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Jacobson's Bond Fund Picks for Retirees

Christine Benz

Christine Benz: Hi I'm Christine Benz for Morningstar. It's Retirement Portfolio Week and here to discuss some of his best ideas for the fixed-income portion of retiree portfolios is Eric Jacobson. He is director of fixed-income research for Morningstar.

Eric, thanks so much for being here

Eric Jacobson: Glad to be here. Thanks.

Benz: So I wanted to cycle through a few different roles that people might use fixed income for in their retiree portfolios. Let's start with that core portion that will take up a big portion of someone's bond portfolio. What are your best ideas? What are your favorite funds?

Jacobson: Well I think it's no surprise that we are big fans of Bill Gross of PIMCO, and I think that one way for people to take a fresh look at this is to decide if they are in the best place it.

For individuals doing their own thing at home, if you will, we like to recommend Harbor Bond, and the reason for that is that it has a much lower expense ratio. It's got a low minimum, and it's available to individuals.

PIMCO has, of course, PIMCO Total Return. Other share classes that are easily available through financial planners and brokers, and if you work with the professional like that, some of them are a better deal than others. You definitely want to take a look.

Benz: And also if it's in 401(k) plan, it may be a pretty good deal if you get that institutional share class?

Jacobson: If it's in your 401(k) plan you want to check on it, but chances are you are getting a great deal there, because a lot of them use the institutional share class, which is, relative to other funds, pretty cheap.

Then the other choice in terms of really what we think of as the core or core-plus space that we would suggest as the centerpiece, would probably be Metropolitan West Total Return, and it's another fund that we've followed for a long time. It is now actually part of the TCW shop, since they were absorbed in there, but they are another one of our favorite choices.

Benz: And Eric you also brought along a couple of the new go-anywhere funds--well, they are not necessarily new. But this seems to be a big vogue right now--funds where the manager has that wide-open tool kit. Can you share some favorites along those lines?

Jacobson: Absolutely. And the only caveat I would make is that the selling point for these with a lot of people, and I think regardless of how much it's talked about, people have to be honest with themselves. I think a lot of people are buying them because they hope and expect that these will bypass any rising rate problems that we might have.

And the good news is, they both have some flexibility to do that or lot of flexibility, in fact. The question, though, is: will they make the timing choices that are required to not only side-step and beat rising interest rates, when they eventually start coming, but will they do it in such a way that they are able to continue to make money in the good periods? That's always a problem with interest rates fluctuations is, even if you think you know long-term what they are going to do, they bop back and forth, and you can make money and lose money if you are wrong.

That said, these are some managers we really like, and we think are pretty good at it. We are still learning about them over the last couple of years, because it's a very unusual space, but one of them is Harbor Unconstrained. That's the Harbor version, the no-load version of PIMCO Unconstrained Bond. It's run by a guy named Chris Dialynas, long-term PIMCO veteran. We like it. PIMCO Unconstrained Bond for folks who are working with a planner.

Other folks might consider also--either way, planner or individual--JPMorgan Strategic Income Opportunities; that's another fund. That's got a lot of leeway, not as aggressive in some ways as the PIMCO fund, but both interesting choices to look at.

Benz: Now, I also want to talk about munis, because I know a lot of our watchers and users, do use munis. Fidelity is the tops of your list most of the time. Still the case?

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Jacobson: Absolutely. I think that the issue there is that we've been following a lot of these firms for a long, long time, and we have a really strong sense of what some of their strengths and weaknesses are. There are a lot of great muni shops out there; it's not that there aren't.

The thing about Fidelity is that it's so holistic, and it's so great from beginning, middle, and end, that it's just a really easy one to recommend.

Benz: So, you like them across the maturity spectrum. You think they do a good job.

Jacobson: They really do. If for some reason, you don't have access to Fidelity or you're using other fund families, we are big fans of the team at AllianceBernstein. We're also big fans of the team at DWS, which is the old Scudder. We like those a lot.

Benz: So, I want to talk about some shorter-term bond funds. A lot of retirees are looking at what they are earning on cash, and I say you do need to have true cash, but if you are looking to take maybe a portion of that cash and move it into something with a little bit of rate sensitivity, what are your top ideas there?

Jacobson: Well, first of all, I'm obliged to mention T. Rowe Price Short-Term Bond, because one of my colleagues, Miriam Sjoblom, threatened me not to come back to the office if I didn't…

Benz: I know she's a big fan of that fund.

Jacobson: She's a big fan of that fund, and rightly so. I would also say if you're looking for something very plain-vanilla and very cheap, Vanguard, of course, is the place to go. Vanguard Short-term Bond Index, longtime one of our favorites.

I'm a big fan as well of PIMCO Short-Term. It's a little tougher, though, because the share class issues; it is a load fund. Some of them are really pricey, and the manager just left, Paul McCulley.

Normally, I would never even bring it up, but the way that fund operates, the tools that it uses, are very sort of institutional and part of the culture there. I think that the guy who is replacing him, a guy named Jerome Schneider, is really solid. It's not an unqualified endorsement just because it's a new manager and so forth, but we feel pretty good about it. But again T. Rowe Price is a hard pick to beat.

Benz: So, I also want to talk about some ideas for inflation protection, because obviously that's one of the natural enemies of any fixed-income portfolio, is the threat of higher prices on stuff. So, do you have any thoughts on inflation protection?

Jacobson: I sure do. We've been talking about this between ourselves a lot. We've been getting a lot of questions and feedback, and one thing I think that we should really make a point of saying is that there is a very distinct, although maybe not obvious in some cases, difference between what is really an inflation hedge or as perfect an inflation hedge as you can get pretty much, which are TIPS funds or TIPS bonds.

