Gross Loses to Goldman in Hot New Bond Strategy as Pimco Trails

Apr 14, 2014 12:24 am ET

April 14 (Bloomberg) -- Bill Gross just can’t catch a break. As investors flock to funds designed to make money even if interest rates increase, Gross’s Pacific Investment Management Co. is alone among the biggest bond managers in suffering withdrawals from the strategy.

In a category that’s been the most popular choice for fixed-income investors this year, the Pimco Unconstrained Bond Fund, has lost $2.7 billion to redemptions. Similar offerings from Goldman Sachs Group Inc., JPMorgan Chase & Co. and BlackRock Inc. have seen a surge of deposits from investors seeking to avoid potential bond-market losses. The Pimco fund has trailed a majority of peers over the past three and five years, and has lagged behind most rivals over the past year.

“Pimco has kind of shot themselves in the foot here,” said Steve Roge, a money manager with Bohemia, New York-based R.W. Roge & Co., where he helps oversee $225 million. “In a new category where there are other choices, why is someone going to look at a fund that has been a bottom performer?,” said Roge, who owns several Pimco funds but has no money in Pimco Unconstrained.

The redemptions from the fund are particularly painful for Pimco because bond managers are counting on the flexible strategy to attract money as investors flee traditional funds in anticipation of the end of a bull market in bonds. Gross’s Pimco Total Return Fund suffered record redemptions last year after the 70-year-old manager misjudged the impact of the Federal Reserve’s move to scale back its bond-buying program -- a mistake echoed by the Unconstrained fund.

Top Sales

Non-traditional funds attracted $12.6 billion in the first three months of 2014, with offerings from Goldman Sachs, JPMorgan and BlackRock collecting a combined $10.7 billion through March, according to data from Chicago-based Morningstar Inc.

Last year, $24.3 billion Pimco Unconstrained Bond Fund was Pimco’s best-selling mutual fund as investors added $8.7 billion. Industrywide, unconstrained or flexible funds as a group collected $55 billion last year. Intermediate funds, the biggest category of bond funds, which includes Pimco Total Return, saw withdrawals of $79 billion, Morningstar data show.

The redemptions over the past year mark a new phase for Pimco, which has more than doubled assets since 2008 as investors fled to the perceived safety of bonds following the financial crisis. As that rally has come to an end, Gross and the Newport Beach, California-based company he co-founded in 1971 have faced their share of challenges this year.

El-Erian Departure

In January, Gross’s heir apparent, Mohamed El-Erian, unexpectedly announced his resignation as chief executive officer and co-chief investment officer. His departure was followed by reports of tension between the two. Gross lashed out at El-Erian in a June meeting as performance stumbled and withdrawals continued, two people familiar with the matter said this year.

Pimco Total Return suffered record redemptions of $41.1 billion last year and lost its title as the world’s biggest mutual fund. Clients pulled an estimated net $3.1 billion from the fund and $7.3 billion from all of Pimco’s U.S. mutual funds in March, according to Morningstar. Pimco’s assets under management declined to $1.94 trillion as of March. 31, from a peak of $2.04 trillion last March.

Pimco Unconstrained’s former manager, Chris Dialynas, said in December that he was going to take a sabbatical. Gross took over the management of the fund, highlighting the importance of the strategy to the firm. Dialynas, who joined Pimco in 1980, had run the fund since it was created in June 2008.

Gross Overhauls

When Gross took over management, he made changes including extending the effective duration, or sensitivity to interest rates, as well as jettisoning 30-year Treasuries and most of the agency mortgage bonds. The duration of the fund more than doubled to 4.1 years in December before falling back to 2.1 years as of March 31, Pimco’s website shows.

Orange County Employees Retirement System voted Jan. 29 to put the Unconstrained strategy on a watch list for change in key personnel after investment consultant NEPC LLC said it had “elevated” concerns following the management change.

Flexible funds can buy anything in the fixed-income realm, from emerging market debt to credit default swaps, and they also have the ability to bet against rates, which means they make money if rates climb.

‘Wide Net’

“We can cast a wide net, long or short,” said William Eigen, manager of the $26.3 billion JPMorgan Strategic Income Opportunities Fund, which passed Pimco Unconstrained in March to become the biggest of what are considered non-traditional bond funds.

While the Unconstrained Bond fund has the flexibility to navigate across the fixed-income spectrum, it wasn’t able to avoid losses last year because, along with other Pimco funds, it is guided by the firm’s world view on everything from the global economy to interest rates. Gross, in a December interview posted on Pimco’s website, said a model portfolio established by the firm’s investment committee is the driving force behind the positioning of its funds.

