilities, health care and consumer staples. The performance of these sectors isn’t as correlated to economic gyrations like cyclical stocks, such as financial names and consumer discretionary.
• Interestingly, year-to-date, consumer discretionary is the best-performing sector in the S&P 500. The Consumer Discretionary Select SPDR (XLY | A-96) is up more than 12%, while the Health Care Select SPDR (XLV | A-93) is up 5% and the Utilities Select SPDR (XLU | A-87) is down 10%. But the theory is that in a crisis—or a recession—defensive sectors tend to outperform.
• It could also mean focusing your equity allocation on value ETFs as opposed to growth funds, which have done well in recent years. In fact, in an unrelated research note last month, PIMCO argued for a focus on value stocks after years of watching growth names outperform thanks to Federal Reserve policies.
• According to PIMCO, falling rates since the financial crisis have hindered “more cyclical and economically sensitive value stocks.” But as investors await the Fed rate hike that could come as soon as this month, the tidal reversal to rising rates should lift value stocks higher than growth, the firm says. It’s choosing between funds such as the Vanguard Growth ETF (VUG | A-91) and the Vanguard Value ETF (VTV | A-100).
• Another segment where investors can trim risk is in fixed income, by picking Treasurys over corporate bonds, which bring credit risk. Year-to-date, one of the 10 most popular ETFs is the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD | A-77), which gathered $5.7 billion in fresh assets in the first 11 months of this year.

Treasurys would be faced with interest-rate risk, but the security remains the ultimate safe-haven asset in times of crisis. Perhaps the idea is to opt for funds like the iShares 7-10 Year Treasury Bond ETF (IEF |A-55) or the iShares 20+ Year Treasury Bond ETF (TLT | A-83)—or even to diversify fixed-income exposure by sticking with a broad strategy such as the iShares Core U.S. Aggregate Bond ETF (AGG | A-98), which has already attracted $7 billion in fresh net assets year-to-date, making it the fourth-most-popular ETF this year.

Gross didn’t specify what assets he would replace in an effort to de-risk. But to quote Andrew Gogerty, vice president of investment strategies for Boston-based Newfound Research, consider being tactical and flexible when making these decisions.

“We believe by combining a quantitative approach with tactical flexibility, we can create an objective portfolio whereby we cast aside emotional biases and reintroduce return-generating asset classes into portfolios—all with the comfort that these solutions can adequately ‘de-risk’ in times of crisis,” he recently wrote on ETF.com.

Contact Cinthia Murphy at [email protected].