The other is what we would maybe call inflation beaters, and by that I mean things that are likely to really outpace inflation by some large margin. A TIPS fund is essentially meant to track it and beat it with a little, reasonably predictable margin of return over the top, but not by a lot. And people who are expecting big returns, especially because they had some in the past, should really pay close attention and understand these are not going to be big high returning funds in the future more than likely. If you really need good long-term inflation-beating power, equities are the way to go …

Benz: And this is from a bond guy.

Jacobson: That's absolutely right. That's the most important lesson, I think, for a lot of people to know. Buy bonds when you need to have bonds, and they're important certainly, and that's why I like to follow them, but for most of us who are not near retirement yet, or even folks going into retirement who have another 20-30 years to plan for, equities are still a critical part of it, obviously.

If you need the TIPS, obviously, we're big fans of the Vanguard TIPS fund, it's Vanguard Inflation-Protected Securities. That one is a very basic, simple tracker. Low-cost, well-managed, not a lot of bells and whistles, but that's great.

For something, if you want to try and do a little bit, sort of, TIPS-plus, if you will, PIMCO Real Return, and of course, there is actually a Harbor version of that, Harbor Real Return, which we suggest for the individuals, do-it-yourself investors, looking for a no-load option. PIMCO has a lot of great choices if you are using an intermediary planner.

Benz: Lastly, Eric, I wanted to talk about some aggressive kicker ideas for retiree fixed-income portfolios, and these would be things that you might keep to 10% or 15% of the portfolio, but would maybe provide a little extra get up and go. I'd like to hear your ideas on that front.

Jacobson: That's the fun stuff, right?

So one of my favorite choices to talk about here, and they are going to be miserable at DoubleLine when they hear me say this in the context of an aggressive kicker, because in a sense it really isn't--the concept isn't--overly aggressive, but DoubleLine Total Return, which is typically a fairly core style offering. It's Jeffrey Gundlach; he's the guy that left TCW, and there are some things to keep an eye on there.

Benz: Some drama.

Jacobson: Drama and so forth. The good news is for fundholders, some of that drama went away recently with some court rulings. DoubleLine is still involved in litigation with TCW. TCW has some of that, too, but if you are able to get comfortable and look past that, [Gundlach] has been doing a lot with non-agency mortgage-backed securities and essentially sort of hedging them with agency mortgage securities. A lot of exotic interesting stuff that he has used over the years.

There are really only a handful of managers that we really trust with this kind of thing. There's a lot of risk in the individual positions. If you manage them well and balance those risks and hedge them against each other in the portfolio, you can really eliminate a lot of it. He's done that; he's produced great returns already. I don't know that we're going to see quite the same level going forward, but it's a pretty good possibility that he's going to continue to perform really well.

I think people need to get really comfortable with it. Make sure it's for them, and they understand it. Don't go overboard, but it's a really interesting strategy, and we're going to update our analysis on that pretty soon for folks who have Premium subscriptions to the website.

Benz: Okay. So if they want to stay tuned and see what you have to say.

Jacobson: That's right. It's not up there yet--that new one--but it will be soon.

Then for some other things, real quick. PIMCO Floating Income; I like this idea because it's a little contrarian. People are going to look at it and wonder if I've lost my mind, because it only has one star. Part of the reason for that, though, is that it's an unusual fund in its construction. It's very credit sensitive, but has almost no interest rate sensitivity.

Benz: So this is a bank-loan fund?

Jacobson: Well, this, Floating Income, actually, is a multisector fund, because it gets that exposure through a variety of different areas across the global credit world. Not all bank loans, but a lot of emerging markets, different things, and it hedges out a lot of the interest rate risk. So, it's going to be really attractive to people who are worried about rising interest rates, but still are willing to take credit risk, feel that the global economy is going to snap back, want to stay away from that rising rate fear and get that exposure.

Now, the question is, is there a lot of gas left in that engine? Hard to say. The high-yield areas, some of the emerging market areas, they've already been pretty hot. So, I am not necessarily making a recommendation on those areas, but people are still asking, what can I buy that's not a Treasury bond? This is an area to consider. Don't be put off by the one-star rating. It is a very unusual outlier fund in its category, and the reason is there aren't any others that are really like it. So, we don't have a whole category of funds. This is the best category to put it in. The one star is just a question of the grouping. You can kind of brush that off. Get to know the fund a little better if it's interesting to you, though.

Benz: So Eric, that's not a pure bank loan fund, but you do have a couple ideas along the lines of pure bank loans funds. What are those?

Jacobson: That's right. There is a very – I don't want to say conservative, because it's relatively so compared with other bank loan funds, and that's the Fidelity Floating Rate High Income, which we've talked about before.

It's one of the more conservative bank loan funds in the group. You are not going to see knock-it-out-of-the-park numbers and ratings when you look at that fund, but it's well managed, and it's a good choice if you want to start hedging against rising rates.

We took a look, for example, at Fed funds futures; you don't have to worry about what those are all about, but the bottom line is the market is not expecting short-term rates to start going up until probably January 2012.

So again, people need to calibrate. You don't want to pour everything in there, because if you sit in a fund like that for too long ahead of time, and I am not suggesting timing, but don't go crazy here, because it's going to be hard to earn a lot of return as short-term rates are very low. But if you're worried about rising rates, that's one way to go.

Another choice is Eaton Vance. ... They have a lot of different funds to chose from structure-wise, but the basic idea behind that one would be Eaton Vance Floating Rate, which is a fund that we're fans of.

Benz: And that's one for people who work with a broker or advisor?

Jacobson: That's right. Absolutely.

Benz: Okay. Well, thank you, Eric. Thanks for sharing all those ideas. It's been terrific.

Jacobson: My pleasure. Glad to be with you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

All Funds Mentioned in This Video: