By Murray Coleman

In an open letter to investors. Pimcos Bill Gross admits that he misjudged ramifications of the European sovereign debt crisis, especially in August and September. Along with political gridlock over U.S. budget deficits, the manager explains that his Pimco Total Return Fund (PTTRX ) took on too much risk namely by slashing Treasuries in favor of issues from other parts of the world.

Investors reacted to debt scares on both sides of the Atlantic by flocking into Treasuries. That drove yields even lower and rallied prices. Gross earlier this year urged investors to avoid government issues, noting more attractive yields elsewhere, particularly in specific emerging markets.

As Europe’s crisis and the U.S. debt ceiling debacle turned developed economies towards a potential recession, the Total Return Fund had too little risk off and too much risk on, Gross writes in a special edition of his monthly outlook simply titled Mea Culpa.

Gross concedes that he’s “having a bad year. Pimco’s centerfielder has lost a few fly balls in the sun.”

Its an interesting letter in which the bond guru self-evaluates his most recent performance. Gross notes that the worlds biggest mutual fund was doing typically well through the first quarter before hitting more rocky times.

Indeed, according to Morningstar data, PTTRX outperformed in Q1 with a return of 1.1% compared to its typical rivals 0.98% gain.

In the following quarter, the funds net asset value rose 1.86%, slightly beating its peers.

During the third-quarter, however, PTTRX lost 1.06% while the average intermediate-term bond fund gained 1.55%.

Gross wrote:

The simple fact is that the portfolio at midyear was positioned for what we call a New Normal developed world economy – 2% real growth and 2% inflation. When growth estimates quickly changed it was obvious that I had misjudged the fly ball: E-CF or for nonbaseball aficionados – error centerfield.

As weve noted in the past, PTTRX isnt easily categorized. And Gross had earlier told the WSJ that he mistimed his exit from Treasures. Still, many pundits have started suggesting that investors dump PTTRX, or at least consider alternatives to place on their watch lists. Some of those most commonly recommended include: the Pimco Unconstrained D (PUBDX ); Loomis Sayles Bond (LSBRX ) and the DoubleLine Total Return Bond Fund (DBLTX ) or the DoubleLine Core Fixed Income Fund (DLFNX ).

But some, including the esteemed team of analysts and portfolio managers at Litman Gregory, have recently recommended that investors deposit more of their money into the fund.

Theres no doubt PTTRXs underperformance gap has become pronounced this year. The fund enters this week with a total return in 2011 of 1.09%. By comparison, a cheaper well-diversified index-tracking ETF like the iShares U.S. Aggregate Bond Fund (AGG ) has produced a 5.56% gain.

But keep in mind the longer-term track record Gross has established: PTTRX has returned 7.79%  in the past five years compared to AGGs 6.27%.

Can PTTRX regain its magic? Gross offered:

You want consistency, no surprises, but at the same time you want to get back through outperformance more than you pay for in fees. PIMCO, Mohamed El-Erian. and yours truly are working hard to make that happen. Despite the approaching World Series, for us it’s the beginning of a new season. Play ball!

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