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Know Your Fund Company's Achilles' Heel

Ideas for complementing a portfolio skewed toward one fund company.

Russel Kinnel, 12/17/2013

Fund companies sometimes move many funds in lock step, 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. 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 like 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's had more winning bets than losing ones over the years and this isn't really a surprise. PIMCO's TIPS bet isn't nearly as scary as Janus' firmwide Internet bet in 2000, but there's no need to make a firmwide bet into a bet across your own portfolio. These examples illustrate why you should diversify out of even the best fund companies.

How do you diversify a portfolio heavily skewed to one fund company? Let's look at some blind spots or other limits that big fund companies can have, and I'll share some ideas for funds that would make a nice fit.

A PIMCO-Heavy Portfolio
Stock funds are the obvious complement to a PIMCO-laden portfolio, but if you have most of your money 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 your 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, I'd consider Dodge & Cox Income DODIX, which also focuses more on issue selection and less on macro bets.

An American Funds-Heavy Portfolio
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. Don't avoid them if they are in your 401(k).

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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