How Bill Gross Topped the S&P 500

NEW YORK ( TheStreet) -- For decades, Bill Gross has been hailed as an outstanding bond manager. His Pimco Total Return ( PTTDX) became the largest mutual fund by consistently topping the Barclays Capital U.S. Aggregate bond benchmark.

But Gross should also be recognized for another feat: operating stock funds that have surpassed the S&P 500. During the past five years, his PIMCO Fundamental IndexPLUS ( PXTIX) returned 13.8% annually, compared with 6.1% for the S&P 500, according to Morningstar.

Other winners include PIMCO StocksPLUS Absolute Return ( PSPTX), which returned 9.8%, and PIMCO StocksPLUS ( PPLAX), which returned 6.7%.

Gross has shined in stocks by relying on a complicated strategy that employs his bond trading skills. While most equity managers hold shares of stocks, Gross uses a mixture of bonds and futures as well as other derivatives. Futures enable a trader to buy something at a fixed price in the future.

To appreciate how Gross works his magic, consider an investor who has $10,000 and wants to take possession of stock worth that amount three months from now. To accomplish the goal, he purchases futures. The value of those rises and falls along with the stock price. The trader may need to give a broker only $1,000 in order to control the full $10,000 worth of the stock. This ability to leverage explains why futures are popular.

After buying the futures, the trader can put the rest of his cash in money-market funds or other investments. Say the stock rises by $1,000. The value of the trader's futures will rise by that amount -- plus he will record any profits produced by the cash holding.

For PIMCO StocksPLUS, Gross buys futures that track the S&P 500 and puts his excess cash in a bond portfolio. If the fixed-income holdings earn nothing, the PIMCO fund will trail the stock benchmark by whatever it costs to trade the futures.

The cost of employing a futures contract rises and falls with money-market rates. At the moment, the futures cost about 0.30%. If the PIMCO fixed-income holdings return more than the futures cost, then the fund will outperform the S&P 500.

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