Our Favorite Core-Plus Bond Funds
Eric Jacobson explains the split of the intermediate-term bond group and offers his picks.
Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Morningstar recently split its intermediate-term bond category into two groups: core and core plus. Joining me to share some of his favorite picks in the core-plus group, and talk about the core-plus group in general, is Eric Jacobson. He's a senior analyst at Morningstar.
Eric, thank you so much for being here.
Eric Jacobson: It's great to be with you, Christine. Thanks.
Benz: Eric, you and the team recently decided to split that intermediate-term bond group into two pieces. Let's talk about why you decided to do that. And also, can you give us a flavor for the complexion of each of these two new categories, core and core plus?
Jacobson: Sure. Well, the original category, which was just intermediate-term bond, was arguably sort of the S&P 500 of the bond universe, sort of the real core of the taxable space, if you will. And that was how a lot of funds ran themselves. Over the years you started to get more and more funds that today we would call core plus, where they would hold the sectors that are in what is now the Bloomberg Barclays Aggregate Bond Index, mainly Treasury bonds, government mortgages, Ginnie Mae, Fannie Mae, Freddie Mac, and then high-quality corporate bonds, and then a little bit of asset-backed and so forth. That's what's pretty much in the index and has always been in the index. The mixes have changed over the years.
After the financial crisis in particular, we started to see more and more funds do what had been done by some of the big names like Pimco all along, but add choices that had a little bit of high yield, maybe a little bit of emerging markets, a lot more of securitized things that aren't in the index, such as CLOs, non-agency mortgages, all these other things. And it's incremental in the sense of how different they are, but the core space is still home to all the funds that are much more like the index, and the core-plus space is home to funds that will go out and maybe hold some more in high yield and all those other things. Those funds, as I said, they always did exist under the old regime. But as the market evolved over the years, you really started to seek the size of each get to the point where it made sense to split the group in half.
Benz: So, the core-plus group, they're prescribed by prospectus in terms of how much they can invest in some of these more exotic bond types, right? They just can't go crazy with them. Isn't that correct?
Jacobson: Exactly. Now, we don't do the category just solely based on what's in the prospectus. But you will find that most funds that we have in that category aren't likely to ever go, say, more than 30% or more than 35% at the most in anything really outside the norm. Most of them will probably traffic between 10% and 25% in some mix of, like I said, high-yield corporates, or things that have more currency risk, perhaps, or something like emerging-markets debt as well.
Benz: So, as investors look at these two groupings now, how should they approach them from the standpoint of adding bond exposure to their portfolios? Is it that they'd want to have both core and core plus? Or is it one or the other? How should investors go about making that decision?
Jacobson: I think the average investor probably doesn't need too many different bond funds. I think a good, well-run core-plus fund that's had decent risk control and has performed well in rough periods over the years can probably serve you well as a core for your portfolio, even though we may call it core plus.
I think if you have a lot of money in bonds, and you're at the point where you're looking to diversify things, it might make sense to start with a core fund as your base, and then add a core-plus fund. Just by way of example, if you look at how pension investors and other large institutions invest, most of them when they have large bond portfolios, they scatter it among several different kinds. They'll use one manager for the core and another for the core plus. So, again, it kind of has to do with how much you have and how diversified you feel you must get in terms of the manager.
Benz: So, my guess is that a core intermediate-term bond fund would tend to be maybe a little better shock absorber in some big equity market correction, whereas the core-plus fund is going to give me a little more income on an ongoing basis, but might not perform quite as well on the downside. Do you think that's a reasonable way to think about it?
Jacobson: Writ large, absolutely. I mean, there's going to be some crossover, there's always going to be some overlap. The less aggressive core-plus funds will look a little bit more like the more aggressive core funds, but you'll probably find the core to be pretty homogenous. And I will say this, as you know, expenses are really important across universe. But even more so--I would say incrementally even more so in core. They're going to be super important in core plus, too. But a core fund, that's limited to almost very, very--excuse me--investing very similarly to the Ag Index--is going to need to have it keep its expenses low enough that they don't overwhelm what--because right now, as you know, yields have been low for a long time. The margin for error is pretty small.
