This Terrific Ultrashort Bond Fund Leaves No Stone Unturned

The following is our latest Fund Analyst Report for PIMCO Short-Term PTSHX. 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 Short-Term's wide-ranging strategy makes full use of the team's global fixed-income expertise. While its approach comes with risk, the fund's skilled manager never loses sight of its modest goals--protecting capital chief among them--supporting a Morningstar Analyst Rating of Silver.

PIMCO veteran Jerome Schneider has called the shots here since 2011. Aside from a rare departure in July 2018, the core team supporting him--four experienced specialists focused on areas including credit, derivatives, and nondollar rates--has mostly remained stable under his watch. The team works closely with other sector and country specialists who focus on shorter maturities and draws on the firm's army of corporate-credit and securitized analysts. It's an impressive roster.

The experience, stability, and breadth of the team is critical given the fund's multifaceted approach. Starting with a focus on liquidity and minimizing volatility, Schneider will then take measured risks when their rewards appear commensurate. After reducing corporate credit risk in 2017, for instance, he took advantage of a market dislocation in early 2018 to increase the fund's investment-grade corporate stake to 45% by August 2018, up from a recent low of 30% in January. Schneider's view of corporate credit remains cautious, though, so he has maintained a high-yield index short (just under 3% of assets) as a hedge against risk-market downdrafts, which helped when Italian government debt sold off in May. And while Schneider has maintained a cautious stance toward U.S. rates, he has tactically implemented modest rates exposure in markets such as Canada and Australia recently.

The fund's broad tool kit has added volatility relative to competitors that lack its range. Still, its occasional setbacks have been mild, and each facet of its approach has contributed to peer-beating results over the long term. The fund's 0.45% price tag is steep for a large fund in the institutional ultrashort bond Morningstar Category, but given the fund's excellent management, it remains a compelling option.

Process Pillar: Positive | Miriam Sjoblom, CFA 09/26/2018 This ultrashort bond fund's aims are modest: Provide slightly better-than-cash returns while preserving capital. Given that conservative mandate, manager Jerome Schneider's chief focus is on maintaining a high degree of liquidity and minimizing volatility. To that end, the fund emphasizes high-quality issues and takes very little interest-rate risk: The portfolio's duration is typically less than one year, and Schneider avoids structured fare with volatile cash flows that could cause that duration to extend.

From there, Schneider and his team make full use of PIMCO's vast resources to identify mispricings among sectors and markets at the short end of the yield curve. Like its PIMCO siblings, this fund uses a mix of macroeconomic forecasting and bottom-up analysis to make interest-rate, yield-curve, currency, country, sector, and issue-level decisions. Allocations to short-dated U.S. government debt, corporate bonds, and high-quality asset-backed securities are routine both here and in competitors' portfolios, but this fund also branches into less conventional territory, such as non-U.S. developed- and emerging-markets debt, and modest currency bets (typically in the single digits).

Those additional levers can add volatility. But the quality of the analysis backing those decisions and Schneider's attentiveness to risk support a Positive Process Pillar rating.

Since late 2014, manager Jerome Schneider has kept the fund's duration on the short end of its zero- to one-year range. He has continued to anticipate volatility on the short end of the U.S. yield curve throughout a series of Federal Reserve target rate increases since then, believing that the market isn't sufficiently pricing in the probability of future rate hikes. Though a tactical long position in Canadian rates lengthened the fund's duration briefly to 0.6 years in September 2017, the fund's duration has mostly stayed near zero for the trailing 12 months through August 2018. As the yield curve has flattened significantly, Schneider also implemented a position to benefit from a steepening between two- and five-year maturities.

After spreads began a tightening trend in early 2016, Schneider became cautious on the credit-risk front. But as corporate spreads widened in early 2018, he took advantage of that dislocation to increase the fund's investment-grade corporate stake to 45% as of August 2018, up from a recent low of 30% in January 2018. He has continued to maintain a small (around 3%) high-yield index short via credit default swaps, however, and to improve the quality of the fund's corporate holdings in general. Schneider decreased the fund's U.S. dollar overweight but has maintained a short in the Japanese yen and euro (shorts of 1.0% and 3.0%, respectively) to benefit from diverging central-bank policies.

Performance Pillar: Positive | Miriam Sjoblom, CFA 09/26/2018 This fund boasts a strong record over both the long term and since manager Jerome Schneider took over in January 2011. After a modest start that year, the fund placed in its category's best quartile in each subsequent year, and its 1.8% annualized return from January 2011 through August 2018 outperformed nearly 90% of the surviving ultrashort-bond competition (distinct funds). The fund has been well-served by its various substrategies over time; temporary weaknesses in one or two areas have been more than offset by strength in others. Even though contributions from the fund's various exposures so far in 2018 have been individually modest compared with prior years, the fund's 1.5% gain through August 2018 was still ahead of more than 80% of its competition.

The fund's adventurous profile can produce a somewhat rockier ride relative to more-staid peers, though. Its volatility (as measured by standard deviation), while still low in absolute terms, ranks among the category's highest. Its occasional stumbles--including during the second quarter of 2013's taper tantrum and again during commodity-related volatility in the third quarter of 2015--have been relatively contained, with drawdowns limited to a percent or less. So, while the fund has courted a bit more volatility than the category norm, it has been effective at preserving capital, supporting its Positive Performance Pillar rating.

People Pillar: Positive | Miriam Sjoblom, CFA 09/26/2018 The skilled team of short-term specialists and vast network of global fixed-income experts that support this fund merit a Positive People Pillar rating. The fund is managed by Jerome Schneider, who was named Morningstar Fixed-Income Fund Manager of the Year for 2015. Schneider joined PIMCO in 2008 from Bear Stearns, where he had a background in credit- and mortgage-related funding transactions. He took over leadership of the short-term desk after Paul McCulley left the firm at the end of 2010.

Aside from the departure of Scott Berman in July 2018, the core team focusing on short-term debt markets (0-18 months) has remained stable under Schneider's watch, and each member has well over a decade of industry experience. That includes Andrew Wittkop, who focuses on rates and derivatives, Nate Chiaverini on corporate credit, Bill Martinez on nondollar rates, and Tony Crescenzi on Fed policy. While PIMCO searches for Berman's replacement, this team, supported by the addition of two junior members in the past year, has the expertise to pick up any slack. This fund doesn't stick purely to debt maturing in 18 months or less, so the core group also leans on PIMCO's extensive global investment team of traders, analysts, and macroeconomic experts. In addition to running dedicated short-duration portfolios, the team also manages billions of dollars across a range of short-term assets for other PIMCO strategies.

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

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: Negative | Miriam Sjoblom, CFA 09/26/2018 The one negative for this otherwise strong choice is a 45-basis-point price tag (excluding interest expense and other investment-related costs) that stands nearly 10 basis points above the median charged by the fund's institutional-share competitors. This levy is particularly problematic given that the fund is the largest offering in the category by several billion dollars. But while some of the fund's retail classes are probably worth avoiding on the basis of prices that are simply too high, the fund's institutional shares still warrant investor interest. The fund has avoided the blowups that have haunted some peers (including a handful of funds that are now defunct) while still managing terrific long-term, peer-beating returns.

Financial professionals are accessing this research in our investment analysis platform, Morningstar Cloud. Try it today.