Much Ado About Nothing
The investment world has been all a twitter lately, both literally and figuratively. Since Bill Gross announced he was leaving Pacific Investment Management Fund Co. (PIMCO), the company he co-founded more than forty years ago, and moving to Janus Capital, investors have been uncertain what to do. The investors and advisors have been wringing their hands and anguishing about whether or not to stay with the PIMCO Total Return Fund managed by Mr. Gross, or move money to other bond funds.
Mr. Gross’ departure is certainly newsworthy, because it is rare for the founder of a thriving company to leave abruptly. The fund has generated outstanding results over many years, but has been under-performing more recently. Reports have circulated that Mr. Gross left before he could be fired due to internal conflicts. There was clearly turmoil within the company, as its high profile CEO, Mohamed El -Erian, voluntarily stepped down earlier in the year.
The shake-up story was made more compelling by Bill Gross’ rock-star status as a commentator on interest rates and all things financial, as well as his idiosyncratic personality. His departure will no doubt hurt PIMCO financially. Investors have already pulled billions of dollars from the company. This makes it a good financial story as well, but when it comes to the true impact on investors, this change is much ado about nothing.
Mr. Gross is certainly an excellent bond fund manager. He has delivered index-beating returns during his tenure which is a remarkable achievement. Even so, he admitted himself that he has benefited from a thirty-year secular decline in interest rates which has also provided a strong tailwind for all bond investors. With interest rates presently at historically low levels, even Mr. Gross recognized the difficulty of repeating his past performance. In fact, investment-grade bond funds are likely to produce meager annual returns in the coming years.
Only a small percentage of managed-bond funds beat the benchmark index. In the current environment, there is even less justification for using a managed-bond fund over a bond-index fund for the low risk portion of a portfolio. The only way a manager can generate outsized returns is by taking exceptional risk, which runs counter to the role of bonds in most portfolios.
The PIMCO Total Return Fund is commonly found in 401(k) plans and is sometimes the only good fixed income offering. As such, I have recommended the fund myself, when a low-cost bond index fund was not available. Mr. Gross’ departure is not going to change my recommendation in such a case. If the PIMCO Total Return Fund was the best selection before, it probably still is.
Unfortunately, some advisors have clients in the fund for the wrong reasons and I suspect they will now take them out for the wrong reasons. The sudden departure of Bill Gross gives them an opportunity to show clients that they are doing something. If an advisor doesn’t switch funds once in awhile, who would pay ongoing fees to manage their accounts?
It is even harder for a bond-fund manager to beat the index, than it is for a stock fund manager. Bonds just don’t earn enough and there is not much opportunity to add value. Bond returns are determined mostly by interest rates. Changes in rates are inherently unpredictable. Therefore, adding another layer as an advisory fee to select the managed funds makes it virtually a sure thing that the account will trail behind the index.
In an attempt to add value, many bond funds and advisors take additional risk unbeknownst to the investor – whereas you might be better served by keeping risk on the equity side of the portfolio and using the fixed-income side exclusively for safety. In that case, the smarter move is to use a bond- index fund for the conservative portion of the portfolio and accept that its purpose is to offer stability, not to make a lot of money. As a bonus, you won’t have to worry about the fund manager leaving or an advisor making changes for the sake of change.
Bonds are a dull topic even among avid investors. The shake-up at PIMCO has temporarily perked up an otherwise boring business. But don’t be fooled by all of the unwarranted attention. In terms of the impact on your financial life, this story is really ‘much ado about nothing’.