FMD Capital Management

Don’t Count PIMCO Out Quite Yet

Written by David Fabian, January 09th, 2014

As the biggest bond fund manager in the world, Bill Gross and PIMCO garner a great deal of headlines in a year like 2013 where rising interest rates capped traditional fixed-income gains.  When you hear that his flagship mutual fund, the PIMCO Total Return Fund (PTTDX) lost more than $40 billion in asset outflows last year, it’s easy to jump to conclusions that the ship may have lost its rudder.  However, I would not be so swift to discount the management or resilience of this company given its long track record of success.

The Total Return fund has not posted an annual loss since 1999, which makes 2013 an outlier year for fixed-income returns.  According to Morningstar, the 2013 price return of the PIMCO Total Return ETF (BOND) was -1.26% in 2013 which beat the benchmark iShares Barclays Aggregate Bond ETF (AGG) loss of -1.98%.  While no one likes a year of negative performance, it is worth noting that Total Return did beat its underlying benchmark which is the objective of the fund.

Volatility in fixed-income is a relatively new concept that investors are coming to grips with given the recent changes in interest rates and Federal Reserve policy measures.  Intermediate-term bond holders are embracing the notion that they have to reduce their duration risk and forego additional yield in favor of safety.  This trend is one of the reasons that ETFs such as the PIMCO 0-5 Year High Yield Corporate Bond ETF (HYS) and the PIMCO Enhanced Short Maturity ETF (MINT) experienced combined net inflows of over $4 billion last year.

Despite the looming threat of higher interest rates, I am still continuing to look for opportunities in fixed-income that are designed to maximize income while focusing on risk management.  An actively managed mutual fund that is one of my favorite core holdings is the PIMCO Income Fund (PONDX) which is managed by Dan Ivascyn.

PONDX takes a multi-sector approach to specific areas of the bond market that the manager feels will outperform over time.  They have done a fantastic job of managing interest rate risk in 2013 and taking advantage of opportunities (both inside and outside the U.S.) when they are available.  This has led to 2013 returns of better than 4.5%, an effective duration of less than 5 years, and a current 30-day SEC yield of nearly 4%.

While the strength of stocks and concomitant rise in interest rates was the story for 2013, I would not be so quick to discount a potential return of strength in bonds this year.  If we see a return of volatility in equity prices, there will more than likely be a flight to quality in fixed-income that will reinforces a deflationary trade.  That is why I am recommending that you continue to hold strategic core bond positions to diversify your income portfolio.

The key to success moving forward is to select funds and/or managers that are adding value through their security selection and investment outlook.  My comparison of the returns of Bill Gross vs. Dan Ivascyn is one example of a changing of the guard at PIMCO that may continue to develop momentum over time.  It should be an opportunity for the “Bond King” to pass his crown to a new generation of portfolio managers that are hitting their stride and offering innovative strategies to their clients.

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