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PIMCO Income a Unique Player

Christine Benz
Eric Jacobson

Christine Benz: The last fund we want to look at is PIMCO Income. In contrast to the preceding two funds, it's actually having a pretty good year so far this year. But before we get into the drivers of that, I'd like to talk a little bit about the complexion of this particular fund, what is it set out to do?

Eric Jacobson: What makes it unique within the PIMCO complex is that it's very income focused. It does have a secondary goal of total return, and that framework makes it look something like other funds out there in the marketplace, but within PIMCO, it's pretty unusual on the open-end side to be just income focused.

The way that they arrive at that goal is to look for the best income delivery and risk-adjusted returns across the marketplace. They view their palate as being very, very broad and perhaps to some degree broader than a lot of other funds and we call the multisector category. But even though they profess to have a lot of flexibility to switch among sectors, they tend to cluster around some that they historically have favored, whether it would be, for example, a third high-yield, a third foreign high-quality, maybe a third emerging-markets. That doesn't necessarily speak to all of them, but that's historically the way that a lot of them operate.

Here, the fund has been very opportunistic historically in the fact that it owns a lot of nonagency mortgages, which is relatively unusual not just in this category but really across the investment landscape, in part because PIMCO has a real tremendous research effort in the nonagency space, and that happens to be the specialty of the managers who run this fund as well. But they argue very, very strongly that it isn't a mortgage fund per se. It only has about half the portfolio in mortgages today. They look to diversify it as other opportunities have popped up and things have reached values that they're comfortable with in the nonagency mortgage space in particular. But it is an area that still offers a lot of opportunity. They intend to exploit that until which time it's not as positive a choice as it might otherwise be. But they're very, very demonstrative and, as I said, enthusiastic about other areas globally across the bond market.

One of the things that they try to do is focus on seniority across capital structures--which is also a little bit different than some of the other more flexible funds--in conjunction with paying attention to what they view as real tail risks in the marketplace, [the] possibility out there of big market shocks and so forth. So that does distinguish them a little bit. I think to some degree they take on a little less risk than some of the more aggressive multisector funds; but overall, this is a much more aggressive fund than PIMCO Total Return. People really need to understand that.

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Benz: So you mentioned the nonagency mortgage-backed bonds have been a pretty big theme for them recently, and that has also been a contributor to the fund's relatively strong performance so far this year.

Jacobson: That's right. Nonagency mortgages have, what we call, a lot of carry, in the sense that they tend to have moderate dollar prices and a lot of income generation. So they certainly help, and they perform quite well.

Benz: And this fund also can use some leverage, correct?

Jacobson: That's right. Now, when the managers talk about it, they describe it in ways of adding an overlay of a particular style, whether it's euro/dollar futures or focusing on certain mortgage coupons and so forth. But even when you strip all that out, the way that Morningstar looks at it, there is some leverage in the portfolio and by that we mean not just on an accounting basis, but actually offering a little bit of economic juice, if you will, to the portfolio. We don't necessarily think it's excessive. That's why we still recommend the fund, but it adds to the picture here that people need to understand the risk profile of this fund. I don't want to overstate it. There are more aggressive styles and more aggressive funds, but relative to PIMCO Total Return it has a different mandate.

Benz: So, you've got the fund at Silver currently. So you're generally pretty sanguine about its prospects, but your point is that investors should also be aware of what they're getting here and be aware of some of the risks that are embedded in this strategy.

Jacobson: One of the reasons I'm so determined to point that out is that the fund's performance has been so good. It has outperformed during periods of market stress, like third quarter 2011. It has performed well this year. I don't want to send the message that people should become complacent about that though, because there is risk in the portfolio. The portfolio has a trailing 12-month yield of over 6%, and that just tells you that there is something going on here that's a little bit more aggressive than you find in other funds, and people need to just calibrate their expectations.

Benz: Well, Eric, thank you so much for being here. It's always terrific to hear your insights about PIMCO.

Jacobson: Glad to be with you, Christine. Thanks for having me.

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