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					                                                                 Investment Outlook
                                                                 April 2013
                                                                 Bill Gross

Your Global Investment Authority

                                   A MAN IN
                                   THE MIRROR
                                   I’m starting with the man in the mirror
                                   I’m asking him to change his ways
                                   And no message could have been any clearer
                                   If you wanna make the world a better place
                                   Take a look at yourself, and then make a…
                                   Chaaaaaaaange …..
                                   — Michael Jackson

                                   Am I a great investor? No, not yet. To paraphrase Ernest Hemingway’s “Jake” in
                                   The Sun Also Rises, “wouldn’t it be pretty to think so?” But the thinking so and
                                   the reality are often miles apart. When looking in the mirror, the average human
                                   sees a six-plus or a seven reflection on a scale of one to ten. The big nose or
                                   weak chin is masked by brighter eyes or near picture perfect teeth. And when
                                   the public is consulted, the vocal compliments as opposed to the near silent/
                                   whispered critiques are taken as a supermajority vote for good looks. So it is with
                                   investing, or any career that is exposed to the public eye. The brickbats come via
                                   the blogs and ambitious competitors, but the roses dominate one’s mental and
                                   even physical scrapbook. In addition to hope, it is how we survive day-to-day.
                                   We look at the man or woman in the mirror and see an image that is as distorted
                                   from reality as the one in a circus fun zone.
Yet at first blush, there is a partial saving grace in the money     business. 10 years, 20 years, 30 years? How many coins
management business. We have numbers. Subjective                     do you have to flip before a string of heads begins to
perceptions aside, we have total return and alpha histories that     suggest that it must be a two-headed coin, loaded with
purport to show how much better an individual or a firm has          some philosophical/commonsensical bias that places
been than the competition, or if not, what an excellent return       the long-term odds clearly in a firm’s or an individual’s
relative to inflation, or if not, what a generous amount of          favor? I must tell you, after 40 rather successful years, I still
wealth creation over and above cash … the comparisons are            don’t know if I or PIMCO qualifies. I don’t know if anyone,
seemingly endless yet the conclusions nearly always positive,        including investing’s most esteemed “oracle” Warren Buffett,
rendering the “saving grace” almost meaningless: everyone in         does, and here’s why.
their own mind is at least a six-plus or a seven, and if not for
                                                                     Investing and the success at it are predominately viewed on a
the most recent year, then over the last three, five, or 10 years.
                                                                     cyclical or even a secular basis, yet even that longer term time
Investors thrive on the numbers and turn them in their favor
                                                                     frame may be too short. Whether a tops-down or bottoms-
when observing their reflections. That first blush becomes a
                                                                     up investor in bonds, stocks, or private equity, the standard
permanently rosy complexion with Snow White cheeks.
                                                                     analysis tends to judge an investor or his firm on the basis of
The investing public is often similarly deceived. Consultants        how the bullish or bearish aspects of the cycle were
warn against going with the flow, selecting a firm or an             managed. Go to cash at the right time? Buy growth stocks at
individual based upon recent experience, but the reality is          the bottom? Extend duration when yields were peaking? Buy
generally otherwise. Three straight flips of the coin to             value stocks at the right price? Whatever. If the numbers
“heads” produces a buzz in the crowd for another “heads,”            exhibit rather consistent alpha with lower than average risk
despite the obvious 50/50 probabilities, as do 13 straight           and attractive information ratios then the Investing Hall of
years of outperforming the S&P 500 followed by … Well,               Fame may be just around the corner. Clearly the ability of the
you get my point. The Financial Times just published a study         investor to adapt to the market’s “four seasons” should be
confirming that a significant majority of computer simulated         proof enough that there was something more than luck
monkeys beat the stock market between 1968 and 2011 –                involved? And if those four seasons span a number of bull/
good looking monkeys that is.                                        bear cycles or even several decades, then a confirmation or
                                                                     coronation should take place shortly thereafter! First a market
In questioning initially whether I am a great investor, I open
                                                                     maven, then a wizard, and finally a King. Oh, to be a King.
the door to question whether other similarly esteemed public
icons like Bill Miller are as well. It seems, perhaps, that the      But let me admit something. There is not a Bond King or a
longer and longer you keep at it in this business the more           Stock King or an Investor Sovereign alive that can claim title
and more time you have to expose your Achilles heel –                to a throne. All of us, even the old guys like Buffett,
wherever and whatever that might be. Ex-Fidelity mutual              Soros, Fuss, yeah – me too, have cut our teeth during
fund manager Peter Lynch was certainly brilliant in one              perhaps a most advantageous period of time, the most
respect: he knew to get out when the gettin’ was good.               attractive epoch, that an investor could experience.
How his “buy what you know best” philosophy would                    Since the early 1970s when the dollar was released from gold
have survived the dot-coms or the Lehman/subprime bust               and credit began its incredible, liquefying, total return journey
is another question.                                                 to the present day, an investor that took marginal risk, levered
                                                                     it wisely and was conveniently sheltered from periodic bouts
So time and longevity must be a critical consideration
                                                                     of deleveraging or asset withdrawals could, and in some
in any objective confirmation of “greatness” in this

