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PIMCO's Fund Board Surprises on the Upside

It's not perfect, but the board has made a positive change.

Eric Jacobson, 11/29/2012

We spend a lot of time pointing out shortcomings in the asset-management business, so it's nice to be able to highlight cases in which somebody makes a proactive decision to make a shareholder-friendly move.

An obscure but crucial corner of the landscape is just who gets to sit on and ultimately control a mutual fund's board of directors. In most cases, firms lay out a handful of rules for the submission of nominees that are typically buried in a fund's Statement of Additional Information and rarely warrant a second look.

Not so in the case of PIMCO's fund board. Historically, the board itself exerted a tremendous level of control on its own membership. In fact, the rules governing how new members could be nominated to the board were more restrictive and potentially exclusive than any others Morningstar had observed among open-end mutual funds. Under the board's old rules, which were originally conceived in the context of the closed-end fund universe, a nominating shareholder was effectively prevented from nominating himself, anyone closely related, or anyone having a business relationship with that person. Meanwhile, the ownership requirements to make a nomination were onerous. In order to nominate a board member, one had to control at least 5% of a fund for at least two years. That would have put a nomination well out of reach for nearly anyone other than a large institution or shareholder group. Even then, restrictions in place made it almost impossible for the owner of a fund to influence the makeup of the PIMCO funds' board of directors.

That contrasts with revised rules that the board recently enacted. By changing the rules for nominating members to the firm's mutual funds board, that body has made their process nearly as permissive as those of any large fund complexes that we cover. In essence, all one now needs to do in order to make a board nomination is hold at least $25,000 worth of funds' shares for at least five years and provide a variety of information about the relationship between the nominating shareholder and the nominee.

Not everything is better. There's no language in the current filing restricting a shareholder from nominating himself to the board, but PIMCO reports that limitation is still in place as an internal policy. And there are other board-related issues for which we find room to criticize. One is how PIMCO reports its expenses. For the fiscal year ended March 2012, PIMCO Total Return's PTTRX advisory fees totaled more than $613 million, while its supervisory and administrative fees clocked in at $591 million. As we've pointed out before, the proximity of those numbers is curious because the first number should represent what shareholders are paying for the expert, value-added services of an active money manager, while the second should account for the relatively commoditized costs that are otherwise associated with operating a fund and servicing shareholder accounts. It doesn't make sense that the true cost of servicing one of the best-run mutual funds in the history of the business is anywhere remotely close to the fair value of its investment advisory services.

For their part, PIMCO and the board have both historically said that investors should look past the technical nature of these breakdowns and simply evaluate fund costs as they appear in total. That's not an entirely problematic suggestion for the firm's Institutional share classes, whose price tags are generally reasonable. But it doesn't quite address the issue with regard to many of the firm's lettered share classes (that is, A, B, C, and so forth), which carry fairly high total expense ratios. Ultimately, though, it's a matter of transparency, and allowing shareholders to understand whether the board is doing enough to make sure that investors aren't overpaying for commoditized services.

None of that takes away from the fact that PIMCO's fund board has overseen an extended period of excellent portfolio management, and ultimately, excellent results for most shareholders. And we strongly laud the PIMCO board for working to make its nomination process less restrictive than it had been. Such changes are relatively rare in this sphere. And though there's nothing to indicate that they're going to result in meaningful changes to the current board, it theoretically opens the door for more shareholders to influence that body in the future. Let's hope that PIMCO's trustees will follow the spirit--and not just the letter--of those changes going forward. Considering that the PIMCO board oversees the largest mutual fund in the world, that's no small issue.

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Eric Jacobson is Morningstar's director of fixed-income research and an editorial director for mutual fund content.

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