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Morningstar Reaffirms Gold Rating on PIMCO Total Return

Jeremy Glaser
Eric Jacobson

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Morningstar recently lowered its Stewardship Grade and Parent Pillar rating for PIMCO, but is affirming its Gold [Morningstar Analyst Rating] on PIMCO's flagship Total Return fund. I'm here today with Eric Jacobson, a senior analyst on our fund team, to explain these changes.

Eric, thanks for joining me today.

Eric Jacobson: Great to talk to you, Jeremy.

Glaser: Can you help us understand why Morningstar downgraded that Stewardship Grade and that Parent Pillar for PIMCO? What were some of the factors behind that decision?

Jacobson: Well there were a few of them that kind of melded together. One is what I just would call sort of heightened level of uncertainty in this new era, after [former CEO] Mohamed El-Erian has left. Around the questions on whether the latest senior staffing transitions will ultimately be beneficial to investors, I think, as individuals, they are some terrific managers and great intellects. But when you mix it altogether, it leads to some uncertainty.

And then I would say that, there is also this issue of whether the recent and senior-level departures indicate some sort of a persistent side effect of the pressure-cooker culture that we talked about before. We know anecdotally that that was the case in a couple of places. But it is something that we think is certainly something that we want to keep an eye on and whether or not that develops in the future, but it's certainly a concern.

We also want to keep looking at whether that culture will improve or turn out to be a problem for some of these rising stars, the deputy CIOs and people on the investment committee. There is a lot of concern about that, now that they are sort of stepping up into very, very high-visibility roles. And frankly [we want to look at] even whether the prospect of tougher bond markets or more potential performance stumbles could actually itself cause that sort of pressure-cooker temperature to rise even further. And we have seen that in other firms before. And so it's something that we are always kind of watching out for.

So when you roll all those things together it's really just a big question of uncertainty, and it was enough, as I said, to push down the overall Stewardship and Parent ratings.

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Glaser: The Parent Pillar is only one component of the overall Morningstar Analyst Rating. Can you talk to us why this downgrade didn't lead to any changes in your view of Total Return?

Jacobson: Yes. The overall Analyst Rating platform is really just a framework for our analysts and our ratings committees to look at a lot of these big issues. It is not a mechanical formula. And in fact the Parent Rating is only one of five pillars we look at alongside of People, Process, Performance, and Price. In this case our conviction in the fund's people, despite the questions and the issues about the investment committee, we still feel very, very strongly about the fund's people, including Bill Gross.

And we still have tremendous conviction over the process. We still think performance is quite good over the long term. And all of that really outweighs, for now anyway, the kind of concerns that pushed the Patent Pillar score down a little bit.

Glaser: Total Return is staying Gold-rated for now. Let's talk about some of the potential issues that could come up and could cause us to rethink our ratings. One that's been around for a while is just the size of the fund. Can you talk about if you have any concerns still there or if these have been mostly ameliorated?

Jacobson: Well size for a fund like this is always going to be something of a question mark because it's such a large fund and PIMCO and Bill Gross manage so much money in the same style. Depending on what kind of accounts you add in, it's almost not too far away from $500 billion in this style.

So, by, his own admission, managing that much money in the same style is certainly more challenging than it would be if you had a small portfolio. But he argues and makes a pretty strong case that the long-term performance of the fund has been very good even since the fund has gotten so large.

And ultimately he has adapted quite well over the years to managing that size by focusing more of his attention on, not only the macro-level economic sort of interest-rate and curve events, but also moving among sectors and so forth. We would never want to say it doesn't matter, but it certainly doesn't seem to be any sort of urgent issue right now.

Glaser: How much of the rating is dependent on Gross being at the helm? There is not a clear succession plan in place. If he were to leave, would that cause you to revisit the rating?

Jacobson: It certainly would be a reason to revisit. I don't think that it's an automatic given that that would immediately reduce a rating, especially because there really are some tremendously talented people now on the deputy CIO list. And frankly even behind them, the depth at PIMCO is something that people talk about in terms of numbers and so forth. And so it's sometimes hard to grasp, and their numbers are ridiculously large. They have something like 240 portfolio managers.

But we have met a very large number of those who are anywhere near the top, including many whose names aren't well known because they are not listed on the funds. But they tend to be really, really sharp, sharp people and among the best in the industry. So again, it's not an automatic outcome if Gross were to step down. But I do think it would be a real noteworthy milestone because I do think a lot of investors would quickly be spooked by that, and that could have its own consequences.

Glaser: Circling back a bit then. If you feel very confident with some of the people who are behind Gross, how does that also play with the fact that we did downgrade the Stewardship Rating and the Parent Pillar? How do those two things kind of coexist?

Jacobson: I think it's more about the uncertainty of the process for the investment committee itself. And I should have mentioned this a little bit more, but also just the broader cultural aspect of, as I said, having people who haven't up until now been the most senior people on the committee sort of finding their legs in the committee structure, working well with Gross, and the whole thing sort of producing as well as it should.

We felt we needed to really be cognizant of all that at the Parent level. But we didn't think that it was enough to directly affect how we always talk about Total Return.

Glaser: If an investor owned Total Return, is the reiteration of this rating a sign that they should just hold on or should they be thinking about potentially diversifying with some other bond funds?

Jacobson: Well as you know, and I have to say, our group is not a registered investment advisor, so we can't actually give advice on specific portfolios or buy/sell advice on individual securities. But that said, given that we are reaffirming our Gold rating, I think it's safe to say that our view is that, neither these recent personnel changes or the Stewardship and Parent downgrades are reasons to leave the fund.

Overall in our view the central investing process at PIMCO doesn't itself seem to be impaired. And we think that when you take all the pluses and the minuses together, that PIMCO Total Return still rests on what we would say is a very strong foundation.

Glaser: Eric, thanks for the update today.

Jacobson: My pleasure, Jeremy. Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser.