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An Upgrade for This PIMCO Fund

It's only a matter of time before Silver-rated PIMCO Low Duration's advantages make more of a mark.

Miriam Sjoblom, 04/22/2017

The following is our latest Fund Analyst Report for PIMCO Low Duration Fund PTLDX

PIMCO Low Duration's flexible approach requires expertise across sectors and strategies; managers Scott Mather, Jerome Schneider, and the broader PIMCO complex have enough to spare. Given continued stability and focus among the firm's senior leadership and key individuals supporting the effort here since Bill Gross' departure, we've upgraded PIMCO's Parent Pillar rating to Positive from Neutral, and its Morningstar Analyst Rating to Silver from Bronze.

As in the past, the firm's macroeconomic views shape the fund's strategy. For example, PIMCO is still concerned that the short end of the U.S. Treasury yield curve isn't fully pricing in the impact of future rate hikes. As a result, the team has kept the fund's duration short of its benchmark's by less than half a year lately. The team has also turned to agency mortgages as a higher-quality, better-yielding substitute for two-year Treasuries (between 26% and 39% of assets since June 2016).

While those same preferences are reflected in PIMCO Total Return's PTTRX portfolio, the constraints of this fund's short-duration mandate may cause the two to diverge. Many PIMCO portfolios have downplayed investment-grade corporates over the past year, for instance, but this fund has run a higher corporate stake (30% outside of the portfolio's cash substitutes), which the team has preferred to similar-duration Treasuries. Informed by PIMCO's corporate specialists, the team also executed timely increases in the debt of energy and financial firms when both sold off in 2016.

Although the fund hasn't yet distinguished itself under this team's direction—its 1.2% annualized return for the 2.5 years through March 2017 lands just shy of its typical peer's 1.3% (distinct funds)—the team is making full use of the resources and flexibility at its disposal. The fund's relatively short duration and caution toward credit risk have been a drag at times during this stretch, but the team has effectively employed other tools in its arsenal, such as modest currency bets and hedging strategies, to make up ground. It's only a matter of time before this fund's advantages make more of a mark.

Process Pillar: Positive | Miriam Sjoblom, CFA 04/17/2017
This fund's robust, well-supported process looks similar to the one in place at flagship PIMCO Total Return but with a focus on the short end of the yield curve, earning a Positive Process Pillar rating. The fund invests in traditional core sectors—government debt, mortgages, and investment-grade corporates—but also takes modest positions in high-yield, developed- and emerging-markets debt, and currencies (the fund's benchmark is the narrowly focused Bank of America Merrill Lynch 1-3 Year Treasury Index). The managers start with the firm's macroeconomic forecasting (determined by PIMCO's Investment Committee) and bottom-up analysis to determine interest-rate, yield-curve, currency, country, sector, and security-level decisions. Themes prominent in PIMCO Total Return's portfolio tend to surface here, too.

That said, the constraints of the fund's short-duration mandate can cause its portfolio to diverge. For example, PIMCO's bearish view toward short-term Treasuries of late has prompted the managers to hold larger stakes in higher-yielding short-duration corporate and emerging-markets instruments here instead. Still, the fund's higher-risk positions, such as currency bets, are generally sized smaller to keep volatility in check, and the team, backed by an industry-leading risk-management apparatus, has historically managed these risks capably.

A central theme in the portfolio remains PIMCO's concern about volatility on the short end of the U.S. yield curve as the Fed embarks on a series of target rate increases. That's reflected in the fund's 1.6-year duration as of Feb. 28, 2017, which is less than half a year shorter than its benchmark's. And in place of owning two-year Treasuries, the team increased the fund's exposure to similar-duration agency mortgage-backed securities starting in mid-2016. That position peaked at 39% in September 2016, more than doubling its size since the start of the year, but the team trimmed it closer to 26% lately. Although the firm is cautious on corporate credit risk at present, the fund holds a sizable helping of short-duration investment-grade corporates, some with floating rates, both as a substitute for nominal Treasuries (30%) and for cash (10%). Volatility in the financials and energy sectors gave the team an opportunity to increase the fund's holdings in those areas in 2016, bets it has since trimmed.

Miriam Sjoblom is an associate director of fund analysis at Morningstar.

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