You once said gambling and investment are basically the same. Yet, games of chance differ in the risks they offer. What was the specific attraction of blackjack?

Bill Gross: Dice have no memory and, it’s said, the only way to win at roulette is to steal from the table. Blackjack is not chance. It is not an independent trial process; rather the cards played affect the odds on subsequent hands. So, situations emerge that give the player the advantage, situations where the house edge can be overcome. It requires discipline, dedication and skill, but it can be achieved. You learn to predict what the next card might be, whether it is likely to be high or low. You may be frequently wrong, but if on average you come out on top, you win in the long term. And I like winning.

Is there a similarity between blackjack and bonds?

Some of the variables within bonds are more predictable if, for example, inflation rises or falls. However, many of the same principles I learned from blackjack apply equally to equities as to bonds. First, spread your risk. Cards run hot and cold, so be prepared. Second, as far as possible know your risks. Quantify them, predict the consequences, and prepare how to react. Finally, even if you lose on a big bet, it’s important to stay in the game.

Casinos are successful because most people lose. Can you really compare your investment strategy to “gambling"?

Yes, but the key word is “professional.” Gambling is viewed negatively because the average gambler is emotional, undisciplined and often desperate. A card counter has a method to assess and evaluate the probability of future events. This probability theory is based on mathematics. Cards dealt are cyclical challenges. The blackjack player, like the professional investor, tries to develop the skill to predict the cyclical challenge to ensure success over the long term. Our bets don’t always succeed, but we win often enough to come out well ahead.

How do you judge which bets to place?

We make decisions based on secular and cyclical analysis. Secular analysis considers the long term – three to five years – and examines geopolitical, social and demographic trends to anticipate what may occur. Cyclical trends affect the market over the shorter term, such as new producer price index figures or changes in the federal funds rate. Taken together they tell us where to invest our clients’ money – domestically or internationally, more interest rate risk or less, high quality or high yield. This approach improves our ability to consistently add value over the long term.

And to avoid getting wiped out, to avoid “gambler’s ruin,” you adhere to the idea of the Kelly criterion?

Big bets are crucial. You need to make them when you believe the odds are in your favor, but big bets can go spectacularly wrong. I always set aside 50 times my maximum bet to avoid significant loss through a bad streak. We apply the same principles at PIMCO with risk management being one of our highest priorities. We can and have lost bets, but we are well hedged and can stay in the game.

“Casino capitalism” is a term used by critics of the financial system. Partially this implies risk is taken too lightly.

Emotion is a dangerous drug when it comes to investing. The search for higher returns allowed unregulated hedge funds and financial conduits to grow into a “shadow” economy built on leverage and cheap financing. The billions on offer inspired greed on a massive scale and people took risks that were not well judged. In my opinion, the private credit markets have forfeited their privileged right to operate relatively autonomously because of the incompetence, greed, and in instances, fraudulent activities they have displayed.

Some of the institutions hardest hit by subprime had the largest teams of risk managers.

They were using the wrong models and looking at the wrong risks.

How does Minsky fit in? I see you’ve quoted him.

A relatively unknown economist whose work helped us save billions. His Financial Instability Hypothesis influenced PIMCO’s Paul McCulley resulting in us developing a strategic plan to avoid the subprime meltdown well ahead of time. Minsky argued that Wall Street encourages businesses and individuals to take on too much risk, creating ruinous boom-and-bust cycles. Sounds familiar, wouldn’t you say?

Unfortunately, our time is up. Thank you.

Thank you.