It is the most widely held bond fund in the world and likely shows up in your 401(k) plan, your brokerage account, or in the endowment of the investment committee you advise. At its peak, the fund held nearly $300 billion in assets and with separate account vehicles, the total strategy assets were reportedly over $500 billion. On Friday, September 26th, PIMCO’s founder and Co-Chief Investment Officer Bill Gross resigned. He was the lead portfolio manager on the PIMCO Total Return fund since its inception in 1987 and often nicknamed the “Bond King”.
Due to his departure, $23.2 billion of net assets left the fund in September. While the media loves the gossipy details of the story inside PIMCO, the consultants and advisors that recommended the fund are scrambling to save face. How could steady underperformance and an embarrassing discontent within the organization go unnoticed by the very people compensated to know these things?
According to the Financial Times, the Texas Municipal Retirement System placed PIMCO on its “watch list”, as the firm managed $2 billion in bonds. One of the largest investment consulting firms, Mercer, downgraded the fund to “B” on its A, B, C ranking. Morningstar put all funds managed by PIMCO under review and moved PIMCO Total Return from a gold rating to bronze (skipping silver).
What are you going to do?
The first question to ask is out of all of the intermediate core fixed income funds available, “Why do I own this fund in the first place?” There was clearly turmoil over the last year with the co-Chief Investment Officer and former manager to the Harvard Endowment, Mohamed El-Erian leaving rather abruptly. There were strange stories from inside the PIMCO halls and an odd presentation at the industry’s biggest conference hosted by Morningstar a few months ago. Little gets mentioned about Paul McCulley, one of the top lieutenants at PIMCO until he left in 2010 and was a strong voice on the investment committee (only to return a bit too late in 2014).
The most glaring though was recent performance. Did Bill Gross leave before the assets actually did? The all-important (to most researchers) 3 and 5-year trailing return numbers were set to be below par for awhile due to performance below the peer median for three of the last four calendar years. In both 2011 and 2013, the interest rate bet on the portfolio was positioned incorrectly relative to the market and peers.
The fund’s strong past track record (pre-2011) and that it is the biggest bond fund were major determinants of its consideration as an investment menu option. Everyone knows past performance is not a guarantee of future results, and chasing performance is a road to ruins, but even ‘professional investors’ do it – as written about in our note a few weeks ago, Picking Fund Winners without Using Returns. Of course, the investment consultants or advisors will not tell you so. There was plenty of due diligence done, perhaps at the offices in Newport Beach, and hard hitting questions asked of the portfolio managers. The structural sources of outperformance were pointed out in a white paper from early September, but the validity of the factors should be questioned on a go forward basis considering the underperformance since 2011.
Portfolio managers change, it is part of the business. If your consultant or advisor does not have a bench of options in place for such a contingency, I would seriously question their current due diligence process. If a consultant or advisor reacted to the Bill Gross news by simply pushing the sell button, I would be very uncomfortable with the investment decision making process of that firm or individual.
I apologize for the saber-rattling tone, but the lack of thoughtful research in the industry by my peers gives us all a bad name, although it does make it easier to stick out among the crowd.
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