Despite investors pulling out around $30 billion from his flagship Total Return Fund (NASDAQ:BOND), PIMCO’s Bill Gross is still a pretty smart guy when it comes to interest rates and the bond market. Managing a staggering $1.97 trillion in mutual fund and ETF assets, when Bill Gross speaks about the global markets, investors tend to listen. Aside from his recent bullish bets on mortgage backed securities, the PIMCO head honcho’s latest missive can be seen as pretty depressing.

Investors should expect low interest rates for a very long time.

While the statement is simple, the effects on a portfolio can be dire if investors aren’t careful. Luckily, there are ways to position yourself, to counteract the effects of a prolonged low interest rate environment.

Economy Not Ready

In his latest investment commentary, Bill Gross painted a world where investors should get used to low interest rates for a long time.

The Federal Reserve has been holding its benchmark interest rate between zero and 0.25% since December 2008. According to official statements from the central bank, it plans to keep rates that low until the unemployment rate falls to around 6.5%. Today, unemployment still stands at 7.3%. Current Fed forecasts show that the jobless rate will hit that 6.5% next year and expect they'll keep interest rates near zero until 2015. By the end of that year, the Fed expects to have raised interest rates to 2%. 

According to Gross, there’s a snowball’s chance in hell of that happening.

The investment guru estimates that economy is still not ready for higher rates- with housing being a prime example. As investor expectations of the Fed ending or tapering its massive $85 billion in monthly bond purchase program, yields on the 10-year Treasury yield spiked from 1.6% to 3%. That pushed up mortgage rates. New home construction faltered as did mortgage refinancing activity. Given how important housing is to the economy, Gross sees this as just one major issue to overcome.

Secondly, Gross estimates that poor policy moves in Washington, such as the partial shutdown of the U.S. government as well as issues relating to the debt ceiling will put a huge dent in the country’s third-quarter GDP. Analysts estimate that if the shutdown lasts about two weeks it would probably cut about 0.3 of a percentage point from GDP.

Overall, Gross’s message can be summed up in the idea that the last time the U.S. economy was this highly levered- back in the 1940s- it took over 25 years of 10-year Treasury rates averaging 3% less than nominal GDP to accomplish the “beautiful deleveraging.” Overall, investors should get ready for low interest rates for decades to come.

Following Gross’s Advice

Given the potential for an extended period of low interest rates, investors should plan accordingly. However, with tapering still on the docket according to Gross, investors should shun longer dated bonds and funds such as the Vanguard Extended Duration Treasury Index ETF (NYSE:EDV) or the iShares Barclays 20+ Year Treasury Bond (NYSE:TLT). Instead, Gross suggests a portfolio comprised of Treasury debt with shorter maturities as well as Treasury Inflation Protected Securities (TIPS). That should produce a 4% annual return. Albeit low, that return maybe the best one investors can get in the new environment. 

On the TIPS side, the PIMCO 1-5 Year US TIPS Index ETF (NASDAQ:STPZ) bets on inflation protected securities with shorter timelines. The ETF tracks 14 different TIPs bonds with an effective duration of 2.7 years. That will help provide inflation fighting, while protecting against any “Taper Tantrum” shocks. Likewise, the Vanguard Short-Term Inflation-Protected Securities ETF (NASDAQ:VTIP) can also be used. 

On the shorter duration Treasury side, investors have a multitude of choices to add exposure. The iShares Barclays 1-3 Year Treasury Bond (NYSE:SHY) tracks 49 different notes with a duration of just 1.88 years, while the SPDR Barclays 1-3 Month T-Bill (NYSE:BIL) shortens that duration down to just 1.92 months. 

Strangely, absent from Gross’s message of low interest rates was equities. Yet, as we’ve seen over the last years, stocks have done quite well in the face of low rates. Adding a swath of a broad fund like the Vanguard Total World Stock Index ETF (NYSE:VT) may be not such a bad idea.

The Bottom Line

According to Bond King Bill Gross, investors may be in for a low interest rate environment for a very very long time. Point blank, the economy just isn’t ready for higher rates. That has wide sweeping implications for portfolios and investors. The previous picks of TIPs peppered with shorter duration bonds, should help get investors through the next few years according to Gross.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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