Benz: And before we leave the topic of core funds, an index fund would be a perfectly reasonable core intermediate-term bond fund, right?
Benz: So, you have been covering these, what we now call, core-plus funds for a long time. And so, let's talk about some of the ones that you cover that you really like, and a couple of them are Pimco funds, and Pimco has sort of a long lineage in this space. Let's start with kind of the main core-plus fund out there, one of the bigger ones, this is Pimco Total Return. You still like it.
Jacobson: I do. And one of the reasons I wanted to talk about is, just because people know it so well and regardless of all the history there, lots of people still own it. So, I think the great thing about it is that it's still a very good fund. If you have or haven't followed the saga, when manager Bill Gross left a few years ago, a lot of people took their money out of the fund because he had a big, big personality and reputation. And what wasn't clear, I think, to a lot of those people is that the staff that he left behind was fantastic. And to his credit, despite all of the tribulations and the noise that surrounded it, he left behind a fantastic team. And not just that, but from others as well. And so, that fund has done pretty well since then. It really is at the level of a core-plus offering. It's going to give you Pimco's best ideas and best effort and it's still a fantastic shop. So, I think that there's a lot of reason for people to continue to look at it that way.
Benz: Another fund that you like in this space also run by Pimco, this is an ETF--Pimco Active Bond. The ticker is BOND. Let's talk about that one. Not quite as familiar as Pimco Total Return.
Jacobson: Well, I thought this would be an interesting one to talk about, because it used to be sort of an ETF version of Pimco Total Return. That's really what it started out as. And then, sometime after Bill Gross left and interest in it waned a little bit, Pimco decided to convert it to this new name Pimco Active Bond, and they took off the old managers who were all very good, and they added three new ones. One of them is a fellow by name of Jerome Schneider, short-term specialist; Dan Hyman, who's a mortgage specialist; and David Braun, who comes from more of an income perspective, he has a lot of history in long-term liability investing. And so, what's interesting about that is, it's a little bit more aggressive in some ways than the more basic version of the fund, but I would call it almost like a Pimco Income light, and Pimco Income, as you may or may not remember, is a much more aggressive version of Pimco offering in the sense of, it holds a lot of non-agency mortgages and things and it's in our multi-sector category, which makes it quite a bit more aggressive than a regular core-plus fund. This one does qualify for core plus, but it's got a little bit more freedom than a more basic fund and it's interesting, and it's had a good record so far. And the main thing is that we really like the managers and think that this is a very interesting offering…
Benz: And costs are reasonable?
Jacobson: Costs are reasonable.
Benz: Another one you like is PGIM Total Return. Let's talk about that one. Not a Pimco fund.
Jacobson: Not a Pimco fund, absolutely. So PGIM is the new branding name for a group that used to be part--it's still part of the Prudential insurance conglomerate. But PGIM is its own firm and then PGIM Fixed Income runs this offering. It's actually a huge organization, but because they've been sort of behind the scenes in institutional and insurance and so forth, a lot of people probably don't know who they are.
What I really like about this fund though, in addition to the fact that it's--it really is sort of team-managed in a way that I think a lot of other firms give flip service to, this is a very, very team-managed fund. They have a lot of resources. They've got very, very big analyst teams, a lot of history in corporate investing, as you might expect from a firm that focuses a lot on insurance money, for example. But one of the things I also really like is, their risk controls are very well thought out, well-designed, and sort of act as great backstops. And part of the thing that I really like about them--and other firms do some version of this--but they do a really good job of explaining, this is how much risk we want to take, and these are the different risk factors we're going to use, and if we decide to take a lot of risk in one area, we're not going to take as much in the other because that will push us up against our limits. And they're really good at elucidating what those are and keeping people aware of where they are in that mix. And you get what you know what you're going to get. You get what you pay for, but you get what you've been sold, you get what you've been promised when you buy this fund, and they've done really well.
Benz: Eric, it's always great to get your perspective. Thank you so much for being here.
Jacobson: I'm glad to be with you, Christine. Thanks for having me.
Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.
Eric Jacobson has a position in the following securities mentioned above: PTTAX. Find out about Morningstar’s editorial policies.