Mary Child’s is the cohost and correspondent for NPR’s Planet Money, but this episode focuses on her new book covering iconic bond fund manager, Bill Gross.
Listen now and learn:
- Why bond trading was invented
- How Pimco came to dominate bond markets
- What’s most interesting about the bond environment today
Listen to the show now or read the in-depth show notes below.
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Show Notes
Mary Childs is a cohost and correspondent for NPR’s Planet Money. But this episode focuses on her new book, The Bond King: How One Man Made a Market, Built an Empire, and Lost It All. The book is a biography of the iconic PIMCO bond fund manager, Bill Gross.
2:22 – The Story of Mary’s First Interaction With Bill Gross
Mary had worked on a story about PIMCO making a really big trade and CDS. After all the painstaking fact checking, it turns out she made a mistake in like the 39th paragraph or something like that.
The next morning when the story has been published, Bill Gross is on Bloomberg Radio saying something like “Mary Childs needs to get her facts straight. She said we’re underperforming by 1%, but we’re actually outperforming by more like 0.75%.
As you might expect, the most famous bond manager on the planet saying your numbers are wrong is panic-inducing. So she tries to fix the story and is trying to replicate the numbers he gave on the radio but she can’t do it. Mary’s “losing her mind” and finally Bill Gross calls her directly to let her know she had messed up.
But when Mary pointed out that she couldn’t replicate the numbers he had provided on-air, he said something to the effect of “Well, you got to say your numbers. I got to say mine.”
As Mary reflects on the conversation, it’s mind blowing that someone would consciously and overtly say that, but she thinks it’s telling about who Bill Gross is and his understanding of the press and of what matters and how to say what you want to say.
4:43 – Why Mary Chose to Cover Credit Markets
Mary finds bonds to be really interesting and influential. They’re difficult sometimes and they’re where some of the more complex financial engineering happens. They’re where the rubber meets the road in bankruptcy court.
All of these reasons make credit very elegant and compelling and fascinating and this beautiful manifestation of our societal values and who we prioritize and how we build a waterfall around that.
6:49 – Why Bond Trading Was Invented
For a long time, bonds were just certificates that you kept in the basement in a vault, and people would clip coupons. And indeed, that was Bill Gross, his first job clipping the coupons at the bottom of the little certificate, and you would send the coupon in an envelope to the literal company, which would receive the coupon and send you the interest payment.
Mary’s theory is that it stayed that way for so long because it worked so well. For example, an insurance company has a schedule of liabilities and knows they’re going to have to pay out having this reliable return of their money, when they know that my bond is going to mature. That’s very comforting. It kind of offsets the liabilities in a really elegant way. And it’s just precise, and you can sleep at night, and it worked. That’s part of why Mary thinks it was so stable.
But then Bill Gross and his cohort come along alongside this rapid inflation. Suddenly, keeping a bond in a vault and letting the value just erode day by day becomes less and less appealing. This creates kind of a window of opportunity for Bill and a lot of these other people who questioned why they were just clipping coupons and keeping these bonds in the basement. They realized it didn’t make sense and they should trade them.
They could sell one bond to someone with different priorities and buy a new bond that’s better. Plus, there was this new idea that you can get capital appreciation – you can trade your bonds and the bond can go up in price. And this was radical, and obviously very exciting.
It kind of made bond trading this extremely profitable, extremely fun, and extremely influential world that previously had just been sleepy, steady-Eddie bonds in the basement clipping coupons.
9:59 – How PIMCO Bet on the Housing Crisis in 2006
PIMCO’s mortgage team saw that the housing market would not be able to keep going up. Eventually, there will be a point at which homeowners would not be able to make their own payments and eventually wouldn’t be able to sell to some greater fool. They didn’t predict the severity of the crisis, but they felt like something was going to happen. So they ramped down risk and they were super early.
They were looking at this coming down the pike in 2006 and had to sit there for the duration of at least 2007. They had to patiently sit and underperform everyone else in a very go-go time in capital markets where everyone was reaching for yield and trying to take on as much risk as possible.
Amazingly, PIMCO clients did stick with them and it all came roaring back. So it did work out in their favor. And they were rewarded for that patience.
12:16 – How a Changing Culture
In 2011, there was this influx of both money and talented people coming from Wall Street that had been laid off at the banks after the financial crisis. The ranks roughly doubled, which has a lot of different effects, one being that just the composition of the place changes.
When Bill Gross was the sole CIO, they were all about each basis point, fighting with the street to get better execution, getting your arms around a credit, trying to predict interest rates even though they were putting on strangles – everything was engineered and very much in the weeds.
