Portfolio Management 101 > Bond Investing

Should Your Bond Allocations Follow Bill Gross to Janus?

Bill Gross

A week ago Friday, the investment world was shocked when Bill Gross, the venerable bond manager, known as the King of Bonds, announced he was leaving the firm he founded and heading to Janus. Not only is it unusual for the founder of a firm to leave abruptly as he did, but to go to a shop that is not known for its fixed income funds? The whole situation was odd, to say the least.

For the last week, investors have been evaluating their options and trying to figure out whether to stay with PIMCO, or take their money elsewhere. These are big money investors so naturally, the risk of heavy outflows from the fund are a major concern for all other investors in the fund. And liquidity issues that may arise from possibly being the biggest seller of certain financial assets could affect the net asset value of the fund in the short term.

Getting Past Premium Bond Prices

The look of an investor evaluating bonds trading above par

Investing in fixed income seems to be straightforward: An investor buys a bond with a face value of $100, receives semi-annual coupons for the life of the bond, and receives the face value of the bond at maturity.

Besides the investor looking to ‘trade’ bonds for a quick profit, most bond investors are looking for either income, preservation of capital, or a combination of both. For these investors, if bonds were always trading at 100, life would be easy. If a bond always traded at 100, for example, the expected return on that bond would equal the amount of the coupon.

But bond prices fluctuate just like any other security, and although they do not have the price volatility of equities, bond prices can deviate quite a bit from their initial issue price, affecting the expected return, or yield to maturity on the bonds.

It is this deviation from par that many bond investors find challenging. Ironically, the problem isn’t so much when prices are below par, but rather, when the price of a bond is above $100. You see, many investors are philosophically opposed to paying more than $100 for a bond. The concept of paying $110 for a bond today and receiving only $100 at maturity, even if maturity is many years away, would imply a loss of capital of $10. The coupons received over the years are either forgotten or ignored.