“Trouble. Trouble, trouble, trouble, trouble.” Reading all the news about Bill Gross and PIMCO, I keep hearing that Ray LaMontagne song in my head. (Go ahead—give it a listen while you read this, just for fun.)
The king of bonds isn’t yet abdicating the throne, but it’s been a rough stretch since PIMCO came down from the mountain to translate the etchings on the “New Normal” tablets. It was, of course, hard to argue the logic in 2009, that U.S. markets would struggle under the weight of a sluggish economy hampered by high unemployment and systemic government debt. But as it often does in the face of supposed certainty, the market defied man’s expectations.
Following the new normal playbook, PIMCO bet against Treasurys in 2011, when its flagship fund, Total Return, captured only 53% of the Barclays U.S. Aggregate Bond index return for that year. In 2013, the fund barely beat the Barclays index, but it lost money for the first time since 1999—accelerating a trend of fund outflows.
Then things started to reflect daytime television, when Gross’ heir apparent, Mohamed El-Erian, departed in the midst of rumors of dissent at the top of the organization. Those rumors were confirmed when The Wall Street Journal published an article based on reports by unnamed inside sources, accusing Gross of comparing himself publicly to the unbeatable racehorse, Secretariat. Then Morningstar downgraded PIMCO’s “stewardship grade” to C from B.
Beyond the tabloid fodder, however, there is a vital investing lesson to take away from this still-evolving story:
Pride goeth before a fall.
Ego and ignorance are at the core of nearly every investment blunder. As un-shocked as most of us were to find that an investment management bigwig making $200 million a year had an ego problem, ego is at the core of the PIMCO dilemma.
(Click HERE to see me discussing concerns about Bill Gross’ ego on CNBC’s “Street Signs.”)
Ego, then, often leads to an interesting form of ignorance. While none of us would dispute Gross’ intellectual brilliance, his presumption of preeminence might be his downfall.
When everything goes right for an extended period of time, we often mistakenly allow ourselves to believe that our success is disproportionately attributable to us and not outside forces. It’s called the fundamental attribution error. We attribute our success to our innate traits and our mistakes to external circumstances while assuming that the errors of others are due to internal shortfalls, like a lack of character or intelligence.
It’s a blind spot. Unfortunately, the financial industry seems to be full of them. Everybody thinks they’re smarter than everybody else—and the market, even though the overwhelming evidence stands in opposition.
Déjà vu all over again?
Remember the story of the fabled fund formerly known as the Legg Mason Value Trust? Bill Miller had beaten the market for so many years that he forgot it was possible for him to not beat the market. When he lost to the S&P 500 for the first time in his tenure with the fund in 2006 and 2007 — and then very badly in 2008, betting he could will the financials out of their downward spiral — everything started to become clearer: The fund had returned more than the broader market largely because it was taking on more risk than the market—then, it simply lost more than the market because it was taking on more risk than the market.
Almost two decades of apparent outperformance were undone in a single year.
Or go back even further to explore the life of Jesse Livermore in the fictional account based on his life in Reminiscences of a Stock Operator. Some Wall Street firms still offer this as a securities trading handbook, even though Livermore lost his fortune more times than he was able to make it and ended his life by his own hand, in poverty and disgrace.
The Bottom Line:
The market rewards humility over hubris, discipline over gut feelings and proactivity over reactivity. By acknowledging that you’re not omniscient, you free yourself to compose an investment strategy grounded in evidence that makes up for its lack of sex appeal with its elegant simplicity—and most important, its effectiveness. You can choose to stop chasing the market and build a portfolio designed to get everything the market has to offer.
More on that next week.