Bill Gross' tarnished crown

The Bond King seeks to rebuild Pimco's flagship fund and his reputation

Jun 15, 2014 @ 12:01 am

By Trevor Hunnicutt

As a fixed-income portfolio manager, Matthew DeLorenzo is sympathetic to the plight of William H. Gross, the storied but embattled bond guru who manages the Pimco Total Return Fund.

That $228.9 billion fund — the world's largest bond fund and the second largest of any kind — has been suffering from serious outflows, often running into the billions of dollars each month, for more than a year, after delivering subpar results. Last year, the fund underperformed most of its competitors, and its institutional share class had a total return of -1.92%, its worst performance since 1994.

In the face of such performance, Mr. DeLorenzo, fixed-income strategist for fee-based financial advisory firm United Asset Strategies Inc., says advisers and investors can be rash.

“The market can be unfair,” he said. “People become overly optimistic or pessimistic and fund flows can definitely hurt the fund manager.”

It's tough, after all, to manage a bond portfolio in a world of bond yields depressed by tens of billions in purchases by the Federal Reserve each month, many advisers say.

“A lot of clients are looking for a certain amount of yield and it's tough to achieve that yield without taking inappropriate risk,” Mr. DeLorenzo said. “It's different for us [than for a mutual fund manager] because we can have a conversation with the client and make sure their expectations are appropriate.”

Nonetheless — fair or not — Mr. DeLorenzo's firm, which manages $700 million, two months ago joined the exodus of retail and institutional Pimco clients making the strategic decision to switch clients with allocations to the Total Return Fund (PTTAX) to a competing product, the Loomis Sayles Core Plus Bond (NEFRX). He moved about $3 million to the new fund.

“With departures like Mohamed El-Erian and potentially continued outflows, we just think it might be tough for them to manage through,” said Mr. DeLorenzo, referring to Pimco's former chief executive and co-chief investment officer, who resigned in January. “Loomis doesn't really have a drastically different strategy, but I just felt it would be better to be in a different fund at this point.”


Mr. El-Erian's departure caused a stir in the financial community. Initially, many advisers weren't making any rash decisions to move out of the funds but were following performance more closely.

In March, research firm Morningstar Inc. lowered its stewardship grade to a C from a B. The highest grade is an A and the worst is an F. One of the categories used for Morningstar's analyst ratings that looks at the priorities of the firm was also downgraded to neutral from positive. Analyst ratings are qualitative, and different from the firm's five-star rating system, which is based on risk-adjusted returns.

By then, some advisers had begun to reconsider their clients' positions in Pimco funds.

“I have invested in Pimco, yes, but it has all been wound down, or it's in the process of winding down,” Paul Schatz, president of Heritage Capital, said at the time.

Mr. Gross is facing one of the greatest challenges of a long and illustrious career in which he has managed not just billions in government and private-company liabilities around the world but also the expectations of thousands of investors and financial advisers who have relied on — and now have come to question — his prowess.

Pimco, the company Mr. Gross co-founded in 1971 where he now serves as chief investment officer, sells dozens of funds and other managed investment products — with some of the world's most respected investment professionals managing, altogether, nearly $2 trillion. But it's the firm's flagship product, the Total Return Fund, that has drawn the most scrutiny.

The fund has suffered nearly $60 billion in outflows in the 13 months ended May 31, according to Morningstar. And even as money has started to move back into bond funds thought doomed by the possibility of rising interest rates, investors have avoided Pimco's Total Return and some of its other funds, choosing funds like the Vanguard Total Bond Market II Index Fund (VTBIX) and the Fidelity Advisor Total Bond Fund (FEPAX). In recent months, the DoubleLine Total Return Bond Fund (DLTNX), managed in part by famed manager Jeffrey Gundlach, has also seen inflows, to the tune of $1 billion.

In May, the Pimco Total Return suffered $4.3 billion in net outflows.