cases, was rewarded with the crown of “greatness.”                   and more credit risk, or that were sheltered either structurally
Perhaps, however, it was the epoch that made the                     or reputationally from withdrawals and delevering (Buffett)
man as opposed to the man that made the epoch.                       that clipped competitors at just the wrong time – succeeded.
                                                                     Yet all of these epochs were perhaps just that – epochs.
Authors Dimson, Marsh and Staunton would probably agree.
                                                                     What if an epoch changes? What if perpetual credit
In fact, the title of their book “Triumph of the
                                                                     expansion and its fertilization of asset prices and
Optimists” rather cagily describes an epochal 101 years
                                                                     returns are substantially altered? What if zero-bound
of investment returns – one in which it paid to be an
                                                                     interest rates define the end of a total return epoch that
optimist and a risk taker as opposed to a more
                                                                     began in the 1970s, accelerated in 1981 and has come to a
conservative Scrooge McDuck. Written in 2002, they
                                                                     mathematical dead-end for bonds in 2012/2013 and
perhaps correctly surmised however, that the next 101 years
                                                                     commonsensically for other conjoined asset classes as well?
were unlikely to be as fortunate because of the unrealistic
                                                                     What if a future epoch favors lower than index carry or
assumptions that many investors had priced into their
                                                                     continual bouts of 2008 Lehmanesque volatility, or
markets. And all of this before QE and 0% interest rates! In
                                                                     encompasses a period of global geopolitical confrontation
any case, their point – and mine as well – is that different
                                                                     with a quest for scarce and scarcer resources such as oil,
epochs produce different returns and fresh coronations as well.
                                                                     water, or simply food as suggested by Jeremy Grantham?
I have always been a marginal or what I would call a                 What if the effects of global “climate change or perhaps
measured risk taker; decently good at interest rate calls and        aging demographics,” substantially alter the rather fertile
perhaps decently better at promoting that image, but a risk          petri dish of capitalistic expansion and endorsement? What if
taker at the margin. It didn’t work too well for a few months        quantitative easing policies eventually collapse instead of
in 2011, nor in selected years over the past four decades, but       elevate asset prices? What if there is a future that demands
because credit was almost always expanding, almost always            that an investor – a seemingly great investor – change course,
fertilizing capitalism with its risk-taking bias, then PIMCO         or at least learn new tricks? Ah, now, that would be a test
prospered as well. On a somewhat technical basis, my/our             of greatness: the ability to adapt to a new epoch. The
firm’s tendency to sell volatility and earn “carry” in a number      problem with the Buffetts, the Fusses, the Granthams, the
of forms – outright through options and futures, in the              Marks, the Dalios, the Gabellis, the Coopermans, and the
mortgage market via prepayment risk, and on the curve via            Grosses of the world is that they’ll likely never find out.
bullets and roll down as opposed to barbells with                    Epochs can and likely will outlast them. But then one never
substandard carry – has been rewarded over long periods of           knows what time has in store for each of us, or what any of
time. When volatility has increased measurably (1979-1981,           us will do in the spans of time.
1998, 2008), we have been fortunate enough to have either
                                                                     What I do know, is that, like Michael Jackson sang in his
seen the future as it approached, or been just marginally
                                                                     brilliant, but all too short lifetime, I am and will continue to look
overweighted from a “carry” standpoint so that we survived
                                                                     at the man in the mirror. PIMCO, Gross, El-Erian? – yes, we’re
the dunking, whereas other firms did not.
                                                                     lookin’ good – in this epoch. If there’s a different one coming
My point is this: PIMCO’s epoch, Berkshire Hathaway’s epoch,         though, to make our and your world a better place, we might
Peter Lynch’s epoch, all occurred or have occurred within an         need to look in the mirror and make a Chaaaaaaaange …
epoch of credit expansion – a period where those that                Depends on what we see, I suppose. We will keep you informed.
reached for carry, that sold volatility, that tilted towards yield

                                                                                                  INVESTMENT OUTLOOK | APRIL 2013        3
                                    Man in the Mirror Speed Read

1) Investors should be judged on their ability to adapt to different epochs, not
   cycles. An epoch may be 40-50 years in time, perhaps longer.

2) Bill Miller may in fact be a great investor, but he’ll need 5 or 6 more
   straight “heads” in a future epoch to confirm it. Peter Lynch is a “party
   pooper.” Warren is the Oracle, but if an epoch changes will he and others
   like him be around to adapt to it?

3) No matter how self-indulgent you think this IO is, I just looked in the mirror
   and saw at least a 7. You must be blind!

William H. Gross
Managing Director

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