Pimco’s Bill Gross Says Bonds Have Seen Best Days

March 25 (Bloomberg) -- Bill Gross, manager of the world’sbiggest bond fund at Pacific Investment Management Co., said thealmost three-decade bond market rally may be drawing to a close.

Excess borrowing in nations including the U.S., U.K. andJapan will eventually lead to inflation as governments sellrecord amounts of debt to finance surging deficits, Gross said.Pimco, which announced in December that it would offer stockfunds for the first time, is advising that investors buy thedebt of counties such as Germany and Canada that have lowdeficits and higher-yielding corporate securities.

“Bonds have seen their best days,” Gross said in aBloomberg Radio interview today from Pimco’s headquarters inNewport Beach, California. “We are focused more in spread spacethan in yield space. Durations should be shorter than index andyou should be taking a little more risk in terms of spreads.”

Yields on two-year U.S. Treasury notes are likely to riseto 1.25 percent to 1.5 percent from 1.08 percent in the nextyear as the economy strengthens and the Federal Reserve beginsto increase interest rates, Gross said.

“Real interest rates are moving higher,” said Gross, whoco-founded Pimco, which manages about $1 trillion in assets. “That’s the main bear element in the bond market.”

Real yields, which take into account inflation ordeflation, have increased to 1.71 percent on 10-year Treasuriesfrom 1.12 percent at the end of last year.

‘New Normal’

The yield on the 10-year Treasury note reached a high of15.8 percent in September 1981 and a record low of 2.03 percentin December 2008 during the height of the credit crunch. Thenotes yield 3.89 percent today.

Investors should avoid the debt of the U.K. and invest inshorter-maturity U.S. and Brazilian securities and longer-maturity German and “core” Europe bonds, Gross, 65,recommended in a commentary yesterday. Under what Pimco callsthe “new normal,” Investors should expect lower-than-averagehistorical returns with heightened government regulation, lowerconsumption, slower growth and a shrinking global role for theU.S. economy.

“Sovereign decoupling is symptomatic of the realization bythe market that sovereign credits are vulnerable at some pointdown the road,” said Gross, who serves as co-chief investmentofficer with Mohamed El-Erian.

Gross increased holdings of bonds from non-U.S. developednations in his Total Return Fund for a fourth month in February,taking them to the highest level since May 2004, according todata on the company’s Web site on March 17.

Total Return Fund

The fund manager raised the proportion of the securities to19 percent of assets in February from 18 percent in January.Gross increased U.S. government-related debt to 35 percent from31 percent, the first rise since October 2009, and lowered netcash to 2 percent from 9 percent.

The $214 billion Total Return Fund returned 16 percent inthe past year, beating 54 percent of its peers, according todata compiled by Bloomberg. As of December, Pimco managed $1trillion in assets. Pimco is a unit of Munich-based insurerAllianz SE.

The U.S. budget deficit reached a record $1.4 trillion forthe fiscal year that ended Sept. 30 amid falling tax revenuefrom the recession, a bailout of the banking and autoindustries, and the $787 billion economic stimulus package.

U.S. Treasuries have returned 0.9 percent this year,compared with 2.7 percent for German government bonds and 0.5percent for U.K. gilts, according to indexes compiled by Bank ofAmerica Merrill Lynch.

Equity Funds

All Group of Seven countries, except Canada and Germany,will have debt-to-GDP ratios close to or exceeding 100 percentby 2014, John Lipsky, first deputy managing director of theInternational Monetary Fund, said in a speech March 21 at theChina Development Forum in Beijing.

Pimco filed with U.S. regulators in December to start astock mutual fund that can also invest in bank loans, junk bondsand distressed securities. The Pimco Global Opportunities Fundwill buy securities and financial instruments “economicallytied” to at least three countries, one of which may be theU.S., according to a company filing.

Investors should “move outside of the United States,” inchoosing stocks, Gross said. Emerging and developing countriesbecause they are now “creditor countries” that feature stronggrowth while developed countries are the “debtor countries”and carry weaker growth, he said.