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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.

For example, one of the launches is a fund called JPMorgan Ex-G4 Currency Strategies. Translation: The fund will seek exposure to a range of global currencies, except for the U.S. dollar, euro, yen, and pound. It will be managed by Jon Jonsson who also helms JPMorgan International Currency Income JCIAX. That fund gains its exposures through sovereign and quasi-sovereign debt and forward contracts. It's reasonable to expect that he may use a somewhat similar approach at the new fund. That may appeal to clients like a pension plan, but mainstream investors need to remember that they already get currency exposure from owning U.S. conglomerates, foreign-headquartered stocks, or through an international mutual fund that hedges its overseas currency risk. This fund's narrow focus on second-tier currencies also raises some concerns that most investors would be better suited avoiding.

Meanwhile, JPMorgan Asia Pacific Focus will be run by a team from the firm's JF Asset Management subsidiary that specializes in that region. It is unclear how this fund will differ from the firm's JPMorgan Asia Equity JAEAX, which has a lackluster track record. While the "focus" naming convention points to a concentrated portfolio, Asia Equity only sports 50-60 stocks itself. One possible differentiator: The new fund appears to have a wider mandate in terms of countries. That said, both feed off the same research network. Investors shouldn't be surprised by some overlap between the two funds. Rounding out the launches are two unconstrained equity funds and a broad emerging-markets offering that invests in both debt and equity. All three will be met by crowded fields once they are launched.

BlackRock Fixed-Income Lineup Remains a Work in Progress
BlackRock is continuing to reshape its fixed-income team, with Andrew Gordon leaving the firm after managing BlackRock International Bond BIIAX since 1997.

BlackRock International Bond has been an inconsistent performer versus peers, and that's resulted in mediocre performance for the fund overall during Gordon's tenure. Scott Thiel, who is the BlackRock's head of European and non-U.S. fixed income, will be taking over the fund and all of Gordon's other accounts, which were considerable at $34 billion. (BlackRock is the world's largest asset manager with $3.7 trillion in assets.) Of course, Gordon didn't manage those accounts on his own. BlackRock International Bond itself has a seven-member team, which like Thiel, is based in London.

While Thiel is a BlackRock veteran, the CIO of fundamental fixed income, Rick Rieder, isn't. Rieder was first hired by BlackRock in April 2009 as deputy-CIO when BlackRock bought his hedge fund firm R3 Capital Management. To help reshape BlackRock's fixed-income efforts, Rieder brought over more than 40 people from R3. While there has been noticeable performance improvement in BlackRock's sector funds, BlackRock Total Return MDHQX fund and other offerings remain laggards. Thiel himself comanaged BlackRock International Bond between 2004 and 2010, so it remains to be seen whether he can improve the fund as lead manager.

Etc.
Bobby Bao will replace Joseph Tse as a portfolio manager on Fidelity China Region FHKCX on Oct. 1, 2011. Bao has been with Fidelity since 1997. He ran sector portfolios after being an energy and telecom analyst, but Bao also has some experience managing a diversified Asia-Pacific fund, a portfolio with a large overlap to Fidelity China Region. Tse will continue to manage funds that are available exclusively to overseas investors.

Vivienne Hsu, comanager of Schwab's active equity funds, left Schwab in late August 2011. Hsu comanaged Schwab Core Equity SWANX and Schwab Dividend Equity SWDSX among others. The management teams for the funds she comanaged remain in place.

Peter J. Niedland is no longer on the portfolio management team for the Forward Funds' Forward Growth FFGRX. Managers Kenneth Mertz, Stacey Sears, and Joseph Garner remain on the team.

Pierre Martin will be removed as comanager at DWS Gold & Precious Metals SGDAX as of Sept. 30, 2011. Current managers Terence P. Brennan, Theresa M. Gusman, Manuel Tenekedshijew will remain with the strategy.

Associate director Miriam Sjoblom, editorial director Kevin McDevitt, and fund analysts Kathryn Spica and Rob Wherry contributed to this article.

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