PIMCO Total Return Will Not Be Changing Its Stripes
Manager Bill Gross is embracing flexibility, but not all-out change.
Manager Bill Gross is embracing flexibility, but not all-out change.
It's important for investors to know what PIMCO Total Return (PTTRX) will and will not be.
In institutional lingo, this is a "core-plus" offering. It keeps its rate sensitivity in a range around its benchmark, the Barclays U.S. Aggregate, invests in the same sectors as the index, and can add some out-of-benchmark bonds. That gives the fund a broad palette. Manager Bill Gross has historically made large bets using the fund's benchmark sectors (in particular with agency mortgages), has peppered in nonbenchmark holdings such as emerging-markets and nonagency mortgage debt, and has long used interest-rate bets to try to improve returns.
For all of its freedom, though, the fund keeps its duration at plus or minus two years around the Barclays Aggregate's. It's also limited to 10% in high yield and 15% in emerging markets. The duration issue is especially notable as many investors have been recoiling from interest-rate risk of late. The fund made its own headlines thanks to more than $30 billion in outflows during the second and third quarters of 2013, and the trend has left the broader intermediate-term bond category with more than $70 billion in estimated net outflows; about the same amount flowed into the more interest-rate-resistant bank-loan and non-traditional-bond groups.
The fund's interest-rate limitations have been less of a problem lately than the direction and magnitude of its bets--the fund was caught short in late 2011 and long during the summer of 2013--but as flows suggest, and Gross believes, many investors want to give more flexibility to their managers to slash their durations. Neither he nor PIMCO see changing this portfolio's rules as the right solution, though. Gross believes he has enough tools here to remain competitive, and he is especially concerned about keeping the fund intact for shareholders who still prefer a corelike offering.
For investors of that mind, Gross' long-term record and massive PIMCO resources remain compelling. But for those who want to give their managers much more freedom--along with more freedom to fail--this isn't the place to be.
Process
Gross uses a mix of macroeconomic forecasting (supported by PIMCO's investment committee) and bottom-up analysis (supported by PIMCO's sector specialist desks) to determine interest-rate, yield-curve, currency, country, sector, and issue-level decisions. He has relied mostly on decisions at the sector level and above for many years given the enormous number of assets he manages across accounts with the same or similar mandates as this.
The breadth of Gross' tool kit was particularly evident in 2011. He made significant interest-rate and yield-curve plays (to the fund's detriment) in that year and took on meaningful exposures to non-U.S. developed markets (roughly 18% in December 2011), emerging-markets debt (10%), and municipals (4%) relative to its benchmark, the Barclays U.S. Aggregate Bond Index. The fund was also more adventurous than most in the intermediate-term bond peer group.
It's difficult to quantify the fund's use of derivatives, but while they've been cutting back lately, Gross and PIMCO have historically used as many or more--in both variety and volume--than just about any of their competitors. The level of analytical research and operational support backing theses is intense. That the fund has survived a number of trying market periods without its derivative exposures creating unexpected problems is a testament to the effectiveness of those efforts.
Portfolio
In the months leading up to the 2013 summer sell-off, PIMCO had argued that most asset classes were fully valued, and the portfolio has grown even more conservative since then, hewing closer to the Barclays U.S. Aggregate. As of Oct. 31, 2013, its duration was more than a year short of the index, its Treasury focus was on intermediate maturities, and its investment-grade credit exposure was light at 6% (versus 22% for the bogy). The fund also slashed to 34% what had been a mortgage bet that peaked at 53% in April 2012. Meanwhile, the fund's out-of-index exposures have lessened. Its combined allocation to high-yield, non-U.S. developed-markets, and emerging-markets debt clocked in at 14% in October, while the fund maintained a 12% exposure to Treasury Inflation-Protected Securities.
That contrasts with the fund's intrepid 2011. In addition to its aforementioned sector bets in that year, the fund's duration ranged between three and five years during 2011's first half, and Gross hiked it to seven years by September. That large number--the fund's benchmark was around five years for most of that stretch--didn't tell the whole story, though. Gross still had a yield-curve bet in place, banking on a widening between short- and long-term yields, which kept a lid on the fund's exposure to long-maturity Treasuries. Meanwhile, much of the fund's excess duration came from non-U.S. bets. At the end of 2011, for example, the fund held 18% in non-U.S. developed markets.
