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PIMCO Total Return: 1 Bill Gross-Less Year Later

Summary The PIMCO Total Return Fund assets under management have shrunk from $293B in early 2013 to less than $100B today. The new managers of the fund were part of the investment committee working with Bill Gross during his tenure so management style should remain consistent. The fund, at least in the year-to-date period without Gross managing, has outperformed its benchmark and Morningstar category. The managers are currently retaining a cautious approach to the portfolio in anticipation of future rate hikes. In the relatively mundane world of mutual fund investing there was perhaps no news bigger than last year’s surprising announcement that Bill Gross was leaving PIMCO – the company he founded – to jump over to Janus. The move resulted in a mass exodus from Gross’ Total Return Fund (MUTF: PTTRX ). Once the largest mutual fund in the world back in 2013 with $293B in assets now has less than $100B. Many investors felt that Gross was the key that drove the engine and fled for greener pastures when he departed (although his current fund – the Janus Global Unconstrained Bond Fund (MUTF: JUCDX ) – has just $1.5B in assets). For investors that have stuck around it’s worth wondering if the “new” PIMCO Total Return fund is the same now as it was when Gross was in charge. Gross himself has said in the past that investors maintain at least a five year outlook when formulating their portfolios. However, Gross has been known to quickly change directions. This is perhaps most notable in his 2011 call on interest rates. Gross thought that interest rates would rise once QE was done and took his portfolio’s allocation in Treasury bonds all the way down to zero. Of course, interest rates went down, the fund badly underperformed its benchmarks and the flow of money out of the fund began. The new fund managers for their part have pledged largely to maintain the groupthink investment style that was part of the decision making process even when Gross was involved. Style-wise, the fund still falls into Morningstar’s intermediate term bond category where it’s been for the last many years. There are a couple of important things to note in the figure above. First, performance on a one year basis can’t really be used as a long term predictor of success but at least the new managers are off to a reasonable start. Year-to-date, the fund is beating its benchmark index by 27 basis points and the broader intermediate term bond fund category by 64 basis points. That puts Total Return in the top 15% of funds – a notable departure from recent performance that saw the fund fall into the bottom half three of the last four years. Second, turnover and trading frequency remain at comparable levels to the end of Gross’ tenure. The fund is running at a turnover rate of about 265% which is fairly comparable to the past two years’ rate of 227%. Going forward, the fund’s managers are limiting duration in the United States anticipating coming rate hikes maintaining roughly ⅔ of the portfolio in government and mortgage-backed securities. Smaller allocations to corporates, high yields and even some emerging markets adds return potential and yield to the portfolio. Consistent with its more defensive outlook, the current portfolio duration is around 4 years – much lower than the benchmark’s 5.6. Conclusion It’s understandable that investors would begin looking elsewhere following Gross’ departure. But shareholders who have stuck around have done just fine in the meantime. I think we’ve seen in the first year post-Gross that the fund is managed in a substantially similar way. The consistency of the portfolio management team that worked behind Gross is still largely intact. Gross’ decades of expertise may no longer be around but Total Return is still in able and, at least thus far, in solidly performing hands. Despite the wave of outflows that is still occurring yet today there’s no reason why the current PIMCO Total Return fund shouldn’t at least be considered for the income part of a portfolio. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Time To Exit Junk Bond Funds?

Summary Junk bond funds have outperformed other bond classes and maturities over the last five years but will the good times end once interest rates begin to rise? An improving economy as we’ve seen with stronger job and wage growth could improve the ability of companies to repay their debt. Rising interest rates could ultimately make junk bond yields look less attractive. The struggling energy sector has been particularly rough on the junk bond group. As the Fed seems poised to raise interest rates at some point during the remainder of 2015 high yield bond funds and ETFs have enjoyed a solid run over the last several years when compared to other Treasury and corporate bond funds. Over the past five years, junk bonds funds like the iShares iBoxx High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) have outperformed their investment grade counterparts across all durations. Junk bond funds have been increasingly popular among yield seekers looking to do better than the measly yields offered by Treasuries and CDs. But as the economic landscape begins to shift it’s worth asking the question if junk bond funds have seen their best days. The free money period looks like it’s going to be slowly coming to a close and so to may the comparatively solid returns offered by high yield notes. There’s evidence pointing in both directions so it’s worth examining the major ideas one by one. Junk bonds could correlate more closely to a stronger stock market and economy The argument that high yields trade more like stocks than bonds could be viewed as a positive sign for their outlook. The stock market has had quite a run over the last three years and while valuations are almost certainly stretched there’s not much evidence to suggest that a huge correction is imminent. That’s not to say that the straight line up should be expected to continue but the environment could be conducive to high yields continuing to outperform other bond funds. The economy could be in a similar spot. While GDP has been weak overall job growth and wage growth have been improving. Additionally, the JOLTS report that was issued last week showed that the number of open jobs advertised at the end of April – 5.4 million – was the highest number in the 15 year history of the survey. The government also indicated 280,000 jobs created in May. Even the unemployment rate which ticked up slightly could be an indication that job seekers could be reentering the marketplace. A stronger economy could indicate an improved ability for companies to pay off their debt making junk bonds attractive. The Fed seems to think that the economy is improving enough to warrant higher interest rates and economic growth could lead to a positive environment for junk bond performance. Higher interest rates could make junk yields less attractive Junk bond funds and ETFs are offering current yields in the 5-6% range. Those yields looked especially attractive when the 10 year treasury note was yielding just 1-2%. The 10 year note is now yielding 2.4% and could soon be heading towards 3% again. An increasingly narrowing yield gap could make the risk/return tradeoff of junk bond funds less attractive. Net outflows in junk bond funds have been increasing in the last several weeks as bonds in general have been selling off – an indication that investors could be viewing fixed income investments as less attractive in the face of rising rates. Junk bond default rates are rising The default rate in junk bonds climbed to its highest level in almost 6 years last month but we have the flailing energy sector to thank for that. Energy and mining accounted for 93% of all defaults in the 2nd quarter. Roughly 15% of the high yield universe comes from the energy sector so weakness in this area of the economy is having a significant effect on the overall group. Conversely, it means that the rest of the high yield universe is performing well. If you can stay away from energy the risk exposure to junk bonds could be much more limited. Conclusion We’ve been in a prolonged period where taking risk has been rewarded but the imminent rising rate environment could be the catalyst that reverses that trend. A stronger economy should help junk bonds but I believe overall that riskier investments will begin falling out of favor as investors seek safer alternatives like treasuries, defensive and health care stocks. High yields exposure to energy could further limit upside. While energy prices look to have stabilized $60 oil is squeezing the margins of many companies and many rigs are still sitting idle. Junk bond funds may have helped boost income seeking investors’ returns over the past couple of years but now might be the right time to take some of those chips off the table. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.