Key Considerations for PIMCO Total Return Investors
Investors need to be aware of risks ranging from outflows to board stewardship, but the core investment process remains sound in the wake of Gross’ departure.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.
In the wake of Bill Gross' departure from PIMCO, we've downgraded the firm's flagship Total Return Fund to Bronze from Gold. I'm here with Michael Herbst, our director of manager research for active strategies in North America, to take a look at this move.
Michael, thanks for joining me today.
Michael Herbst: Glad to be here.
Glaser: Let's talk about that Bronze rating. What does that represent, and why did we move it from Gold?
Herbst: In a nutshell, what this signals is that we have a high level of confidence in the managers who are taking over responsibility for the fund. But it also signals some very significant areas of uncertainty around the fund itself and around PIMCO as a firm, and also around the fund board quality, too, which we can touch on.
Glaser: Let's talk about what's staying the same and what makes you positive on the fund. What gives you confidence that it is going to continue to outperform?
Herbst: There are a couple of key things here that shape our thinking.
Scott Mather, Mark Kiesel, and Mihir Worah are taking over as leads on the fund. Scott Mather will ultimately be making the day-to-day decisions. These are managers that we're very familiar with. We've grown familiar with them over the past decade and watched their work at PIMCO. These are three highly accomplished, very experienced managers in their own right who have also built out very deep and strong teams around them, especially over the past five to seven years. That's one thing that gives us a great vote of confidence.
The second thing is the managers, in tandem with Group CIO Dan Ivascyn, all basically assumed oversight for the investment committee that's so central to the process at PIMCO. They assumed joint leadership of that committee in January, essentially sharing responsibilities for running that with Bill Gross at the time. So that is a key part of the process that essentially had already been up and running.
A third key part that is also intact at this point is the bottom-up expertise that will be feeding the fund. Mather, Kiesel, and Worah are also known for their bottom-up expertise, as is Ivascyn. ... These folks had been key contributors to Gross' bottom-up thinking historically, and now they just take on new responsibilities at the fund.
Glaser: On the flip side, though, what are the uncertainties. What makes you maybe a little bit less confident now than you were when Bill Gross was at the helm?
Herbst: That's a great point, and this is to highlight some of the issues that we're going to be watching in the days, weeks, and months going forward.
We do have a high level of confidence in the three managers that we spoke a little bit about, but they are taking on new responsibilities at the firm's flagship fund, which is undoubtedly headed into a period of turmoil, in some respects, if outflows pick up. A lot of people are trying to handicap what the flow situation at the fund is, as are we. We are comfortable with how the fund's portfolio could withstand outflows, at least in the near term. By our accounting, at least a third of the fund is in highly liquid securities; that's before you even account for cash. That's before you account for coupon payments into the fund as well.
That situation could change as we start to see flow data coming out of the firm in the days and weeks going forward. Everyone is trying to crack that, but from the news reports that we have seen, nobody has got a very close accounting for that. So that would be one level of uncertainty.
Another area of uncertainty is to see how these managers gel in their new role--that is, how do the responsibilities get divvied up? Ultimately, this is a group of people making decisions day-in and day-out. How effectively they're able to do so is something that we're keeping a keen eye on, too.
Last but not least, we are likely to see some ripple effects from these management changes in terms of management at other PIMCO funds, too. So watching that shake out would be something else that we're keeping a very close eye on.
Glaser: We also updated our Stewardship Grade for PIMCO. Could you talk a little bit about changes that we've we made there and your thinking behind them?
Herbst: Something that sometimes gets lost in a shuffle is that fund boards actually are the overseers for mutual funds and should be acting on behalf of fund shareholders. The PIMCO fund boards--we won't go too far into the weeds here--but both have lost two independent trustees over the past 18 months or so, leaving both key boards well below industry standards for independent representation.
Why is that important? One, it reflects poorly on the board's interested chairman and PIMCO as a firm. Two, like I said, it falls below the industry standard for board oversight that we see at other firms, and it falls well short of best practices that we see in the industry.
Third, and perhaps most importantly, this is a time of turmoil at PIMCO, and over the past year, there is evidence to suggest that the fund boards may not have been as well equipped as they could to stay on top of the situation and to act on behalf of fund shareholders. These are fund boards that, by and large, have not successfully negotiated lower expenses for non-institutional shareholders and most fund shareholders in PIMCO funds, and the loss of the independent trustees, too, raises a red flag for the board quality. So we downgraded our board quality grade or aspect of the Stewardship Grade from C to D.
Glaser: How does that shake out for the overall Stewardship Grade?
Herbst: The overall Stewardship Grade remains at neutral for now. This is something that we'll continue to monitor going forward, but it's a stewardship aspect driving PIMCO funds that people ought to be paying attention to.
Glaser: Turning to Bill Gross' new fund at Janus, it's obviously very early on. We don't have a lot of information yet. What's your initial sense of it? How are you going to go about getting more information and thinking about a recommendation for it?
Herbst: Here are a couple of things that we know about the situation so far. At least initial indications and in conversations with both PIMCO and Janus, Bill Gross will not be moving to Janus with a team from PIMCO--that is, the operation that he will be building out around himself at Janus remains pretty skeletal at this point. Why that's important is because a key part of Gross' success at PIMCO stems from the depth of the research and the input that he got from seasoned professionals across the firm in driving his positioning. Those resources are not moving with him to Janus. So that's a key thing to keep in mind.
The second thing that we know is that Gross will be reporting directly to Dick Weil. Something that we are getting more clarity on is to what extent will Gross be interacting with the fixed-income operation at Janus. Why this is interesting is because Janus, somewhat under the radar over the past five to 10 years, has actually built a very strong fixed-income operation centered around corporate credit. Gibson Smith and Darrell Watters, who co-lead that effort, deserve a lot of credit for building out a very strong team at Janus.
That said, it remains unclear how much interaction there will be between Gross and Gibson Smith's team. Those are two key things driving our thinking right now, and we will also be moving quickly to bring the new Janus fund under full analyst coverage in coming months.
Glaser: So what are the next steps for Morningstar research? What can readers expect over the next few weeks?
Herbst: The next steps for our team: We are already at work re-rating our 50-plus rated PIMCO strategies globally. We're going to move as quickly on that as we can based on the information that we've got.
Again, in terms of extensive conversations with PIMCO over the weekend and really non-stop interaction among our analyst team since Gross' departure, we have a very good sense of what the implications of Gross' departure will be for all PIMCO funds at this point. There may be some questions around certain strategies or certain management teams that we're currently digging into, but we're going to move quickly to re-rate all of those funds.
Secondly, we will be keeping a very close eye on the situation at PIMCO, especially in terms of flows and potential personnel departures or other evidence of disruption. One thing we would offer there too, though, is that Gross' departure from PIMCO could actually promote stability at the firm, rather than detract from it. In our conversations, there has been a palpable sense of relief, essentially, that some of this is behind the firm, and that they can refocus their energies. So this is not a gloom-and-doom scenario for PIMCO by any stretch. But the things that we will be watching very closely are flows and personnel departures.
That said, our ratings reflect our current views on the fund, so as we incorporate new information, good or bad, we'll reassess our ratings wherever and whenever is appropriate.
Glaser: Michael, thanks for the update.
Herbst: My pleasure.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.