Pimco's Total Return Bond Fund experienced problems throughout the first half of 2007. A prolonged period of low economic and financial market volatility led market participants to become increasingly comfortable with taking additional risks, often unjustified by rational assumptions, and this process drove the compensation that investors received for taking risks to extremely low levels. 'As Pimco forecast the eventual unwinding of this process, we did not participate in the exuberance that gripped the market at the time. As a consequence, we underperformed through the first half of the year,' said William Gross, founder and managing director of Pacific Investment Management Company (Pimco) and co-chief investment officer. In the second half of the year Pimco's conviction paid off as the market unwound. It also avoided credit and other 'toxic instruments' including collateralised debt obligations, collateralised loan obligations and structured investment vehicles. This helped the fund to outperform with an annual return of 8.87 per cent compared to a benchmark of 6.97 per cent. The fund, which manages more than US$4billion, attracts individual and institutional investors. The investment philosophy is driven by Pimco's cyclical forums which give investment professionals from around the world an opportunity to gather in Newport Beach, California to discuss economics, policy, the markets and, most importantly, the investment implications for managing global bonds. These forums are followed by a strategy week where speciality desks, including mortgage-backed securities, corporate bonds and emerging markets, discuss the best trade ideas in their particular sectors, before passing them on to Pimco's investment teams. Pimco's investment committees also meet regularly between forums to discuss changes in the market and implications for strategy to ensure that the process and positions are prevalent. 'This gives the investment committee a solid basis from which to take discussions from the forum and transform them into practical implementation.' Volatility is managed primarily through risk budgeting and the sizing of trades. 'What has become apparent in the current crisis is that many investors took the recent past experience of low economic and financial volatility into consideration when determining risk exposure and leverage ratios,' said Mr Gross. 'As a result, these investors have suffered.' Following last year's period of risk aversion due to concerns surrounding the housing market and lending standards, the fund has been increasing its exposure to high quality credits that suffered from the current crisis. 'Sovereign debt has become quite expensive as market participants have been hoarding liquidity,' to Mr Gross said. 'The focus has been on those credits that have very little probability of default, including agency mortgage-backed securities. As a provider of liquidity, Pimco is squarely positioned to take advantage. We continue to avoid high yielding credits or subprime mortgage assets as defaults are likely to increase.' Looking ahead at the rest of the year, Mr Gross believed it would continue to be a time of poor US economic data and heightened uncertainty. 'However, many markets are pricing in a fairly severe outcome and offer attractive opportunities for those that have liquidity,' he added. 'These opportunities include agency mortgage-backed securities, high-grade credits, municipal bonds, and emerging markets. Often, even good assets get swept away in a financial storm.'