Performance
Those factors made for a tough 2011. Gross' moves kept the fund's government-bond exposure muted as he worried that long-maturity Treasury valuations were too rich. Treasures began rallying in the second quarter, though, and things just got worse. The portfolio lost 1.1% during the third quarter, while its benchmark galloped to a 3.8% gain; the dearth of Treasuries, paired with some of the fund's risk exposures, was the primary cause.
The fund turned a better 10.4% return in 2012. Its yield-curve bet worked well, and the fund picked up gains over its benchmark from a broad range of its sector exposures.
The fund stumbled again in the summer of 2013, though, in part because of a spike in long-maturity yields that hit its TIPS allocation especially hard. What turned out to be premature talk of the Fed tapering its quantitative-easing program helped drive up yields more than 133 basis points between May 2 and Sept. 13. With a duration longer than its benchmark and category average going into the sell-off, the fund tumbled 5.5% through that stretch, placing near the bottom of its peer group.
Stalwarts can take heart. For one thing, the fund has already bounced back some from its summer trouble and its year-to-date return through November 2013 has crept back into the intermediate-term bond category's best half. Despite the ugliness of its summer troubles, meanwhile, the fund's longer record remains among the category's best. The fund has fallen behind before, if only infrequently, and each time Gross has found a way to get back to producing some of the best performance in the intermediate-term bond category.
People
Gross has managed this fund since inception with excellent results. He has won Morningstar Fund Manager of the Year accolades three times and is the reigning Morningstar Fund Manager of the Decade for bond funds. Once a bond-by-bond picker of corporate-debt securities, Gross' expertise evolved over the past 40 years, and today he is a titan in the world of investing across fixed-income sectors such as mortgages, corporates, and governments. One of his greatest strengths has been an ability to adapt to the challenges of size, in particular, as this strategy's massive asset base has grown.
PIMCO's staff has tremendous depth, boasting world-class practitioners and intellects across its investment committees and specialist desks, as well as a true global reach with strong integration across physical domiciles. There's reason to retain great confidence in the various teams here, as well as the process of critical analysis and debate that Gross and co-CIO Mohamed El-Erian attempt to foster. Skeptics will note that the firm's macro bets have been mixed in recent years, and the firm has seen changes in the makeup of its investment committees and specialist teams (that have resulted in a bevy of newer and younger members). It's rarely a good idea to count out Bill Gross, but it is fair to ask whether the firm's other shifts will ultimately prove to be for the better.
Parent
PIMCO boasted nearly $2 trillion in assets under management as of September 2013. The firm has long been dominated by Gross, one of its co-founders, who manages this fund and serves as the firm's co-CIO with Mohamed El-Erian (also the firm's CEO). Gross and his colleagues have long employed some of the most complex tools in its portfolios and have produced some of the industry's best results.
One of the keys has almost certainly been Gross' decision to stay on the investing side of the business without distracting himself with CEO duties. That has translated to an investment culture that has survived the firm's growth and expansion. Gross' singular influence has a flip side, though, in the form of key-man risk. PIMCO has a deep bench to take up the slack in the event that Gross were to leave. Few other skippers have shown a yen for managing as much money as Gross, though. It's also unclear whether investors might choose to leave PIMCO in his absence.
Meanwhile, PIMCO does have blind spots. The growth of its flagship Total Return offering has made Gross' job more difficult. The fund has maintained a strong record, but it remains unclear whether its girth might take its future success beyond the realm of difficult to prohibitive. Costs are an issue at the overall firm, as well: The average percentile ranking of expenses across classes clocks in close to 50. That number could be better given the enormous size of the firm's asset base.
Price
At first blush, this fund's annual expense bite at 0.46% certainly looks reasonable. It's a lot lower than most retail fund classes and even clocks in below average among other institutional funds of its ilk. But we're talking about a very large fund here, with nearly $250 billion in assets. PIMCO's decision to actually raise the fund's price from 43 basis points after the financial crisis looked greedy. The bottom line is that the fund's institutional price tag is fair but a little difficult to justify for such a large portfolio.
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