Hedges Drive Bond SuperStar to the Edge

Bill Gross is Wall Street's long-reigning bond king, but he is struggling to adapt to a new world. For more than three decades, Mr. Gross, the 62-year-old chief investment officer at Pacific Investment Management Co., which has $617 billion in assets, has run the world's largest bond mutual fund. In that time, the $95 billion Pimco Total Return Fund has handily outpaced both the bond market and almost all of its competitors. In 2000, when Germany's Allianz AG bought Pimco, based in Newport Beach, Calif., it was so eager to keep Mr. Gross at the helm that it agreed to a pay package valued at about $200 million to keep him around through next year.

As hedge funds and other investors have been scooping up riskier bonds with the highest yields, however, it has been harder for Mr. Gross to beat the market by buying this kind of debt. Eager to keep returns up but wary of focusing on riskier bonds, Mr. Gross has chosen to make Pimco's portfolio more volatile by focusing on short-term Treasurys and currency bets, among other things.

Mr. Gross and his team have been focusing on short-term Treasury bonds, currencies and other moves that tend to make results jump around more rapidly in an effort to try to generate better returns. The fund now averages a daily volatility of about 0.05 percentage point above the volatility of the overall bond market -- not especially volatile compared with many stock portfolios, but about twice the fund's volatility in the past.

"Our approach is to accept more volatility in areas we don't consider to be risky and we are more confident of," he says. "It's getting harder because risk takers" like hedge funds are driving yields on many bonds lower.

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