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Rekenthaler Report

5 Years Later: PIMCO Total Return

What have we learned since the fuss?

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The Big Slide
In the spring of 2013,  PIMCO Total Return (PTTRX) was the world's largest mutual fund. Its fortunes were about to change, and then some. That May, the fund suffered the first of what would become 51 straight months of net outflows. PIMCO Total Return now ranks 28th in assets. It is not even the company's biggest offering, having been overtaken by  PIMCO Income (PIMIX).

The sales debacle seems silly, in hindsight. Intermediate-term bond funds by nature are sedate, and PIMCO Total Return has been no exception. The fund's negative 1.9% return in 2013 was its only calendar-year loss over the past decade. Even then, it slightly outpaced the industry's standard benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index (albeit while trailing its typical competitor). Nothing remarkable can be said about the fund's performance.

The same does not hold for the media coverage. The fire was routine, but the smoke was not. Along with the fracas at TCW (when the company terminated Jeff Gundlach), the outflows at PIMCO Total Return--and the subsequent exit of co-founder Bill Gross--generated arguably the most attention ever placed on a bond fund. That discussion is worth revisiting.

Chaos Avoided
At the time, PIMCO Total Return touched off two fears about institutional safety.

One was the health of the bond market. Would PIMCO Total Return's asset sales, done to meet heavy shareholder redemptions, disrupt trading? On several previous occasions, including most recently in 2008, the fixed-income marketplace had become sticky during panics. Bid-ask spreads for all but the largest, most liquid securities rose sharply, thereby discouraging activity. It was thought that PIMCO Total Return might cause similar problems.

Not so. Although bond prices dipped during 2013, that was cause instead of effect. The marketplace's losses sparked PIMCO Total Return's early and modest redemptions. Then, as the outflows became heavier, bonds rallied. In 2014, when the fund experienced an unprecedented $94 billion in net redemptions, bonds fared well, with the Aggregate Index gaining almost 6% for the year.

This lesson, I think, we can generalize. Mutual funds are often accused of carrying the seeds of market destruction. That might happen because a huge fund is hit with outflows, as with PIMCO Total Return. Or, perhaps, the inexperienced 401(k) shareholder will panic from stock market losses (heard in the late 1990s). There have been many varieties of this argument over the years. None has come true. On the contrary, mutual funds have generally been stabilizing forces.

(One exception: money market funds. Reserve Primary Fund "broke the buck" in September 2008, thereby severely disrupting commercial-paper prices. The SEC has since implemented money market fund reforms, but it is not clear that the new rules solve the underlying problem.)

No Surprises
The other system that worked was informal: the trust that shareholders place in the major mutual fund firms. The Investment Company Act of 1940 prevents fraud, but not professional incompetence. With fixed-income funds becoming more complicated (much more so than equity funds), and PIMCO Total Return's portfolio being notoriously so, there was always the possibility that, under the pressure of asset sales, the fund might not act quite as management expected. Happily, it did.

The trust is not always warranted. In 2008, for example, the steep losses of Oppenheimer's target-date funds surprised the company's executives, as they had not realized how badly the funds' high-yield bonds could perform. (Shareholders, of course, were even more bewildered.) That was not the first such miscalculation by a fund company, nor will it be the last. Mistakes do occur.

There should, however, be fewer such errors going forward. With the fund industry being mature rather than expanding rapidly, the leading companies have more reason to preserve what assets they have and less reason to risk their reputations by being too aggressive. Consequently, they pay more attention to risk management than in the past.

Organizations vs. Stars
Former Chicago Bulls general manager Jerry Krause once stated that organizations win championships. In this belief he was vociferously opposed by the Bulls' star players, who quite naturally thought that organization man was overstating his own importance while understating theirs. The competing arguments were put to the test when the Bulls' best players left the team in the summer of 1998, while Krause remained. The players won; the organization, it turned out, couldn't win a thing without its All-Stars.

One might be tempted into thinking that the same thing would hold for mutual fund firms. Bill Gross not only co-founded PIMCO, but he was the fund's lead portfolio manager throughout its long, illustrious history. To the extent that bond fund management had a Michael Jordan (which, as a Bulls fan, I cannot bring myself to grant--that would be blasphemy), Gross was that person. Thus, one would think that when he departed PIMCO to manage Janus Henderson Global Unconstrained Bond (JUCIX), that his new fund would thrive, while PIMCO Total Return would not.

That has not been so. As previously mentioned, while PIMCO Total Return has not returned to its former glory, it has been a steady, solid performer. Meanwhile, Gross' Janus Henderson Global Unconstrained Bond has struggled, particularly for the year to date, when it has dropped 6%. It seems that with mutual fund management, the organization counts for more than the star.

That, however, would be overstating the matter. The sample size for the PIMCO Total Return/Gross situation is one. Of course, that is also true of the Chicago Bulls example. But with basketball, the Bulls' case is supported by many others. Teams win where LeBron James goes, not where the sport’s general managers head. The matter is far less clear with mutual fund firms. Sometimes, funds collapse soon after star managers leave, demonstrating that the organization was insufficient for the task. And sometimes they do not.

Thus, with this issue I will not generalize. The proper answer to the question of organizations versus stars is, "It depends."

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.