A firm’s mutual funds tend to share characteristics. Here’s how to diversify a portfolio laden with one family’s offerings.
This article originally appeared in the December/January 2014 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
Mutual funds within large fund companies often share investment traits, and they sometimes perform in lockstep for good and bad.
For example, over the summer, PIMCO’s bullish bet on long-term inflation-protected securities in a bunch of its funds stung investors. Interest rates rose while inflation expectations fell, a double whammy for long-term Treasury Inflation-Protected Securities. It wasn’t a disaster for PIMCO, but it did take a bite out of a wide swath of its funds. PIMCO’s macro calls such as this one are often included in a bunch of PIMCO’s bond funds. In addition, PIMCO runs asset-allocation funds that own a number of its bond funds, so it affects them, too. It also can have an impact on stock funds such as PIMCO StocksPLUS
The mistimed bet hasn’t shaken our faith in PIMCO because it has had more winning bets than losing ones over the years. And its TIPS bet wasn’t nearly as scary as Janus’ firmwide Internet bet in 2000. Still, there’s no need for investors to make a firmwide bet into a bet across their own portfolios, and this goes for even the best of fund companies. So, how do you diversify a portfolio heavily skewed to one fund company? First, look for the firm’s blind spots; then, search for funds from other companies to fill in the gaps. Here’s a look at the limits that some of the largest fund companies have and ideas for funds that would make nice complements to a portfolio heavily-laden with one of these families of funds.
Stock funds are the obvious complement to a PIMCO-laden portfolio, but if most of a client’s money is in fixed income, consider some non-PIMCO bond funds, too.
Municipal bonds are a small sliver of PIMCO’s business, so let’s start there. A fund that doesn’t make top-down calls but instead focuses on issue selection would make a nice diversifier, so consider a fund like Fidelity Tax-Free Bond
Although American Funds has fallen in investors’ minds, you can still build a pretty good portfolio with its funds. It runs outstanding foreign- and domestic-equity funds that are dependable and cheap.
However, the American Funds multimanager run-a-ton-of-money-in-one-fund model hasn’t worked too well for small-cap stocks or bonds. The multimanager system doesn’t work well in bonds where one manager’s views can undo another one’s bets or double them. In addition, they haven’t kept pace with the competition when it comes to bond analytics. In fact, we rate seven bond funds from American, and they all earn Morningstar Analyst Ratings of Neutral. For small caps, American has just one very diffuse world-stock fund that doesn’t really have that much appeal.