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PIMCO Offers Yet Another Take on 'Absolute Return'

Ruling on American Funds' fee case upheld, JP Morgan launch machine revs up, and more ...

Morningstar Fund Analysts, 09/01/2011

PIMCO launched PIMCO Credit Absolute Return fund this week within an increasingly crowded field of "absolute-return" bond funds. The fund is run by Mark Kiesel, who has skillfully run the $6 billion PIMCO Investment Grade Corporate Bond PIGIX since late 2002. With this addition, PIMCO is hoping to build on the success it has already had in this arena. When the firm launched its first "go-anywhere" fund PIMCO Unconstrained Bond PFIUX more than three years ago, the number of such bond funds had not yet exploded in popularity. The fund has since attracted nearly $18 billion in assets.

Cast in a similar mold to Unconstrained Bond, the Credit Absolute Return fund isn't beholden to traditional bond benchmarks and seeks to provide positive returns in a variety of market environments. But unlike its more diversified sibling, the new fund will focus on a range of credit sectors, including investment-grade and high-yield corporates, bank loans, convertibles, municipals, and emerging-markets credit. It also doesn't have as much flexibility to adjust its duration (a measure of interest-rate sensitivity), which can go only as low as zero by prospectus. By contrast, Unconstrained Bond has the flexibility to lower its duration as far as negative three years.

New bond funds that have come out under the absolute-return or unconstrained labels in recent years don't necessarily agree on what those terms mean. Some of these funds aim to prevent losses in any year, but PIMCO tends to take a long-term approach in keeping with the firm's three-to-five year secular outlook. The same should hold true for Credit Absolute Return. Given its focus on credit-sensitive sectors, investors should expect it to experience a bit more volatility than Unconstrained Bond. Kiesel also plans to concentrate the fund's exposure in fewer issuers than Investment Grade Corporate Bond, which is another potential source of volatility. But unlike Kiesel's other charge, expect the new fund to take more dramatic steps to rein in credit risk when PIMCO's macro views warrant such a move.

The fund may not offer as gentle a ride as some absolute-return competitors. And because this is a new strategy for PIMCO, the portfolio will need to take shape before investors can have a better idea of what to expect here. But PIMCO has the global-research chops to be able to pull off an approach like this. Kiesel's record also bodes well for the fund's prospects. Since he took over Investment Grade Corporate Bond in December 2002, it has gained 7.9% per year, on average, beating the Barclays Capital U.S. Credit Index by an average of 170 basis points per year. Kiesel also has credibility when it comes to protecting against losses. The fund finished a trying 2008 up 1.9%, even though its benchmark suffered a 3.1% loss that year. It held up well partly because Kiesel bought protection through credit default swaps on a broad investment-grade corporate index and a handful of individual cyclical names, and then removed those hedges in time to benefit from the rebound. Such techniques are old hat to Kiesel and PIMCO.

Ruling on American Funds' Case Underscores Challenge of Getting a Better Deal
American Funds was vindicated last week when the Ninth District Court upheld a ruling declaring that its mutual fund fees were not unjustifiably high. While clearly better news for the managers collecting the sums than the shareholders paying them, we don't find a reason to argue with the ruling itself. American's funds typically have lower expense ratios than most peers' and the firm has been a good steward of investors' capital.

However, the case does reaffirm the difficulty that mutual fund shareholders face in challenging the costs charged by investment managers. This latest ruling echoes a similar case decided last year (Jones v. Harris). In neither case have shareholders convinced the courts that they have been overcharged by fund companies.

This isn't to say, though, that the courts have given the fund companies a free pass. In the original American Funds' decision, the judge highlighted areas where the independent boards of directors could improve their oversight. He pointed out, for example, how the boards had repeatedly approved 12b-1 fee increases despite growing asset bases. More assets typically generate economies of scale and should lead to lower expenses as a percentage of assets.

JP Morgan's Launch Machine Revs Up Again
In the last three years, JP Morgan has launched over a dozen new funds, making it one of the most active on the new product front. The firm continued that trend this week by filing with the SEC to add an additional five funds to its lineup. Full details of the funds have yet to be released, but based on preliminary information, a couple of the launches seem less than compelling.

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