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An Intrepid Choice Among Inflation-Protected Bond Funds

Silver-rated PIMCO Real Return maintains its Morningstar Analyst Rating despite a key management departure.

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Despite the departure of a talented manager, PIMCO Real Return remains in skilled hands and continues to benefit from a deep team. It retains its Morningstar Analyst Rating of Silver.

On Jan. 9, 2019, PIMCO announced that Jeremie Banet, the fund’s lead manager since January 2015, would leave the firm in February. Steve Rodosky, who led PIMCO’s U.S. Treasury trading desk in earlier years, has taken his place on this fund alongside longtime comanager and Real Return team head Mihir Worah. While Banet’s departure is a loss, Worah’s continued presence and Rodosky’s experience are reassuring. Worah also grew PIMCO’s real return effort in recent years, tapping European rates head Lorenzo Pagani to manage global real return accounts and moving agency mortgage-backed securities specialist Daniel He to the team in January. That follows the hiring of inflation-linked bond specialist Daniel Brhel in 2017 and macro expert Tiffany Wilding to support the firm’s inflation-forecasting efforts in 2016.

PIMCO’s resource depth beyond the Real Return team also matters because the team has made full use of its wide latitude to invest beyond the Bloomberg Barclays U.S. TIPS Index, including modest exposure to non-U.S. inflation-linked bonds and currencies and up to 20% in other sectors such as corporate, securitized, and emerging-markets fare.

The fund’s flexibility has made it one of the more intrepid--and volatile--funds in the inflation-protected bond Morningstar Category. For instance, it lagged its typical peer and benchmark in periods such as 2013, when modest emerging-markets exposure exacerbated a rough stretch for Treasury Inflation-Protected Securities, and in 2015, when a pronounced bet on reflation suffered as commodity prices slumped. Such plays have buoyed the fund in more-favorable climes: In 2016 and 2017, the team had success with a diversified set of measured calls over large directional bets. The fund’s multifaceted approach has given it the firepower to outperform over Worah's tenure.

Process Pillar: Positive | Miriam Sjoblom, CFA 01/18/2019

To beat the Bloomberg Barclays U.S. TIPS Index, the team looks to obtain cost-efficient exposure to U.S. TIPS and other inflation-linked bonds by seeking better execution than received by passive investors. It employs macro-driven strategies (driven by real growth, inflation, and country-specific analysis) and micro-driven themes (including Consumer Price Index seasonality, on-the-run/off-the-run premiums, and implied inflation volatility). Although U.S. TIPS and, to a lesser extent, other global inflation-linked bonds dominate the portfolio, the fund can invest up to 20% in other sectors, such as developed- and emerging-markets sovereigns, corporates, and securitized fare.

The approach has led to sizable off-index bets at times, a trait that distinguishes it from its more-constrained peers, including use of PIMCO's bonds-plus techniques, by which the fund gets exposure to its primary sectors via derivatives and invests the cash collateral in short-term bonds. The team may also make meaningful and swift maturity shifts, though the fund’s overall duration has generally stayed within a year of the benchmark’s. The fund’s adventurous nature can cause its performance to diverge from that of the U.S. TIPS market at times. But overall, its flexible approach, which benefits from the insights of PIMCO's broad, deep bench of global bond experts, earns a Positive Process Pillar rating.

The fund’s overall duration stuck close to its benchmark’s for much of 2018, with shorts in U.K. and Japan nominal yields meant to offset a modest U.S. duration overweighting; the team shortened the fund’s duration as yields rallied late in the year, to 6.7 years as of December 2018 versus the benchmark’s 7.4 years. While the team continued to overweight U.S. break-even inflation rates (the difference between yields on inflation-linked and nominal bonds) for much of 2018, its views evolved to express an outright overweighting in U.S. real yields later in the year. The team also continued to view U.K. and European break-even inflation rates as overpriced versus U.S. break-evens, adjusting the magnitude of that bet as valuations shifted.

The fund’s positions away from inflation-linked debt have been modest. It has retained a cautious stance toward credit, with low-single-digit stakes in corporate and structured credit. The team increased its exposure to agency mortgage pass-throughs--which it views as a high-quality diversifier--to 16% as of December 2018 from 6% a year ago. After reducing the fund’s U.S. dollar overweighting in 2017, the team has run a U.S. dollar exposure closer to neutral, while continuing to hold small (under a percent each) long and short exposures to other currencies, including select emerging-markets currencies.

Performance Pillar: Positive | Miriam Sjoblom, CFA 01/18/2019

This fund has generated impressive long-term returns since Mihir Worah took over almost a decade ago. Its 3.3% annualized return from January 2008 through December 2018 beat all but two of its inflation-protected bond competitors (also PIMCO funds managed by Worah) and the Bloomberg Barclays U.S. TIPS Index by 24 basis points per year, on average, earning a Positive Performance rating.