The Unconstrained Bond fund was hurt last year by holding intermediate and long-dated bonds when former Fed Chairman Ben S. Bernanke in May hinted that the central bank might scale back its bond-buying program. The subsequent increase in interest rates caused those bonds to lose value. The fund also suffered losses in its holdings of emerging-market debt, according to a December regulatory filing.

Trailing Peers

Pimco Unconstrained fell 2.6 percent last year, lagging behind 84 percent of peers, Morningstar data show. The fund’s assets have declined 16 percent since July 31, according to data compiled by Bloomberg.

Pimco Unconstrained has had “unexciting,” results, Eric Jacobson, an analyst for Morningstar, wrote in an email.

“It’s also possible that the recent drama at Pimco is having some effect,” said Jacobson, referring to the departure of El-Erian.

Sabrina Callin, the product manager for Pimco’s Unconstrained Bond strategy, which has $46 billion in assets, said it is not a surprise that some rival funds have done better.

Shunning Credit

“Many of the funds in this universe are very credit- oriented, especially high-yield credit,” said Callin in a telephone interview. “People who have had that risk exposure have done well.” Credit generally refers to corporate debt, which is sensitive to the ups and downs of the economy.

Pimco Unconstrained has never been focused on corporate credit or other risk assets, she said. It is designed instead to preserve capital and limit losses in falling markets.

U.S. high-yield bonds returned 7.4 percent in 2013, according to a Bank of America Merrill Lynch index. The Pimco fund had 2 percent of its money in junk bonds as of Dec. 31 and had a bet against the bonds as of Sept. 30, according to data on Pimco’s website.

JPMorgan’s Eigen said his fund had more than 40 percent of its money in high-yield bonds at the beginning of 2013. He cut that allocation to 25 percent as of Feb. 28, according to the fund’s website, as the bonds rallied. JPMorgan Strategic Income Opportunities Fund climbed 2.8 percent in 2013, ahead of 74 percent of rivals, according to Morningstar data.

Goldman Beats

The $20.7 billion Goldman Sachs Strategic Income Fund, which gained 6.1 percent last year to beat 97 percent of peers, was generally bullish on corporate bonds in 2013 on the assumption the debt would do well in an improving economy, Jonathan Beinner, manager of the fund said in a telephone interview. The fund had 5.1 percent of its money in high-yield bonds as of Dec. 31, data from Goldman’s website show.

The $14.8 billion BlackRock Strategic Income Opportunities Portfolio, which rose 3 percent last year, had a 21 percent allocation to bonds rated BB or lower, below investment grade, as of Dec. 31, a blend of high-yield bonds, bank loans and emerging-market debt, the firm said.

The Pimco fund has also had a different take than rivals on the maturities of bonds it prefers. Last year, the fund held intermediate and long-term bonds. This year, according to Pimco’s website, the fund has invested at the front-end of the yield curve, usually defined as bonds with maturities of 1-5 years, and has bet against longer-dated bonds.

In 2014, the fund has advanced 1.3 percent, with the second-best returns of the four biggest flexible funds, trailing only the BlackRock fund. In March, shorter-term bonds fell as the Federal Reserve suggested it could begin raising interest rates in 2015. The bonds have rallied in April.

Rieder’s Approach

Rick Rieder, manager of BlackRock Strategic Income, took the exact opposite approach to Pimco’s. He avoided longer-term debt in 2013, which helped his performance, he said in a telephone interview. He bought those bonds this year, another plus, and bet against bonds with between 3 years and 7 years of maturity.

“There are not a lot of cheap assets out there so you have to be nimble,” said Rieder.

The Goldman and JPMorgan funds are both wagering that rates in general will climb this year.

“We are believers in an economic rebound, and you have to think rates will normalize as is the economy does,” said Eigen. Goldman expects rates to rise in the U.S., and the United Kingdom, said Beinner.

Low Inflation

Gross has argued the Fed will be in no rush to raise rates because inflation remains well below the central bank’s target of 2 percent.

At Pimco, Callin said the goal of the Unconstrained Bond fund is to produce good risk-adjusted results over the long haul. In the past three years, the fund’s risk-adjusted results were the lowest among the four funds, according to the Bloomberg Riskless Return Ranking. The BlackRock fund ranked first, followed by the Goldman fund.

“Pimco may not get every call right every day or every year,” said Callin. “But we have a good long-term record of getting things right for investors.”