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Family Blind Spots

A firm’s mutual funds tend to share characteristics. Here’s how to diversify a portfolio laden with one family’s offerings.

Russel Kinnel, 01/07/2014

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 PSTKX, where the strategy is to buy index futures and try to add value with a fixed-income portfolio held as collateral against those futures.

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 FTABX. You can also lower costs with the help of a Vanguard fund such as Vanguard Intermediate-Term Tax-Exempt VWITX. Even taxable bonds might be an area to diversify. On the lower-risk side, consider Dodge & Cox Income DODIX, which also focuses more on issue selection and less on macro bets.

American Funds
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.

Russel Kinnel is Morningstar's director of mutual fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping investors pick great mutual funds, build winning portfolios, and monitor their funds for greater gains. (Click here for a free issue). Mr. Kinnel would like to hear from readers, but no financial-planning questions, please. Follow Russel on Twitter: @russkinnel.

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