The sailing hasn’t always been smooth. PIMCO’s wary stance on U.S. Treasuries and the portfolio’s non-TIPS exposure weighed on relative performance in 2011’s strong Treasury rally, for instance, and the fund stumbled again in 2013 when out-of-index emerging-markets exposure augmented steep losses in the U.S. TIPS market. The fund’s 2015 weakness stemmed partly from a bet on rising U.S. inflation when commodity prices slumped. The team’s more modest bets have held the fund back again in 2018, resulting in a 2.0% loss that trailed the index and the category median.

The fund's distinctive views have proved rewarding in more-favorable climes, such as the postcrisis credit rebound in 2009 and 2010, and again in 2012. The fund doesn’t only rely on broad macro themes to compete, either. In 2016 and 2017, the team's focus on small relative value trades alongside a modest helping of out-of-index sectors, such as nonagency mortgages, paid off.

People Pillar: Positive | Miriam Sjoblom, CFA 01/18/2019

On Jan. 9, 2019, PIMCO announced that Jeremie Banet, the fund’s lead manager since January 2015, would leave the firm in February. Steve Rodosky, an experienced U.S. government rates trader who led PIMCO’s U.S. Treasury trading desk from 2007 to 2016, has taken his place on this fund alongside longtime comanager Mihir Worah. While Banet’s departure is a loss, Worah’s continued presence, Rodosky’s experience, and the support of PIMCO’s of macro experts, quant researchers, and sector specialists, support a Positive People rating.

Worah joined PIMCO in 2001 and has led the firm’s Real Return team and this fund since 2008. He became one of six deputy CIOs in early 2014. After Bill Gross left later that year, Worah was named a CIO, became a comanager on PIMCO Total Return PTTRX, and gained oversight of the firm's U.S. portfolio managers.

As his duties increased, Worah had leaned more heavily on Banet to execute the strategy, but stepped up his oversight as Banet’s duties transitioned to Rodosky on U.S. accounts and head European rates trader Lorenzo Pagani on global accounts. Worah also grew the Real Return team in early 2019, bringing over former agency MBS specialist Daniel He in 2019 alongside dedicated inflation-linked bond specialists David Brhel, who joined PIMCO in late 2017, and Michael Althof, who has managed global real return accounts since 2015.

Parent Pillar: Positive | 10/03/2018

PIMCO's investment culture has long been successful, if also rigorous, demanding, and intense.

Despite worries that the turmoil after Bill Gross' 2014 departure might lead others to follow, there has been notable stability among the firm's senior investors. Meanwhile, the firm is back to a faster pace of hiring following a rough patch of asset flight and has also been taking more proactive steps in succession planning, elevating the next generation of leaders in the investment ranks.

There are other evolutionary changes in progress. CIO Dan Ivascyn has facilitated efforts to inject more diverse views into the investment process, whether by rotating a wider range of investment staff through PIMCO's Investment Committee or by incorporating more quantitative research and risk insights into the workings of that body. CEO Manny Roman has also driven significant technology investments since he arrived in 2016, intent on ensuring that the investment team's analytical tools remain cutting edge.

We have taken the firm to task for failing to share economies of scale for pricing, and while its expense profile is reasonable in the United States, it is decidedly not so in Europe. We would also prefer to see the firm give more attention to questions around closing fast-growing funds. That said, nearly all of the major factors relating to the firm's Positive Parent rating have been improving.

Price Pillar: Negative | Miriam Sjoblom, CFA 01/18/2019

The fund's Institutional share class, which comprises just more than half the fund's $9.9 billion asset base as of November 2018, carries a 0.45% expense ratio, excluding certain investment-related costs. That levy was slightly higher than the category median for similarly distributed funds but not unreasonable. A little more than 40% of the fund's assets are held in share classes with either above-average or high fees within their respective distribution cohorts, though, and that mix results in a Negative Price Pillar rating.

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About the Author

Miriam Sjoblom

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Miriam Sjoblom is a director on the global manager research team at Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. She oversees the global ratings process for fixed-income strategies.

Sjoblom returned to Morningstar in 2016 after spending three years as a senior consultant for Aon Hewitt Investment Consulting, where she researched alternative credit strategies and advised institutional clients on hedge fund and private debt manager selection. Previously, she was a member of Morningstar’s manager research group from 2007 to 2013, during which time she covered multisector and specialist fixed-income managers and oversaw the North American fixed-income manager research team. Before joining Morningstar, Sjoblom worked as a business analyst in Citigroup's investment banking division and as a fixed-income analyst for Performance Trust Capital Partners.

Sjoblom received a bachelor’s degree in English literature from the University of Chicago and a master’s degree in media studies from The New School. She also holds the Chartered Financial Analyst® and Chartered Alternative Investment Analyst designations.

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