ELECTION WATCH
Pimco: Kerry Could Bolster Bonds;
Bush Policies Better for Wall Street
By ANDREW SIMONS
As always, bond fund manager Pacific Investment Management Co. in Newport Beach will be watching the November presidential election with interest.
A Democrat or Republican win could yield very different results for the bond market,the bread and butter for the mutual fund management company known as Pimco.
“A Democratic win would be unambiguously bullish for bonds versus stocks because there would be deficit hawks (calling for) increasing taxes for the affluent,” Pimco Managing Director Paul McCulley told Barron’s magazine a few weeks ago.
“Conversely, the Republican Party wants to make tax cuts permanent for the affluent and never has lost a night’s sleep about the budget deficit,” said McCulley, who has donated money to the Democratic Party in the past. “Everything else being equal,and it never is, of course,a Republican win is bullish for stocks versus bonds.”
A widening budget deficit,pegged at more than $400 billion this year,could hit the price of bonds, which make up the bulk of Pimco’s mutual funds.
As the deficit rises, interest rates tend to increase as investors demand a greater rate of return for buying more bonds. Prices of existing bonds fall in response to rising bond coupons, as they become less attractive to buyers.
Stocks, on the other hand, are more likely to gain with a victory by President George W. Bush, whose tax cutting policies are seen as better for the economy than Sen. John Kerry’s economic plan.
“Rarely do we ascribe market moves to the political situation,” said John Prichard, managing director at Knightsbridge Asset Management LLC in Newport Beach, which manages stock and bond funds. “But one of the reasons that that the stock market hasn’t been better is due to the political situation. The stock market weakness from March until now has been a digestion of the fact that Kerry has a chance. And stock markets don’t like uncertainty. From a pure investment standpoint, it’s widely viewed that a Kerry win would be bad for stocks.”
Meanwhile, the Federal Reserve Board has raised its market-moving federal funds target rate by 50 basis points since June, and is expected to raise it another 25 basis points later this month.
Rising interest rate expectations first hit the bond market last summer following a historic run that had taken rates to 40-year lows. Pimco had been tweaking its strategy ahead of the rate moves.
Led by oft-quoted bond fund manager William “Bill” Gross, Pimco’s Total Return Fund,the nation’s largest bond mutual fund,exchanged longer-term bonds for treasury inflation protected securities, known as TIPS, as the bond market cooled.
The safe investments pay a relatively low yield, but have a return that adjusts with inflation.
Total Return has $73 billion in assets. The closely watched fund posted a 7.7% annual return during the past five years through June 30.
Pimco’s bond funds have sold off some of their TIPS holdings, though they’re keeping some as a hedge against inflation, according to Pimco’s third-quarter outlook.
The mutual fund company said it now believes that interest rate hikes already have been factored into the market, “which makes treasury bonds more attractive now than earlier this year,especially on the short to medium end of the market,” according to the outlook.
Still, that doesn’t mean they are all that attractive to the bond investor. Pimco expects bonds to “meander” in the near term, the outlook said.
What’s attractive: U.S. municipal bonds and European bonds, in particular German bonds in the 5- to 10-year range, according to Gross.
The German bonds “yield more than U.S. Treasury (bonds) and the quality is similar,” Gross wrote in his September outlook report.
The lure of German bonds, according to Gross, who describes himself as an “Orange County Republican,” is that it has “a more conservative central bank.”
“They view inflation as an enemy, whereas here in the U.S., we view inflation and the economy as dual objectives,” Gross wrote. “And so given higher yields in Europe, we prefer to go with a more conservative central bank.”
Meanwhile, sustained high oil prices could prevent the U.S. fed from raising interest rates quickly, McCulley said.
“After paying up for petrol, (consumers) have less purchasing power left from their paychecks to buy other things,” he wrote in his monthly outlook. “In this sense, the oil price shock is similar to a tax hike.”
If consumers have less money to buy books, electronics and other goods, companies won’t be able to raise prices as easily.
Despite the uncertainty, Pimco has managed to boost overall assets following a dip last summer.
When the bond rally ended a year ago,Total Return slipped 4% in July 2003,investors pulled some $800 million from the fund, marking the first net withdrawal since late 1997.
But $500 million of the money found its way to other Pimco funds, according to the company.
Last fall, Pimco Chief Executive William “Bill” Thompson called that flight extreme, predicting a 10% to 15% growth in assets in the next year.
“For most investors, bonds have a very important and permanent place in their portfolio,” he said.
Indeed, Pimco now counts about $392 billion in assets under management, an increase of 12% from the $350 billion under management last September.
And Pimco’s global staff counts 630 employees, up from 600 last year. In addition to its Newport Beach headquarters, Pimco has offices in New York, London, Munich, Tokyo, Singapore and Australia.
In the past year, Pimco successfully fended off allegations that its bond funds allowed illegal market timing trades. After an investigation, the Securities and Exchange Commission went after Pimco’s sister stock mutual funds, based in New York, but not the bond funds.
Both Pimco and the stock funds are part of Germany’s Allianz AG.
The stock funds agreed to pay a $50 million fine to settle the charges and now operate under a new name.
Plenty of competitors have boosted their bond presence during Pimco’s bang-up past few years. The Vanguard Group Inc., Citigroup Inc., Loomis Sayles & Co., Metropolitan West Securities LLC and Dodge & Cox all are vying for bond investors alongside Pimco.
One of Pimco’s biggest competitors in bond funds has diversified. Last month, New York-based BlackRock Inc. bought Boston-based State Street Research and Management Co., from insurer MetLife Inc. for $375 million.
State Street Research and Management provides asset management services for individuals and pension plans, corporation, nonprofits and unions. The company also has its own stock mutual funds.
State Street Research and Management is not associated with State Street Corp., which agreed earlier this year to pay $1.5 million in fines for alleged market-timing violations.
With the buy, BlackRock picked up a sizable equity management business of about $52 billion. With about 70% of its $314 portfolio in fixed income investments, BlackRock is one of the country’s largest bond fund managers.