But the influence of being a culture of thought leaders intensified as the firm grew and there was a growing cultural sense that “we were right before and we will be right again.” Plus, now they had Co-CEO and Co-CIO Mohamed El-Erian, who was a very macro top-down kind of economist.
Those dynamics led to Bill Gross in 2011 making a big bet against US Treasuries that turned out to be spectacularly wrong. And to his credit, of course, he apologized, he reversed he still managed to make money that year.
In this moment where he thought he had the odds, Mary wonders if he thought that by virtue of his call his own call, it would kind of move the market for him. So many people would watch would he did and what PIMCO did. So maybe it got in his head that he could influence the trajectory of the Treasury market.
But this was a real marker for the change in direction and drift from what they had been and what they had always done. Mary thinks this is where you start to see the seeds of everything coming undone.
15:32 Strategic Mediocrity
Mary highlights Bill’s experience playing blackjack in Vegas and how that influenced the way he made bets – he’s not betting more than 2%, he knows when the odds are in his favor to bet proportionally more, and to always avoid ruin.
There’s another fund manager who in the book talks about his strategy, which he calls strategic mediocrity. This was the idea that if you wanted to be the best fund manager over a 10-year period, you had to not be the best fund manager in any one year. If you’re number one or even in the top decile, you would have had to take too much risk that in some way you just got lucky – and had the winds blown a little differently, you might have been last.
So all you need to do is avoid ruin, and stay within that kind of middle band, upper middle, we’re not trying to please anybody here but upper middle, and not get blown out. And then over 10 years, you will have made more money for your clients, and you will have been the best bond fund manager.
18:32 – PIMCO’s Self-Actualized Trades
People have been surprised at the extent to which some of these trades were self-actualized. PIMCO had to basically construct the circumstances that would make the trade win.
Mary’s favorite trade was in 1983 with Ginnie Mae CDRs, in which PIMCO basically cornered the market and broke the contract. They just bought up so many of these contracts and revealed multiple fundamental flaws in these contracts, so these contracts don’t exist anymore. But PIMCO basically had to make that happen. There weren’t futures contracts and people didn’t use derivatives at the time, so PIMCO had to go to clients.
It’s a great example also of how individual investors may realize that the professionals know more, but they also don’t realize the lengths that professionals go through to find arbitrage opportunities and additional profits.
And it’s very clear that they read deep in the legalese of all their contracts to make as much of an advantage for themselves as they could. One thing that seemed kind of interesting to me is as the book progressed, it was kind of like a slow replay of a car crash in the way that Bill’s life unwound. Is there a point when you were writing the book where you’re like, “Hey, I’m pretty sure the story’s over….” And then, it just kept going.
20:33 – When Bill’s Story Kept Getting Messier
There was a nice tidy narrative: the rise and fall, he leaves PIMCO to go to Janice, and that’s what Mary thought was the ending. But it got messy with his divorce and neighbor dispute.
Mary suggests that without a benchmark to beat, he got kind of bored and had too much time on his hands.
22:24 – The Most Interesting Aspect of Bond Markets Today
We haven’t seen inflation like this since Bill Gross’s career began, which really upends a lot of assumptions. Much like the contract that broke, which we discussed earlier, we have made a lot of assumptions that we don’t know that we’ve made because of the interest rate environment that we’ve been living in.
Cracks in our assumptions and our logic and our engineering in our modeling, all of those really start to show when interest rates change. Mary thinks the behaviors of a lot of things are going to start to kind of go upside down and we’re going to see a lot more disruption for lack of a better word.
Because we have new problems to confront and one of the things Mary loves about financial markets in general, but especially about credit markets, is there are so many ways to express opinions and forecasts. Mary laughs a bit at herself for being excited about the new products that will be invented as a result.
26:41 – Mary’s Favorite Finance Books
Mary recently created this list of finance books for people who hate finance.
From this list, she calls out Liar’s Poker by Michael Lewis, Severance by Ling Ma, and Where Are the Customers’ Yachts? by Fred Schwed.
Mary also noted a book she is about to read called Undiversified: The Big Gender Short in Investment Management by Ellen Carr and Katrina Dudley.
29:27 – What Does It Mean to Be A Long-Term Investor?
Mary takes it back to the book. She finds it very admirable that Bill would come to the table every day and just stick to his strategy.
Knowing that your strategy is good and that it will work out, even if it didn’t work out today or yesterday or the past month or the past year, you just need the true odds and you need to avoid ruin. That’s all you have to do, but that’s really hard.
Nobody is going to call you if the world has changed and your strategies have stopped working. That’s why the long-term investors have a good strategy and stick with it.
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