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How About a Little PIMCO Helper?

You might need a little non-PIMCO exposure.

Russel Kinnel, 10/11/2010

Do your clients own Harbor Bond HABDX, Ohio CollegeAdvantage 529 Savings Plan, and Schwab Target 2020 Fund? If so, they own PIMCO Total Return PTTRX, in varying degrees, in three different products.

Total Return everywhere may be a case of too much of a good thing. The fund's insanely large asset base of $252 billion (plus another $236 billion that PIMCO runs with the same approach elsewhere) has led manager Bill Gross and his team to increase their use of derivatives to execute their strategy. Clearly, they know what they're doing, and they continue to make savvy big-picture calls--such as anticipating the housing downturn in 2007 and, recently, shifting into Treasury bonds, which have delivered fine results this year.

Given the size of the fund, it makes sense for Gross to rely on top-down forecasts to manage it. Adding a few corporate bonds here and a few foreign issues there just won't have much impact on the fund's performance.

How to Build a Bond Portfolio
A smart way to invest is to make Total Return the core of a bond portfolio and complement it with other funds. So, let's talk about PIMCO helpers. Begin with Dodge & Cox Income DODIX. Dodge & Cox's managers conduct excellent research on corporate bonds. But with assets of $22 billion, Income's corporates are likely to pack more punch than similar holdings in Total Return. Comanager Dana Emery and company have about 40% of Income's assets in corporates, though that figure can go higher if they choose. They've executed their strategy well, as evidenced by the fund's consistent results: Over the past 20 years, it has landed in the top 40% of all intermediate-term bond funds 15 times. That record puts it among the top 10% in 20-year returns.

With income tax rates potentially set to rise, tax-free municipal bonds have a lot of appeal. Vanguard and Fidelity are the best fund families in this neighborhood. I'd go with Fidelity Tax-Free Bond FTABX, Vanguard Long-Term Tax-Exempt VWLTX, or a single-state muni fund from one of those families if they have one for your state.

I'd also want a bolder fund that invests in high-yield and foreign bonds. So, I'd add Loomis Sayles Bond LSBRX, run by Dan Fuss and Kathleen Gaffney, or a pure junk-bond fund, such as T. Rowe Price High-Yield PRHYX, whose manager, Mark Vaselkiv, has done an excellent job since 1996. The seasoned hands at both funds don't take imprudent risks.

You'll need protection against rising interest rates, so take a look at Fidelity Floating Rate High Income FFRHX. The fund invests in bank loans that reset at higher yields when rates rise. The fund comes with some credit risk (the possibility that some borrowers will default), but Christine McConnell, who has run the fund since its 2002 launch, has taken a reasonably conservative tack to preserve capital rather than just find the biggest yield.

If you're really concerned about inflation, you might also consider a fund that invests in Treasury Inflation-Protected Securities. PIMCO runs a good TIPS fund, but I prefer Vanguard Inflation-Protected Securities VIPSX, a low-cost, direct play on these bonds.

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