PIMCO Total Return Fired From Some Retirement Funds

Morningstar rates 24 of the industry’s most widely held target-date series each quarter. Full reports, which include analytical text for the five pillars that underlie the ratings, are available to subscribers of Morningstar's software for advisors and institutions: Morningstar Principia®, Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM). Morningstar.com Premium Members can access each of the target-date series’ Summary Report.

Bill Gross' surprise departure from PIMCO and its flagship PIMCO Total Return (PTTRX) at the end of September affected investors of all stripes. The fund is pervasive in defined contribution plans as participants' primary core bond holding, for example. Retirement-plan tracker BrightScope counts the strategy in almost half of the more than 55,000 plans in its database. (Indeed, the fund stands as the mainline fixed-income option in Morningstar's 401(k) plan.)

Not only does PIMCO Total Return stand on its own in many retirement plans, it's also included in many target-date series. As such, target-date funds haven't been immune from the question of whether to replace or retain the strategy. Nine of the 55 target-date series in Morningstar's holdings databases as of the end of September held PIMCO Total Return, including PIMCO's own target-date offering, the Bronze-rated PIMCO RealRetirement series. (Two of the 55 series, State Street Target Retirement and Principal Lifetime Hybrid, launched on Sept. 30, 2014, and had no holdings available.)

While PIMCO is a common constituent in target-date series, it is not present in the industry's three largest target-date series, all of which invest only in their firms' proprietary or affiliated investments and control about three-quarters of the industry's assets. These series are Vanguard Target Retirement, Fidelity Freedom, and T. Rowe Price Retirement.

In fact, only 18 target-date series use actively managed strategies from nonaffiliated managers and thus would consider PIMCO Total Return as a holding, and nine of the 18 included the strategy at the end of September. The table below shows series' Total Return holdings (via the mutual fund, exchange-traded fund, or equivalent subadvised fund) that were available as of the end of September, a few days after Gross announced his departure from PIMCO.

- source: Morningstar, Inc.

Few Early Movers
Gross' timing in leaving PIMCO may have been unexpected, but a number of industry watchers, including Morningstar, have said that the move wasn't shocking given the turmoil that followed Mohamad El-Erian's January departure from the firm. In the ensuing months, there was uncertainty but not enough to move many target-date fund managers to action, judging by each series' allocation to Total Return at the end of September 2014 compared with the year prior.

Most series saw minor changes in their allocation to the strategy over that period. Harbor Target Retirement series showed the greatest change, with an almost 5 percentage point decrease over 12 months. While Morningstar analysts don't rate the Harbor series, a look at its prospectus shows that Harbor took steps to diversify its bond sleeve in February 2014, adding  Harbor Unconstrained Bond , which largely took assets from the PIMCO-subadvised  Harbor Bond (HABDX), a clone of PIMCO's Total Return strategy. Of course, Gross also managed Harbor Unconstrained Bond, a clone of  PIMCO Unconstrained Bond (PFIUX), so most of the assets from one fund flowed right into the other, and the series' exposure to Gross remained largely unchanged. At this point, Harbor Funds has stuck with PIMCO for both of those subadvisory relationships.

PIMCO's own RealRetirement target-date funds show a nearly 2 percentage point decrease to Total Return during the year. Most of that comes from the series' strategic increase to equities across most of its funds, a change that management announced in January 2014. 

One eye-catching change comes from AllianzGI Retirement, the target-date series managed by PIMCO parent Allianz SE. Morningstar analysts also don't rate this series, which is relatively modestly sized at $400 million in assets, but holdings data show that the series had sold out of all its PIMCO Total Return holdings by October 2014. The series does continue to hold a number of PIMCO funds, though none were managed by Gross prior to his departure.

Some Now Moved to Action
Of the six target-date series in Table 1 that are under Morningstar analyst coverage, three (including PIMCO's) have chosen to stick with Total Return, while three have moved on to new strategies. Table 2 summarizes the changes announced thus far. Schwab Target series logged the quickest reaction, announcing it replaced the strategy on the first business day following Gross' exit. In conversations with Morningstar, Schwab's target-date team said its $8.5 billion collective investment trust target-date offerings had already halved its allocation to Total Return earlier in September, partially as a result of El-Erian's departure. Investors in the $2.8 billion, Neutral-rated target-date mutual funds, though, did not see a similar shift in assets over that time. That discrepancy is especially disappointing as Schwab had taken steps in recent years to coordinate the research between the two offerings, and both series have shared the same manager-research team since 2011.

- source: Morningstar, Inc.

The Schwab Target mutual funds moved its assets into the firm's Schwab Total Bond Market as well as Gold-Rated  Loomis Sayles Investment Grade Bond (LSIIX). The former is a passively managed fund that had notable problems tracking its Barclays U.S. Aggregate Bond Index during the financial crisis. In 2008, for instance, the fund lost 4.4% while the index gained 5.2%. The fund has better matched its index in recent years. The move to the Gold-rated Loomis Sayles fund represents a clearer upgrade for investors. Morningstar analysts downgraded its rating of PIMCO Total Return to Bronze from Gold--a recognition that the analysts' confidence in the fund's potential to outpace its peers over the long term has diminished, but is still present.

The teams at Voya Solution and MassMutual--both of which manage Neutral-rated target-date series--also veered away from Total Return. The former went into Voya U.S. Bond Index on Sept. 30. The fund has tracked its Barclays U.S. Aggregate Bond Index adequately over its almost six years in existence. Still, its 0.40% expense ratio looks pricey compared with equivalent funds from competitors with more-established index-based businesses. (The Institutional share class of PIMCO Total Return has a 0.46% expense ratio, while the previously used fund, VY PIMCO Bond , has fees of 0.58%.)

MassMutual remained more contemplative in the days immediately after Gross' departure. By mid-October, though, the team announced its plans to replace subadvisor PIMCO with a team at Metropolitan West Asset Management, which also manages the Gold-rated  Metropolitan West Total Return Bond (MWTIX). The change to a higher-rated fund bodes well for investors.

Others Standing Firm
Besides PIMCO, the target-date managers at Bronze-rated Principal LifeTime and Bronze-rated John Hancock Retirement Living have so far decided to stand pat with PIMCO Total Return. Of course, that doesn't mean that those management teams won't act in the future. Conversations with both teams suggest that they're tracking the same issues as are Morningstar's analysts.

In Morningstar's opinion, liquidity concerns and the fear of being the "last investor standing" with PIMCO Total Return are thus far unwarranted. True, the fund had record outflows of $27.5 billion in October 2014, though most of that movement occurred in the month's first few trading days. Even so, Morningstar's research found that the fund made it through that initial round of withdrawals with no ill performance or liquidity effects. In addition, our analysts continue to believe the portfolio offers ample liquidity, and its overall positioning and sector concentrations have not changed materially due to the outflows. While the fund's manager changes and other related personnel changes stemming from Bill Gross' departure bear watching, there's still strong confidence in the vast research and personnel resources at PIMCO's disposal. Over the longer term, it bears monitoring how outflows affect team morale and compensation, but on that count as well, Morningstar's research suggest PIMCO has plenty of leeway to maintain its compensation and hiring practices with the explicit support of its corporate parent Allianz.

Though PIMCO's September tumult may have created less-than-ideal situations for investors in Total Return, the fund's prevalence in the target-date world provided a unique opportunity to observe how different managers reacted to the same set of circumstances. Schwab, for instance, continued to live up to its middle-of-the-road reputation. Meanwhile, teams from the more highly regarded Principal LifeTime and John Hancock Retirement Living series have lived up to their loftier expectations. It's reassuring to see that managers' actions have largely conformed to analysts' views.