PIMCO’s Total Return Fund
October 25, 2011
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When a manager’s performance slips, the inevitable question is why. Was this a simple misjudgment on the direction of the markets or an incorrect selection of securities in the portfolio? On the other hand, is the slip indicative of a more serious process failure? When the manager in question is Bill Gross, acknowledged “bond king” of the Western World, a man who manages more than $240B of individual and investor assets, the answers to these questions become crucial to money managers and investors across the country.
PIMCO Total Return is the largest mutual fund in history. Along with its clones, Harbor Bond and offerings from ING, John Hancock, Managers, MassMutual, and Principal, investments managed by Gross make up the backbone of the fixed income allocations of an enormous number of institutional and individual investor portfolios. Co-CIO with Mohamed El-Erian of PIMCO, which has $1.2 trillion of assets under management, Gross is deservedly regarded as one of the most capable and brightest people in the bond business.
But, year-to-date, the company’s flagship Total Return fund lags its BarCap US Aggregate Bond benchmark by some 5%, after a disastrous third quarter in which Gross was completely mis-positioned as US Treasury prices took off. Five percent underperformance is an enormous deficit by fixed income standards.
Total Return’s substantial under-performance in 2011 has been the direct consequence of allocation decisions, from shunning Treasuries and reducing duration to nearly zero to overweighting Emerging Market debt. Gross acknowledged as much on a recent call, and to his credit, took full responsibility for this misjudgment. Morningstar data back to 1991 show that never before had the fund stumbled so badly. Its worst prior underperformance relative to its benchmark was in 2002, an event perhaps unnoticed by most investors as Total Return earned a respectable 10%, but its benchmark returned 13%.
I do not fault a high-conviction manager such as Gross for occasionally zigging when the market zags. Sporadic under-performance is the price one pays for investing with managers who are aggressively seeking “alpha.” That said, there is something truly disconcerting about the current situation, and it should raise substantial questions for investors in the fund.
Total Return is a core fixed income fund. As such, its role in portfolios is often to track, and yes hopefully to outperform, the bond market benchmark. Gross has managed to do just that for the better part of 25 years. Active managers are expected to make benchmark deviations; that is, after all, what active management is paid to do. But this particular allocation deviation was far from business as usual; it was an “all in” bet that, among other choices, reduced a 34% benchmark weighting to Treasuries to zero.
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