Intermediate-Term Bond Alternatives to PIMCO Total Return

PIMCO co-founder Bill Gross’ departure for Janus in late September unleashed a torrent of outflows from flagship  PIMCO Total Return (PTTRX). The $200 billion fund still has plenty going for it, including the arguably unparalleled resources of PIMCO's investment staff. However, we lowered the fund’s Morningstar Analyst Rating to Bronze from Gold to reflect the uncertainty regarding the outflows and reshuffling of management resources supporting the fund.

Some investors who don’t stick with PIMCO will no doubt follow Gross to his new charge, Janus Unconstrained (JUCIX). However, that fund’s wide latitude in managing interest-rate and credit risk means that it’s likely to look quite a bit different from Gross’ PIMCO Total Return. For those looking for a more traditional core fund that’s not as frequently in the headlines, the intermediate-term bond Morningstar Category offers four options that earn Morningstar Analyst Ratings of Gold.

 Dodge & Cox Income (DODIX)
Unlike PIMCO, which makes heavy use of derivatives in managing its sprawling portfolios, Dodge & Cox takes a plain-vanilla, cash-bond-focused approach. The fund is team-managed by a seasoned and stable investment staff, removing the potential disruption caused by the departure of a star manager. And its careful, value-based approach to investing--with the occasional contrarian bet--has generated strong long-term returns versus its category and the Barclays U.S. Aggregate Bond Index. The corporate-heavy and Treasury-light portfolio, which has run with a roughly 10% junk-bond stake in recent years, carries more credit risk than its benchmark and, as a result, is more correlated with the equity markets than some of its more well-rounded peers. That leaves it vulnerable to bouts of underperformance in rocky credit markets, but investors have done well here over the longer haul.

 Fidelity Total Bond (FTBFX)
This is Fidelity’s core-plus entrant in the intermediate-term bond category, and, as such, holds modest positions in emerging markets (5% recently) and an up-to-20% stake in junk-rated corporates. Fidelity has worked hard to develop robust teams around its top investment staff and has invested significantly in the quantitative resources supporting this effort. Lead manager Ford O’Neil works with other portfolio managers on the core/core-plus team, as well as with a recently expanded macroeconomic research group to determine the fund’s broad asset and sector mix. He then draws on the firm’s impressive lineup of mortgage, corporate, high-yield, and emerging-markets experts in selecting individual securities. Unlike many of its competitors, Fidelity sticks close to its Barclays U.S. Aggregate Bond Index benchmark when it comes to duration and typically holds meaningful Treasury stakes as a hedge against volatility in the credit markets.

 Loomis Sayles Investment Grade Bond (LSIIX)
Loomis Sayles is still synonymous with bond legend Dan Fuss, but, under the leadership of CIO Jae Park, the firm has made significant strides over the past decade in broadening and deepening the investment resources backing Fuss. Firm veterans Matt Eagan and Elaine Stokes are impressive in their own right and have served as co-portfolio managers of this fund since 2006; Brian Kennedy was added to the fund in 2013. Although this fund is managed against the Barclays U.S. Government/Credit Index, which includes a sizable stake in Treasuries, this fund has not held many Treasuries in recent years. It also doesn’t hold meaningful stakes in mortgages, which figure prominently in most core bond funds. Instead, the fund leans heavily on corporates, including high yield, and will even buy the occasional stock. This preference, together with significant exposure to nondollar currencies, can leave the fund vulnerable to trouble when credit and equity markets turn stormy, and, of the four funds with Morningstar Analyst Ratings of Gold, it’s consistently the most correlated with the equity markets. However, investors who have stuck with this fund have been well-rewarded with gains that come out near the top of the intermediate-term bond category in most periods.

 Metropolitan West Total Return Bond (MWTRX)
This fund traces its origins to PIMCO, where its three comanagers got their start more than two decades ago. The fund, which, like most of its intermediate-term bond peers, is managed against the Barclays U.S. Aggregate Bond Index, stands out for its broad palette and value-driven approach. The team is willing to stray beyond the fund’s benchmark to invest in high-yield bonds and nonagency residential mortgages. It has also shown a willingness to dive into troubled sectors when it thinks fundamentals warrant. However, it is just as careful about trimming risk when valuations appear stretched. Interestingly, despite its willingness to take on credit risk, of the four featured funds, this one has consistently been the least highly correlated with the S&P 500. There is some firm-related risk here following the Carlyle-backed buyout of TCW that closed in 2013. However, that’s partially mitigated by the significant ownership stake in the firm held by TCW employees and management and the five-year contracts signed by key members of the investment staff, including MetWest’s founders.