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PIMCO Total Return Is Weathering the Storm

Christine Benz
Eric Jacobson

Christine Benz: Hi, I'm Christine Benz for Many investors delegate their portfolios' fixed-income components to PIMCO. Joining me to discuss three of the firm's biggest bond funds is Eric Jacobson. He is a senior fund analyst with Morningstar.

Eric, thank you so much for being here.

Eric Jacobson: Glad to be with you Christine.

Benz: Eric, you recently spent a lot of time at PIMCO, so we thought it would be interesting to cycle through the firm's biggest bond funds and talk about your outlook for them, as well as how they're positioned currently. Let's start with PIMCO Total Return. It's having a year to forget so far in 2013. Let's talk about what has been behind its recent underperformance.

Jacobson: Well, there are few things going on there, but one of the biggest is really that the fund has had a fairly sizable allocation to TIPS--it's run between 10% and 12% in the last several months. The big story that we've been hearing from a lot of managers, not just PIMCO, is that there are these so-called risk-parity funds, which use a particular style to their asset allocation.

Benz: Are they hedgie-type funds?

Jacobson: It's really about how to do asset allocation across different sectors. It's slightly different than some of the conventional methods, really focusing on risk factors that they model, rather than just what the sectors are. But a lot of these portfolios have leverage in them, and there are some that are being buzzed around in the industry suggesting that during this most recent sell-off, the models told them to dump their TIPS allocations. So there is a perception out there that TIPS really, really underperform more than they otherwise would given this environment. The interesting thing, though, was that [manager Bill] Gross was committed to the sector, he views it as an insurance policy naturally against inflation being higher than the level at which they're currently priced. So it doesn't sound like he has any intention to get away from them despite this. He still thinks they are valuable part of the portfolio.

Benz: What is Gross' current thinking on interest-rate positioning?

Jacobson: In general, he's still being very cautious on interest rates. He looked to take on a little bit more interest-rate risk after the sell-off, feeling that Treasuries have been oversold. But, by and large, he's trying to steer the fund toward other sources of return and generally not taking benchmark or longer-than-benchmark-like duration positions.

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Benz: The fund has made up some ground on the performance front recently, Eric, but I'm wondering in your speaking with Gross, did you have the sense that he is doing some soul-searching about the fund and about its overall position in the PIMCO lineup?

Jacobson: It's a great question. I don't want to overstate the soul-searching element of it. I can't read into his mind very well, but he certainly is thinking a lot about what investors want in a total-return bond fund in today's environment. The underlying framework and structure of a fund like this, and this is true of most of the fund's direct competitors, is that it naturally includes some of what we call term-premium or duration risk because it's tied to a benchmark. That's how this fund has been run for years. He competes with Vanguard Total Bond Market Index, which is a very large fund [that] investors still want to own. So he doesn't necessarily want to get away from that but does understand that a lot of investors are worried about just protecting their principal, getting their money back. He's acutely aware of the fact that he's got some investors, for example, that are represented by the proverbial 69-year-old client who just can't suffer even a few-percentage-point loss.

I think the key thing, though, is he hasn't changed the mandate of the fund. He is really cognizant of the fact that investors can and do chose to leave the fund, for example, and go into other funds in the PIMCO complex, including the Unconstrained Bond Fund, [and] the shorter-duration, low-duration funds. And he's fine with that. But like I said, I think overall he's still a little bit struggling with what the evolution of this picture is going to be like going forward.

Benz: Another related question, Eric, is that we have seen pretty sizable outflows from the portfolio recently from PIMCO Total Return. But, I guess, a question sort of looking backward: Did the fund get too large, is it too large currently? What's your take on that question?

Jacobson: It's a very difficult question because the question is: Too large for what? The way I would like to think of it is: Is it too large to perform well? And I think the answer there is no. Is it too large to do everything that everybody else can do, including smaller funds? Yes, it's too large for that. You can't get the same kind of juice out of small corporate positions, for example, that you can with a much smaller fund. He's limited to larger issues of issuers in order to have any kind of impact on the fund. But like I said, it doesn't mean that the fund can't outperform.

[Gross] has adapted over the years to having a very macro focus--big, big sector-allocation shifts. When I say big, the sectors are big, not necessarily the shifts, although occasionally they are, focusing on things like interest rates and so forth. Those are things that I think sometimes require a better skill set, and he has adapted very well over the years, notwithstanding the last few months of trouble and little bit of difficulty in the third quarter of 2011. But if you look at the fund's overall record, he's really, really adapted well to that over a very long period of time.

Benz: So, overall, your take on the fund is still quite positive despite this little blip of underperformance year to date?

Jacobson: It is. It requires a higher level of conviction because of the fact that he's limited in some of the tools that he has, but we still recommend the fund, we have it as a Gold medalist. But I think it's a very good sign that Gross is very sensitive to investor risk appetites. But it's still a benchmark-constrained offering, and people need to understand that if they own this fund. It's going to have a lot of similarity regardless how carefully he manages the interest-rate sensitivity. It's going to have similarity to the benchmark. So, if you really don't want that, you've got to look somewhere else.