Fund companies shift focus in managed-payout funds

Managed-payout funds designed to give retirees a steady stream of income landed with a thud when they were introduced ahead of the stock market’s swoon, but some mutual fund companies are seeking to breathe new life into the concept.

Pacific Investment Management Co. this month launched two managed-payout funds: the Pimco Real Income Fund 2019 (PCIAX) and the Pimco Real Income Fund 2029 (POIAX).

They are unique in that they use a laddered portfolio of Treasury inflation-protected securities, meaning maturities are structured to generate inflation-adjusted distributions.

Distributions are a combination of interest and principal, both of which are automatically adjusted to the rate of inflation. They are paid out monthly until the funds reach their maturity date.

The strategy is so different that Pimco has filed for patent protection.

Pimco, however, isn’t the only firm tinkering with managed-payout funds.

The Vanguard Group Inc. is looking at adding an absolute-return strategy into which its three managed-payout funds, launched last year, can invest.

“As soon as we have completed background work … we will move with all deliberate speed to include [an absolute-return strategy] as part of the funds,” said John Ameriks, a principal and head of the investment counseling and research department at Vanguard.

NOT AN ADMISSION

The move isn’t an admission that there is anything wrong with the funds, he said.

Vanguard made its intention to include an absolute-return strategy known when it launched its managed-payout funds, Mr. Ameriks said.

“I am satisfied with the design,” he said. “There’s not much better that can be done.”

But some industry insiders said that poor performance — many managed-payout funds were forced to reduce the amount of income they were able to disburse dramatically because of the stock market’s nose dive — is a strong argument for action.

With just more than $500 million spread across 23 funds — not including the two new Pimco funds — it is fair to say the managed-payout funds haven’t caught on with investors.

“I think all of these products need to be redesigned,” said Darlene DeRemer, a partner at Grail Partners LLC, a merchant bank that specializes in the investment management industry.

At least two asset managers, however, said that they have no plans to change their managed-payout funds.

“As part of our ongoing investment process, we’re always doing due diligence,” said Jonathan Shelon, co-portfolio manager of Fidelity Investments’ 14 managed-payout funds, the first of which were launched in 2007.

And that due diligence hasn’t led Fidelity to the conclusion that it needs to redesign the funds.

It doesn’t appear that any changes are in store for the Baron Retirement Income Fund (BRFIX) either. Launched in June 2008, the managed-payout fund from Baron Capital Group Inc. seeks to make a 4% annual distribution to supplement the income of investors who are planning for their retirements or help replace income for in-vestors who have retired.

The Baron fund had a rough year last year, but that hasn’t dampened the firm’s enthusiasm for it.

“I love the way this fund is set up,” said Ronald Baron, the manager of the fund and chairman, chief executive and chief investment officer of Baron Capital.

Other firms that offer managed-payout funds — John Hancock Financial Services Inc. and The Charles Schwab Corp. — didn’t make anyone available for comment.

It seems clear, however, that managed-payout funds haven’t lived up to investor expectations, critics said.

For example, though Vanguard’s managed-payout funds aim to make monthly distributions, they also aim to preserve capital. At one point last year, however, at least 90% of distributions were coming out of fund capital.

As a result, monthly distributions were adjusted downward 15% to 20% at the end of last year.

On the other hand, Fidelity’s managed-payout funds — like Pimco’s — use principal to make payouts. In fact, the funds liquidate when they reach a set date.

The catch is that the dollar value of those payouts hinges on the assets held in the fund — assets that fell as a result of market declines.

As a result, Fidelity at the beginning of the year had to adjust distribution payments on some funds downward by more than 18%.

Year-to-date through last Wednesday, all 23 managed-payout funds identified by Morningstar Inc. were in positive territory, led by the Baron Retirement Income Fund — up 29.51%. The Fidelity Income Replacement 2042 Fund (FIXRX) was up 24.58% and the Fidelity Income Replacement 2040 Fund (FIRWX) had gained 24.16%.

Financial advisers, however, are skeptical that managed-payout funds have turned a corner.

“I haven’t seen evidence that these things are that impressive,” said Daniel Wiener, chairman and chief executive of Adviser Investment Management Inc., which manages more than $1 billion in assets.

The issue is that the managed-payout funds make promises in terms of yield, he said.

“To do that in a low-interest-rate environment, you know what happens? You eat into capital,” Mr. Wiener said.

“Essentially, the funds are just returning the investor’s money,” he said.

STEP FORWARD

Vanguard’s tinkering may improve the performance of its -managed-payout funds, but any improvement is likely to be “incremental,” said Mr. Wiener, who is also the editor of The Independent Adviser for Vanguard Investors.

The Pimco funds, however, may be a step forward, he said.

Pimco has certainly caught the attention of Eric Jacobson, a fixed-income specialist with Morningstar.

The concept of using TIPS to generate inflation-adjusted distributions makes sense, he said.

In fact, Mr. Jacobson wouldn’t be surprised if other fund companies tried to emulate Pimco’s strategy by working around the potential patent.

“Chances are if someone wants to compete with them, they will,” he said.

E-mail David Hoffman at [email protected].