A Wide-Ranging--and Successful--Corporate Bond Fund

The following is our latest Fund Analyst Report for PIMCO Investment Grade Corporate Bond Fund Institutional Class PIGIX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

PIMCO Investment Grade Corporate Bond's advantages include the tenacity of its veteran lead manager, the support of a large group of corporate managers and analysts, and a versatile process that draws on the firm's robust macroeconomic and fundamental research. It earns a Morningstar Analyst Rating of Silver.

This corporate-focused bond fund has rarely met a market it didn't like. For the year to date through Sept. 30, 2017, the fund's 7.0% gain was roughly 2 percentage points ahead of the Bloomberg Barclays U.S. Credit Index and in front of all other corporate-bond funds with a similar duration profile. Indeed, the fund has only lagged its benchmark in one calendar year out of the past 10; that consistency over shorter periods has produced outstanding long-term results.

Lead manager Mark Kiesel, who has steered the fund for 15 years, draws on the firm's myriad resources for ideas. The macroeconomic analysis that takes place in PIMCO's quarterly forums and regional committees gets translated into guidance by the firm's Investment Committee. Those views inform the fund's overall risk level, interest-rate positioning, and out-of-benchmark exposures, such as its Brazil-heavy 10% emerging-markets stake (as of August 2017). The rigorous fundamental work performed by the team's 50-plus credit analysts, combined with the 20-plus corporate portfolio managers taking the market's pulse, drive the fund's credit selection.

This wide-ranging process means the fund hasn't had to rely on just one or two tactics to succeed. In 2015, for example, its corporate issue selection more than offset the drag from its duration underweighting. But the fund's interest-rate calls, such as a bet on a flatter yield curve, have once more pulled their weight over the trailing 12 months. Longer-term themes--such as an emphasis on the debt of companies poised to benefit from the ongoing U.S. housing market recovery--have paid off in recent years, but the team also deserves credit for quickly mobilizing in response to market dislocations, as it did during the 2015 energy sell-off. That multifaceted approach should continue to serve investors well.

Process Pillar: Positive | Miriam Sjoblom, CFA 10/10/2017 The fund benefits from PIMCO's resourcefulness across the board--including thoughtful macroeconomic analysis, solid bottom-up research, and the managers' price-consciousness--earning a Positive Process Pillar rating.

Benchmarked against the Bloomberg Barclays U.S. Credit Index, this fund focuses on investment-grade corporate bonds. The fund may also hold smaller stakes in nonindex sectors, such as high-yield corporates, developed-markets sovereign bonds, emerging-markets debt, securitized fare, and currencies. As a member of PIMCO's Investment Committee, lead manager Mark Kiesel helps formulate the top-down themes that show up in the fund's interest-rate positioning and sector weightings. PIMCO's corporate specialists then scrub the universe for bottom-up ideas. The corporate team's managers and analysts communicate regularly; Kiesel chairs a weekly meeting in which the entire group scrutinizes portfolio positioning, and he frequently joins analysts on research trips.

A suite of analytical tools helps the managers quickly identify trading opportunities and assess relative value between an issuer's cash bonds across geographies, capital structures, and credit default swaps. Kiesel also uses index CDS, coupled with U.S. Treasuries, to obtain liquid corporate market exposure. Extensive use of derivatives adds complexity to the portfolio, but PIMCO has managed the risks of those positions well.

Several of the fund's investment themes have remained consistent in recent years. Chief among them is a conviction that the U.S. housing market's ongoing recovery argues for exposure to sectors poised to benefit, such as select building materials and lumber companies, an overweighting to banks (19% as of Aug. 31, 2017), and a modest helping of nonagency mortgages (less than 3%). As credit spreads have tightened, Mark Kiesel has gotten more cautious. Sticking with the housing theme, for instance, he has increased the fund's exposure to REITs (3%), which the team likes for their strong covenants preventing issuers from increasing leverage to bondholders' detriment. Kiesel has trimmed the fund's exposure to other riskier areas, such as certain energy companies he had picked up at bargain prices in 2016 (the fund maintained its overweighting to pipelines). He also continues to downplay more-vulnerable industries, such as retailers and autos.

PIMCO's optimism toward select emerging markets was reflected in the fund's 10% emerging-markets stake, with a mix of rates, sovereign, and corporate exposures in Brazil and Mexico taking up the lion's share. Its duration is still slightly less than its benchmark's, with the fund positioned for a flatter U.S. yield curve. The firm's view that U.S. rates are attractive relative to other developed markets drove modest interest-rate shorts in Japan and the eurozone.

