Pimco Total Return lags peers for second-straight year

Ex-boss Gross' forecast of reaching the top doesn't pan out; fund poised to benefit in '15 from rising rates

Jan 2, 2015 @ 10:35 am

By Bloomberg News

Pacific Investment Management Co.'s biggest mutual fund trailed a majority of peers for the second straight year after missing a rally in longer-term bonds and betting incorrectly that inflation would rise.

The $162.8 billion Pimco Total Return Fund, managed by Chief Investment Officers Scott Mather, Mark Kiesel and Mihir Worah after the surprise departure of Bill Gross on Sept. 26, returned 4.7% in 2014, trailing 53% of comparable funds, according to data compiled by Bloomberg. In 2013, it lost 1.9%, lagging behind 65% of peers.

In May, amid the fund's longest streak of redemptions, Mr. Gross vowed in a Bloomberg Television interview that Pimco's performance will be at the top by the end of 2014. That didn't happen as Pimco, guided by an economic view called the “new neutral,” predicted that shorter-term bonds will do better than longer-dated debt out of a belief that investors are overestimating how much the Federal Reserve will increase the benchmark rate. The managers were also stymied by sinking expectations for inflation amid a slump in oil prices. The new managers have said they're sticking with their holdings.

“Although the long end of the yield curve has rallied in recent months, we believe our underweight is justified from a secular viewpoint,” Messrs. Mather, Kiesel and Worah wrote in a Nov. 30 commentary posted on the firm's website. “We will continue to hold intermediate TIPS, as we believe policymakers will ultimately be successful in raising inflation expectations.”

Agnes Crane, a spokeswoman for the Newport Beach, Calif.-based firm, declined to comment.


Pimco Total Return Fund (PTTRX) suffered its biggest decline in almost two decades in 2013, hurt by similar positions in shorter-term debt and inflation-linked bonds. Under Pimco's “new neutral” thesis, the firm's outlook for the next three to five years set in May, global growth is converging toward lower, more stable speeds and interest rates will be stuck below pre-crisis levels.

The fund had 81% of its money in bonds with maturities of 10 years and less as of Nov. 30, according to the firm's website, with the biggest concentration, 32%, in bonds with maturities of five to 10 years.

The fund had 6% in maturities of greater than 20 years. As of the end of the third quarter, the average fund in the same category as Pimco Total Return had more than one-third of assets in bonds with maturities of 20 years or more, according to data from Chicago-based research firm Morningstar Inc.

Treasuries maturing in five years returned 2.8% in 2014 through Dec. 30, compared with gains of about 11% for 10-year notes and 29% for 30-year bonds, Bank of America Merrill Lynch Index data show.

The fund has maintained lower interest-rate risk than its peers. As yields on 10-year U.S. government bonds declined about 85 basis points in 2014, “by having less interest rate exposure, they didn't benefit as much,” Todd Rosenbluth, director of mutual-fund research for S&P Capital IQ in New York, said. “More exposure to Treasuries would have helped, given how well Treasuries have done.”

Performance also suffered from an allocation to TIPS, or Treasury Inflation Protected Securities. TIPS returned 4.2% in 2014 through Dec. 30, compared with 5.9% for the broader Treasury market, according to Bank of America Merrill Lynch index data.

Bond traders have lowered their inflation expectations as oil prices tumbled and the dollar climbed, making it cheaper for U.S. consumers to purchase goods from abroad. A measure of the outlook for annual inflation over the 10-year period derived from yields on TIPS, known as the break-even rate, fell to 1.68 percentage points from 2.31 percentage points in January.


Mr. Gross still likes TIPS, telling CNBC last month that the securities “look great” as the Federal Reserve seeks 2% inflation. “You can buy a 10-year TIP with inflation expectations of 1.5%.”

Facing record redemptions, Pimco has sold the fund's most liquid, easily tradable securities. Total Return reduced the amount held in a money-market account, and cut holdings of securities issued by government-sponsored enterprises such as Fannie Mae and Freddie Mac by 22% to $31 billion at the end of September from June 30, according to a report posted on the fund's website.

The trading left the fund with a slightly higher percentage of holdings in less liquid assets, such as corporate bonds, bank loans and asset-backed debt.

Pimco Total Return, the world's biggest mutual fund until October 2013, had more than doubled from $132 billion at the end of 2008, after weathering the financial crisis with returns that beat 82% of rivals.

The fund ballooned to $293 billion in April 2013, before the Fed hinted it would unwind stimulus measures, sparking redemptions and unsteady performance. In 2013, clients pulled a record $41.1 billion, according to estimates from Morningstar.

After Mr. Gross' departure, they yanked a record $60.5 billion in September, October and November, according to Pimco.

The firm can weather withdrawals from institutional and retail clients of as much as $350 billion without hurting performance, according to Morningstar.

Mr. Gross, who co-founded Pimco in 1971 and built it into a $1.87 trillion money manager, left after deputies including now-group Chief Investment Officer Daniel Ivascyn said they would quit and management debated his ouster, according to people familiar with the matter. He abruptly resigned to run an unconstrained fund at money manager Janus Capital Group Inc.


The Janus Global Unconstrained Bond Fund (JUCIX) had grown from $13 million before Mr. Gross took over to $1.2 billion through Nov. 28, according to data compiled by Bloomberg. It's outperformed 59% of peers in the past three months, according to data from Morningstar.

Morningstar analyst Eric Jacobson cut Total Return's rating to bronze from gold after Mr. Gross's exit, citing uncertainty regarding potential client withdrawals and the reshuffling of management responsibilities. Some investors have put Pimco on watch lists before they make a decision about their allocations.

Pimco Total Return's new chiefs sought to reassure clients in the days and weeks following Mr. Gross' exit, saying on Sept. 27 that there will be no major changes in investment strategy, it's “business as usual,” and the new managers have “all been part of the team as members of the investment committee,” according to Mr. Mather.

The next month, they reiterated that the fund was highly liquid because it's invested in easy-to-trade segments of the bond market and uses derivatives such as futures and swaps.

The fund's managers have positioned the fund in anticipation of rising interest rates in 2015, S&P's Mr. Rosenbluth said.

“If that doesn't play out, if we see yields stay relatively low, then we may not see performance improve in 2015.”


After Pimco's tumultuous year in 2014, what do you think of the firm today?

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