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Fund Spy: Morningstar Medalist Edition

Storms Be Damned: PIMCO Short-Term Paddles Smoothly Under the Surface

PIMCO's big 2014 departures have had no noticeable effect on this fund, a cornerstone contributor to many in its family.

Pundits have been predicting for years that rising bond-market yields were just around the next corner, arguing it inevitable thanks to the Fed's unprecedented stretch of loose monetary policy. That perspective became more mainstream over the past 18 months thanks in part to healthier data on the U.S. economy.

Just as conventional wisdom became all but certain that the Fed would act in late 2015, weak economic data from China, combined with rising U.S. bond yields in anticipation of that near-term Fed hike, changed the landscape. As of mid-October, the pricing of futures contracts signaled that the market didn’t put more than a 50% probability of a hike until at least March 2016.

Whenever it comes, however, investors who are anxious to plan ahead may find themselves looking to the ultrashort bond category for shelter.  PIMCO Short-Term (PTSHX) isn’t a money market alternative given the moderately higher risks that it takes, but it might be an attractive choice for those pining for less interest-rate risk.

Reassuringly, the fund shows no strains from the 2014 departure of PIMCO CIO and co-founder Bill Gross. The firm's short-term desk has been stable and humming along under the leadership of manager Jerome Schneider. The fund hit some small bumps late in the summer of 2015 as a handful of factors drove up the U.S. dollar and spooked most credit markets. It also felt some heat from a September 2015 Fed decision not to raise short-term rates, given PIMCO's long-term expectation--still in place--of higher growth and bond yields. But that did little to hurt the fund's returns for the year through September 2015, which placed near the top of the ultrashort bond Morningstar Category, an extension of its stellar long-term record. The fund has been slightly more volatile than its average peer in recent years but has distinguished itself by avoiding blowups when some competitors have faltered. Although the fund’s expenses are a mark against it, the fund’s experienced and stable team, strong record, and sensible approach support its Morningstar Analyst Rating of Silver.

PIMCO's Big-Picture Process With a Short-Term Focus
Like all PIMCO funds, this one uses a mix of macroeconomic forecasting and bottom-up analysis to make interest-rate, yield-curve, currency, country, sector, and issue-level decisions. In recent years, its managers have relied more on broad sector and macroeconomic positioning to drive returns--not surprising given the enormous number of assets they manage across accounts with the same or similar mandates.

Following the departure of co-CIO Mohamed El-Erian in January 2014, the firm made notable changes to its investment committee, which takes the lead in setting broad portfolio parameters. With the addition of some of the firm’s best fundamental analysts, including new group CIO Dan Ivascyn, the committee shifted from being dominated by macro specialists to being more balanced with those focused on bottom-up analysis.

While these changes warrant monitoring, they're unlikely to trigger big news here. Schneider’s careful approach--focused on liquidity and minimizing volatility--together with the depth of quantitative and analytical resources backing the effort help make this fund one of the top choices in the ultrashort bond category.

A Steady Short-Term Team and a Growing Stable of High-Profile Macro Specialists
Longtime former manager Paul McCulley hired Schneider in 2008 to be his right-hand man and to take over after McCulley's 2010 retirement. Schneider considers himself a bit more conservative than McCulley--who redefined the short-term bond category by being risk-averse. The eyes of the firm are always on Schneider and team because they also run billions of dollars in short-term bond allocations for other PIMCO strategies, including that behind  PIMCO Total Return (PTTRX), typically as a cross between this fund's strategy and that of a money market fund.

PIMCO has also recently hired several additional macroeconomic experts and consultants that stand to be an important source of expertise given the impact of economic trends and central bank responses on the short end of the yield curve. Those hires include the appointment of former Morgan Stanley chief economist Joachim Fels, the rehiring of former GMO fixed-income CIO Marc Seidner (who had left PIMCO in January 2014), and the retention of several high-profile economic advisors over the past couple of years, including Nobel laureate Michael Spence, former presidential advisor Gene Sperling, and former Fed chair Ben Bernanke.

Despite appearances to the contrary, PIMCO has always been more than Bill Gross, and the skilled managers who support the firm and this fund continue to impress.

Conservative on Rates but More Intrepid in Credit
After running the fund with a duration that landed at the long end of the fund’s albeit conservative range for much of the past several years, Schneider turned cautious in mid-2014. He shares PIMCO’s widely publicized view that yields are likely to remain well below historical norms even once the Fed starts to raise overnight rates, but he has continued to anticipate volatility in the short end of the curve. By August 2015, he had driven down the fund’s duration to 0.02 years, from 0.9 years in spring 2014.

Credit-sensitive bonds cheapened notably in the fall of 2015, and while the fund is clearly managed to minimize volatility, Schneider will take on measured risks when their rewards appear commensurate. As such, his team has raised allocations to investment-grade corporates (54% in August 2015, up from 28% in late 2013), while also bumping up its high-yield (9%, up from 5% in August 2014) and emerging-markets stakes (8.2%, up from 5% a year earlier); short-term Mexican and Brazilian government bonds have been favorites. Within the high-yield bucket, meanwhile, Schneider is loathe to take on too much liquidity risk in the pursuit of yield. He also focuses on issuers with enough cash to pay off their bonds or work toward earning investment-grade ratings.

It's notable that the fund proved relatively impervious to the large outflows that slammed other PIMCO portfolios following Gross' departure. Given its highly liquid portfolio, it’s likely to be in position to weather a significant storm even if investors were to head for the exits for other reasons.

Performance That’s Hard to Argue With
The fund's record over both the long term and since manager Jerome Schneider took over in January 2011 has been strong. After a modest start that year, the fund placed in its category's best quartile in each that followed. And while the fund felt some effects from the bond market's August and September 2015 volatility, success earlier in the year kept its returns near the top of the group for the year through September 2015. PIMCO reported that the fund's yield-curve positioning detracted from performance, but the rest of its allocations otherwise made positive contributions.

There's no escaping all volatility, of course, and during 2011’s turbulent third quarter, for example, the fund stumbled when its exposures to financial companies caused trouble. The fund hit another snag during the second quarter of 2013 as yields spiked. With a one-year duration that landed at the longer end of its self-imposed range, the portfolio lost more than most in its ultrashort-bond category, falling 0.57% between May and August 2013. However, that setback proved temporary and the fund finished the year ahead of a sizable majority of its peers.

Despite its role as a safe haven for protecting assets, the ultrashort category is surprisingly prone to troubles in times of market turmoil. That makes this fund’s tried-and-tested approach even more appealing.

A Weakness, but Not One Large Enough to Steer Investors Away
It's important to note that despite its impressive history and the massive resources it brings to bear, the fund faces a self-imposed headwind in the form of its institutional shares' 45-basis-point price tag, which stands 9 basis points above the median for the fund’s institutional competitors. That earns the fund a Negative Price Pillar rating, and that levy is particularly problematic given that the fund is the largest offering in the category by nearly a factor of two. But while some of the fund's retail classes are probably worth avoiding on the basis of prices that are simply too high, the fund's institutional shares still warrant investor interest. The fund has avoided the blowups that have haunted many peers, while still managing terrific long-term, peer-beating returns.

Eric Jacobson has a position in the following securities mentioned above: PTTRX. Find out about Morningstar’s editorial policies.