Psst...what's Bill Gross up to?

When the subject of interest rates and inflation creeps up - as it has with today's higher-than-expected consumer price index numbers - Bill Gross can't be too far behind. Gross, chief investment officer of Newport Beach-based Pacific Investment Management Co. (Pimco to most everybody in the financial world), figures that the Federal Reserve might find it hard to keep cutting interest rates in the face of inflation, a weak dollar and the fact that the recent cuts haven't done much to revive the economy. Gross appeared on Bloomberg Radio - he's often called the most prominent bond investor and Pimco is such a mammoth investment company - $747 billion in bond assets - that it's sometimes accused of throwing its weight around. "It's a double-edged sword, having huge size in the markets,” Don Phillips, a managing director at Chicago-based research firm Morningstar Inc., tells Bloomberg's Seth Lubove and Elizabeth Stanton. "The negatives would tend to outweigh the positives - unless you're very smart about using the positives to your advantage and to your clients' advantage.” This is more than theoretical grousing - NY lawyer Christopher Lovell claims that Pimco intentionally manipulated the Treasury futures market in mid-2005 in violation of the Commodity Exchange Act of 1936. Lovell's firm represents a hedge fund and two individuals who sold the contracts short and claim they had to pay higher prices to replace them (Lovell is seeking damages that Pimco estimates would exceed $600 million).

"There wasn't any squeeze,” Gross says. "When you're this size, and this big, you're a target of class-action legal maneuvering." Gross adds: "Like an elephant, you have to watch where you step, knowing there are people out there who are willing to make accusations.” The bond fund giant has so far failed to halt Lovell's suit, whose primary plaintiff is now part of Chicago options-trading firm Peak6 Investments LP. On July 31, 2007, U.S. District Judge Ronald Guzman approved the litigation as a class action. "Here, considering the totality of the circumstances, it can be reasonably inferred from the facts alleged that Pimco Funds intended to cause artificial prices or otherwise manipulate the futures market,” the judge wrote. Pimco appealed to the Seventh Circuit. On Feb. 6, 2008, Pimco requested a 60-day stay to try to settle out of court. Lovell agreed to talk. "The case is not anywhere close to over,'' says Christopher McGrath, a Lovell associate.

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In general, whatever their intent, big fixed-income funds that hold unusually large positions in bond issues may find that their own size becomes a liability, says Michael Rosen, co-founder and chief investment officer of Santa Monica, California-based Angeles Investment Advisors LLC, a pension consultant to institutional investors. When it's time to sell, the pool of potential buyers is limited. "It makes it hard if you want to find an active buyer and get out,'' Rosen says. The biggest market participants also attract an unwelcome spotlight, Morningstar's Phillips says. "Everybody is watching your every move,'' he says. "Just whispers that Bill Gross is doing something in the market can cause people to dramatically alter their own investment strategies."