A Lousy Year for Bond Ace Bill Gross

At least when Bill Gross makes a mistake, he admits it -- and makes moves to fix it fast.

Gross, manager of Kiplinger 25 member Harbor Bond Fund (symbol HABDX), has called his recent performance “a stinker.” Over the past year through November 21, Harbor -- a near-clone of Pimco Total Return, the nation’s largest mutual fund -- returned 0.9%. That trailed Harbor’s benchmark, the Barclay’s Capital U.S. Aggregate Bond index, by 5.2 percentage points (a big shortfall in the relatively placid bond world) and landed the fund in the bottom 6% of taxable, intermediate-term bond funds.

Behind the stumble was Gross’s decision in early 2011 to bet against Treasury bonds -- that is, he expected yields to rise (and prices to fall), but instead yields sank. To defend against rising interest rates, Gross lowered his fund’s average duration, a measure of interest-rate sensitivity; Harbor’s average duration slipped to 3.5 years in mid 2011 from nearly 5 years in late 2010.

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By April 2011, Gross had trimmed the $7.4 billion fund’s holdings in U.S. government-backed debt to just 1.4% of assets -- a far cry from the nearly 38% exposure to U.S. debt the fund had six months earlier. As frightened investors rushed into Treasury bonds over the spring and summer because of their perceived status as safe havens (notwithstanding Standard & Poor’s decision on August 5 to strip Uncle Sam of his coveted triple-A debt rating), Harbor Bond missed out on the rally. On a relative basis, its 1.4% loss in the third quarter was dreadful; over the same period, the average intermediate-term bond fund gained 1.6%.

But Gross gets points for trying to turn things around fast. In July he began to step back into U.S. debt, beefing up exposure to inflation-protected I bonds and government-backed Fannie Mae and Freddie Mac bonds. At last report, Treasuries and agency bonds made up 29% of Harbor Bond’s portfolio.

Harbor’s performance picked up in October, thanks in part to bets on riskier assets, including corporate debt and foreign bonds. The fund posted a 1.2% return for the month, outpacing its bogey and the average intermediate-term bond fund, albeit by a slim margin.

Lately, Gross has been adding bonds from what he calls the “highest-quality places,” such as Germany, Canada and Australia, which he says have “as good or better” balance sheets than the U.S.