Performance Pillar: Positive | Miriam Sjoblom, CFA 10/10/2017 Mark Kiesel has produced outstanding results here, earning a Positive Performance Pillar rating. The fund's annualized gain of 7.7% over the past decade through September 2017 outpaced its Bloomberg Barclays U.S. Credit benchmark by 2.2 percentage points per year, on average, and beat all other funds with a similar duration profile in the corporate-bond Morningstar Category. The fund has been remarkably consistent over shorter periods as well, rarely trailing its benchmark in any 12-month period.

Positions tied to a U.S. housing recovery, including a multiyear overweighting to banks, have been strong contributors in recent years. Versatility in the face of market dislocations has also kept the fund a step ahead. For example, the team's in-depth research on energy companies during 2015's sell-off informed Kiesel's decision to pick up cheap bonds in time to benefit from the sector's 2016 rebound. Brexit-driven volatility in the banking sector also gave Kiesel the opportunity to top up the fund's exposure to subordinated U.K. bank securities, a move that has paid off so far in 2017. At other times, implementation of firmwide macro themes have been fruitful, as when Kiesel increased the fund's exposure to a recovering Brazil, including oil company Petrobras, starting in mid-2016. The fund's interest-rate positioning, while serving as a headwind in prior years (particularly in 2015 when the fund was underweight duration), has also rewarded it in 2017.

People Pillar: Positive | Miriam Sjoblom, CFA 10/10/2017 The fund earns a Positive People Pillar rating thanks to its strong leadership and expansive supporting team of credit analysts and portfolio managers. Two-decade PIMCO veteran Mark Kiesel has run this fund since 2002. He eventually became head of the firm's global corporate-bond portfolio managers in 2008 and was awarded Morningstar U.S. Fixed-Income Fund Manager of the Year in 2012. In early 2014, Kiesel was named as one of the firm's six deputy CIOs and, following Bill Gross' departure, he was named global credit CIO and appointed as a comanager on PIMCO Total Return PTTRX. His investment in this fund exceeds $1 million.

While the fund has thrived under Kiesel's direction, its success hasn't depended on just one individual. In recognition of that, PIMCO named Amit Arora and Mohit Mittal as comanagers here in October 2016. The two are senior members of a team of more than 20 investment-grade corporate-focused portfolio managers; Mittal oversees the U.S. investment-grade and emerging-markets corporate trading desks, and Arora has been instrumental in the team's analysis of financial firm capital structures globally, a strategic area of focus for the firm. Though PIMCO's public corporate research ranks have shrunk from a peak of just over 60 in 2015, the managers still benefit from the support of more than 50 credit analysts led by research head Christian Stracke, up from roughly 30 in 2009.

Parent Pillar: Positive | 04/04/2017 PIMCO has endured rocky waters, including the late-2014 departure of co-founder Bill Gross. Outflows soared at the firm thereafter but slowed in 2015 and 2016; the firm returned to net inflows in January 2017.

The firm continues to benefit from a standout investment culture. Dan Ivascyn has been successful as comanager of PIMCO Income PONAX and has clearly grown into his CIO role. In November 2016, Emmanuel “Manny” Roman took over as PIMCO’s CEO. His priorities appear mostly aligned with the investment management team's, though we intend to keep an eye the addition of quant capabilities and investment offerings, as well as the expansion of alternative strategies such as those involving private-market debt.

We have historically taken the firm to task for failing to pass along economies of scale in pricing, but its overall expense profile is reasonable if not notably attractive. That said, PIMCO has never closed a fund to new investors. That is an issue of import given that assets managed in, and using the same strategy as, PIMCO Income grew to more than $100 billion of assets at the end of 2016. We've yet to see evidence drawing a direct line between asset size and performance, but we continue to evaluate the situation.

On balance, PIMCO has many more pluses than minuses and has earned a Positive Parent Pillar Rating.

Price Pillar: Positive | Miriam Sjoblom, CFA 10/10/2017 Nearly 60% of the fund's assets reside in its institutional share class, which charges an annual levy of 0.50%, landing below the median 0.58% charged by other corporate-bond fund institutional shares. That's enough of a discount to earn the fund a Positive Price Pillar rating. However, the rest of the fund's share classes charge fees that are either average or above average compared with their respective distribution channels. The fund's D shares charge an exorbitant 0.90%, for instance, which is well above the 0.55% norm charged by no-load corporate-bond funds. That's disappointing given the volume of assets managed by PIMCO in this asset class (nearly $300 billion in dedicated corporate strategies as of June 2017). The firm could do more to share these economies of scale with investors in the form of lower fees.