More than any fund, it's Pimco Total Return, which Mr. Gross has managed since 1987, that has defined the bond fund universe. It has beaten a benchmark bond index, the Barclays U.S. Aggregate Bond Index, and the vast majority of its competitors over the past 15 years, winning Mr. Gross a bevy of awards and the moniker Bond King.

But some missteps, including betting against U.S. Treasuries in 2011 when the securities benefitted from concerns about the debt crises in Europe and the U.S., have registered with investors.

Last year, Mr. Gross bet that inflation would increase, and purchased Treasury inflation-protected securities to soften the blow. When the increase in consumer prices failed to materialize, the securities suffered, according to Eric Jacobson, an analyst who covers the fund for Morningstar.

The fund company also has seen leadership changes, led by the unexpected announcement in January that Mr. El-Erian would leave the company. Mr. El-Erian, a well-recognized public face of the company and Mr. Gross' heir-apparent, reportedly had clashed with Mr. Gross, who is often described as mercurial.

Mark Porterfield, a spokesman for Pimco, did not respond to a request for comment.

Mr. Gross now is saying the fund has turned a corner, and early evidence suggests that might be true. In May, the fund's institutional share class returned 1.25%, beating its benchmark and ranking in the 23rd percentile among funds in its category, according to Morningstar.

“The last few months have experienced, I think, one of the most significant performance turnarounds in Pimco's history,” he said in a Bloomberg Radio interview on June 6. “And as retail [investors] and institutions get wind of this — and they will at some point, I suppose, see our 12-month numbers in addition to our one-to-two-month numbers over the next few weeks — there's going to be fear on our competitor's faces again. I mean, the game is on, and Pimco's back.”

Mr. Gross said the fund has benefited from, among other things, stocking up on intermediate-duration Spanish and Italian debt. Yields on those countries' bonds, maturing in 10 years, have fallen this year by more than 30% apiece.

That compares with yields on U.S. 10-year Treasuries, an economic benchmark that's also considered a safe-haven asset, which have fallen just under 15% to yield 2.6% over the same period. When bond yields fall, their prices rise. (Treasuries also remain a major component of Pimco Total Return, comprising about 50% of Total Return's portfolio as of the end of May, according to the firm. That figure includes Treasuries, related derivatives, TIPS, government agencies, interest-rate swaps and government-guaranteed corporate securities.)

It remains to be seen how long Mr. Gross' winning streak will last and how forgiving advisers will be.

What is clear is that the market environment for bond managers like Mr. Gross is not getting more forgiving.

Chad Carlson's firm, Balasa Dinverno Foltz, cut back its client allocations to Pimco Total Return last August as he decided to take a wait-and-see approach. But he's decided to stick with the fund for now.

“I think the market in general has been a little rough on Bill,” said Mr. Carlson, who is the advisory firm's director of research. “He's a great investor. I wouldn't always say he's a great manager, but to tie the two together so closely and say if he's bad at managing he'll be bad at investing going forward is tough.”

Mr. Gross forecasted “a 4-to-5% year” for investors in the fund this year, saying it would be performing close to the top of the list shortly. He's basing the fund's investments on an updated master theory, called the New Neutral, a controversial framework that assumes bond returns will be low but also exhibit less downside risk and volatility as the world's slow-and-steady growth keeps inflation tame.

“Don't give up on actively managed bonds, which can utilize lower asset price volatility to exceed New Neutral yielding indices,” a recent paper from Pimco stated.

“In terms of rates moving, there's more risk of rates going up than rates going down,” said Keith Amburgey, chief executive of advisory firm Rutherford Asset Planning. “Even though he's probably right, there's a good chance he's wrong.”

Mr. Amburgey has lowered his clients' exposure to the Pimco Total Return Fund by about $600,000 over the last quarter. He said bonds would be tough for anyone in a bond market in which people are taking increasing credit risk to enhance yield, but the leadership turnover and performance stumbles particular to Pimco have made him less confident in the firm.

He said Mr. Gross' strong May is not enough. He wants to see a track record of strong performance for “at least a year” before he re-examines his views.

Minda Smiley contributed to this article.


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