PIMCO’s Bill Gross, manager of the world’s largest bond fund, is betting big on mortgages. The Financial Times reported last last week that Gross had shifted more than 60 percent of the $130 billion PIMCO Total Return fund he manages into agency-backed mortgage debt during the first quarter, a move that has put the PIMCO fund’s returns ahead of 99 percent of its peers. The fund has returned 12.6 percent over the past 12 months, according to Morningstar rankings, and 3.8 percent so far this year. From the report:

“Government policy is moving to sanctify the status of the government-sponsored agencies. It became a question of which institutions would be sheltered by the government umbrella,” he said … Mr Gross said Pimco was buying primarily mortgage agency debt and “not the subprime garbage”.

Of course, Gross has been making headlines and grabbing the attention of policymakers with continued bantering around what to do about “the subprime problem,” most recently suggesting that government-subsidized write-downs of mortgages in the private-party market would help stanch price declines. (See earlier HW commentary on the issue here). But he surely hasn’t been investing in that space, instead favoring an age-old tactic used by most successful fund managers: divert attention into one area, while acting in another. And, if anything, his posturing about the need to do something for troubled subprime homeowners has only buttressed the emerging view of both Fannie and Freddie as saviors of a U.S. housing market undergoing what many economists feel is a needed correction. As HW has covered extensively in recent weeks, returns in the agency-backed MBS market have been the best in well over a decade; excess returns over Treasuries were at their highest level since 1997 in April, a trend that certainly boosted those funds that had piled into the agency MBS market at the right time. Which puts us squarely into the current state of the secondary mortgage market: as more than a few market pundits have noted, there are essentially two very distinct secondary markets right now — the agency MBS market, which is ballooning in size, and a sizeable junk-bond private party market teeming with subprime, Alt-A and option ARM mortgage debt gone bad.