Pimco Leads Funds Protecting Against Inflation: Riskless Return

Apr 23, 2014 8:02 am ET

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April 23 (Bloomberg) -- Mihir Worah decided it was time to bet on rising consumer prices in November after Treasury Inflation-Protected Securities were on track for their worst year on record.

“The selloff had gone too far and the market was pricing in a rate of inflation that was just too low,” said Worah, 47, who was named one of six deputy chief investment officers at Pacific Investment Management Co. in January.

Now TIPS are rebounding and Worah’s $15.2 billion Pimco Real Return Fund is benefiting from the type of timely call that produced the best risk-adjusted result among inflation-protected funds over the past five years, according to the BLOOMBERG RISKLESS RETURN RANKING. The fund combined the second-highest total return and below-average volatility in a group of 37 peers with at least $100 million.

Worah’s fund is one bright spot for Pimco as the firm struggles with lackluster performance and redemptions, including in the $232 billion Pimco Total Return. Worah supplements TIPS with a mix of assets including corporate bonds and emerging- market currencies, giving him more flexibility than some of his competitors.

The fund is required to have at least 80 percent of its money in inflation-protected debt. Worah has about 90 percent in TIPS because he is convinced the market still underestimates the prospects for inflation, he said in an interview last week.

Inflation Outlook

In a January article headlined “U.S. Inflation Outlook 2014: Signs of Life,” Worah and Pimco colleague Nicholas Johnson predicted that consumer prices would climb 2 percent this year, led by an increase in housing costs. One-year TIPS are forecasting 1.6 percent inflation, based on the yield spread with regular Treasuries, he said. TIPS are designed to insulate investors from the brunt of climbing prices because their face value is adjusted in step with changes in the inflation rate.

Inflation has stayed tame through the sluggish U.S. economic recovery of the past five years. Consumer prices climbed 3.2 percent in 2011, 2.1 percent in 2012 and 1.5 percent last year, according to data compiled by Bloomberg. Economists surveyed by Bloomberg expect the consumer price index to rise 1.6 percent this year and 2 percent in 2015, the average forecast of 74 respondents.

‘Significant Consensus’

The Bank of America Merrill Lynch U.S. Inflation Linked Treasury Index, whose 9.4 percent drop in 2013 was the largest since the securities were introduced in 1997, advanced 3.1 percent this year through April 21, as buyers sought value, diversification and inflation protection. Worah isn’t the only money manager who thinks many investors remain too sanguine about inflation.

“There seems to be a significant consensus that inflation will never reappear,” Paul Wynn, head of the inflation-linked team at Western Asset Management Co., a unit of Baltimore-based Legg Mason Inc., said in a telephone interview from Pasadena, California. “I have never seen that happen, which makes me like TIPS.”

Bloomberg’s risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit risk. The returns aren’t annualized.

Pimco Real Return gained a risk-adjusted 6.3 percent in the five years ended April 18, and its volatility of 6.3 compared with the average of 6.5. The $552 million Western Asset Inflation Indexed Plus Bond Fund, whose managers include Wynn, ranked second with the fourth-highest total return and below- average volatility. The $331 million Nuveen Inflation Protected Securities Fund was third, combining the fifth-highest return and relatively low volatility.

Second Career

For Worah, money management is a second career. A theoretical physicist with a doctorate from the University of Chicago, he worked at the Stanford Linear Accelerator Center in Menlo Park, California, where he built models to explain the difference between matter and antimatter.

“The field was stagnating so I decided to look for something else to do,” said Worah, who joined Newport Beach, California-based Pimco in 2001 as a quantitative analyst. In 2008 he was made head of the firm’s real return unit, which manages TIPS, commodities and real estate investments. Following the unexpected resignation of Chief Executive Officer Mohamed El-Erian in January, Worah was given responsibility for the multiasset group, which El-Erian had run. El-Erian is now a columnist for Bloomberg View, the opinion section of Bloomberg News.

‘Bigger Toolbox’

Pimco Real Return beat 99 percent of peers in 2009 and 97 percent in 2010 buying a combination of U.S. TIPS and inflation- linked bonds from Australia as well as corporate and mortgage debt, regulatory filings show. Worah benefited again from holding corporate bonds in 2012, when they outperformed TIPS.

“He uses a bigger toolbox than most of his peers,” said Michelle Ward, an analyst for Chicago-based Morningstar Inc. “Over time he has added value by buying things beyond TIPS.”

Worah is listed as a manager on more than 20 funds, according to data compiled by Bloomberg, including the $14.1 billion Pimco Commodity RealReturn Strategy Fund, which beat 93 percent of rivals over the past five years. He oversees about $120 billion of the $1.94 trillion Pimco managed as of March 31.

Following the global financial crisis of 2008, TIPS rallied as the Federal Reserve drove down interest rates to stimulate the economy. Real yields, which are adjusted for inflation, fell sharply and pushed TIPS prices higher, said Gemma Wright- Casparius, manager of the $26.2 billion Vanguard Inflation- Protected Securities Fund.

‘Highly Responsive’

“TIPS were highly responsive to the easing of policy and they did incredibly well,” Wright-Casparius said in a telephone interview.

Ben S. Bernanke, Fed Chair Janet Yellen’s predecessor, triggered the slide last year in TIPS and other Treasury debt when he paved the way for the end of the central bank’s quantitative easing, sending interest rates higher. The slump was exacerbated by hedge funds dumping bonds, according to Wright-Casparius.

Real Return was among a number of Pimco funds that suffered. Bill Gross’ $232 billion Pimco Total Return Fund, the world’s largest bond fund, attributed its weak 2013 showing in part to its TIPS holdings, according to regulatory filings. Gross’ fund trailed 65 percent of peers last year, according to data compiled by Bloomberg. Worah lagged behind 63 percent, the worst relative performance since 2008, his first year in charge.

Gross and Worah said they were also hurt by investments in Brazil.

Agenda Influencer

Like other Pimco managers, Worah takes his cues from the firm’s investment committee, which sets policy on macroeconomic issues such as global growth and the direction of interest rates. Under that umbrella, Worah said he has the freedom to position the fund as he chooses.

With his January promotion, Worah became one of the panel’s 10 permanent members.

“I’m now in a position to influence the agenda,” he said. “Topics such as TIPS and real assets are discussed more frequently than they were before.”

There is a “lively” debate within the committee about the potential for inflation, Worah said. On one side, he said, are those who see little chance that prices will pick up. Those in the other camp, including Worah, are more wary.

“Wages are picking up,” he said. In its regular survey of the economy called the Beige Book, the Federal Reserve last week reported that in the New York, Chicago, Cleveland, Kansas City, Dallas and Richmond, Virgina, districts, many respondents reported difficulty finding skilled workers.

Market Scale

What’s more, because economic activity tends to lag behind monetary policy, the Fed’s low-interest rate policies may lead to higher prices two or three years from now, Worah said.

“My concern is that we will get to 2 percent inflation and we don’t stop there,” he said.

Pimco owns about 10 percent of the trillion-dollar U.S. market for TIPS, a scale that can present a challenge.

“If I am wrong I cannot turn around in a day,” Worah said. “At a smaller shop if I am wrong I could turn around with one phone call.”

Even so, he said, “I would much rather be here than somewhere else where I would be spending my time trying to guess what Pimco will do. I’d rather be guessing what Janet Yellen is going to do.”