The PIMCO Total Return Bond Fund (NYSEARCA:BOND) has lost its crown as the world’s largest bond fund, after more than two years of outflows.
The bond fund, started by Bill Gross, lost another $5.6 billion in April, marking 24 straight months of net withdrawals, meaning the fund now has just $110.4 billion in assets under management. That’s a far cry from the $293 billion the fund had at its peak in April 2013.
Pimco has suffered more than most mutual fund managers due to the sudden departure of its founder Bill Gross, who sensationally quit the firm he founded in September 2014.
More than $130 billion has left Pimco’s open ended funds since the departure of Gross, but it’s fair to say the problems started long before then. It was Gross’s misjudging of the Fed’s plan to scale back its quantitative easing program in early 2013, that set the ball in motion. That decision spurred Pimco Total Return biggest decline in more than two decades.
The outflows mean that Pimco Total Return has relinquished its largest bond fund crown to Vanguard Group, whose Total Bond Market Index fund now boasts $117.3 billion in assets under management.
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This is remarkable turnaround for the two funds which twelve months ago were more than $100 billion dollars apart. Vanguard Group, which is renowned for its hands-off approach to investing, has so far won more of Pimco’s outflowing assets than any other fund manager, including the pretender to the Bond king throne, Jeffrey Gundlach.
It also marks a significant change for the industry as investors shun big name fund managers, preferring plain old vanilla funds that track indexes instead.
The downfall of PIMCO
Pimco has long reigned supreme in the rather staid world of bond funds. Launched by Bill Gross in the summer of 1971 with just $12 million under management, the firm went on to become the world’s largest bond fund, with assets under management exceeding $1 trillion for the first time in 2010, before reaching a height of $1.973 trillion in June 2014.
So what went wrong? Pimco started hitting the rocks as far back as 2011 when Gross called the Treasury market all wrong. Gross had sold all of the firms Treasuries on the premise that interest rates were about to surge.
Gross became convinced that interest rates were going to rise because QE2 was set to end in the summer of 2011. Gross wrote to investors in March 2011, asking: Who will buy Treasuries when the Fed stops?
But Gross’s thinking that the Fed’s buying of Treasury debt was the prime factor holding down interest rates proved to be way off the mark. It might have sounded compelling but it was based on some pretty flimsy economic thinking according to economist Paul Krugman.
Krugman argued that low interest rates were not the result of the amount of debt the U.S. was offering, but more about the lack of inflation and growth prospects. And with the U.S. digging itself into a massive hole at the time, there was little chance of inflation ever picking up.
Who was right? Following the end of QE2, interest rates actually fell, spelling disaster for Gross.
But that wasn’t the last time a foray into Treasuries would cause problems for the fund. In April 2013 Gross announced he was buying Treasury-Inflation-Protected Securities (TIPS), betting that continued money printing by central banks would increase consumer prices. The bet went sour as interest rates climbed and inflation remained stubbornly low. TIPS lost 6.8% between May 21st and August 30th according to Bank of America Merrill Lynch data.
And Gross wasn’t just having problems at home. In January 2013 he told his legion of Twitter followers that the Brazilian Real offered better value for money than high-yield bonds. How did that trade turn out? The Real lost 13% against the greenback during 2013, while U.S. high-yield bonds climbed 7.4%.
All of this and the much publicized fallout with longtime lieutenant Mohamed El-Erian, who resigned in January 2014, became too much for Gross to bear. He had dodged too many bullets and finally fell on his sword on the September 26th 2014, having served over 40 years at the firm he founded.
The move away from star managers
It would be unfair to blame Pimco’s woes squarely on Gross. Yes his management style may have come in for criticism and he might have made a few bad decisions in his 40 years at the top. But can investment managers really be expected to be right 100% of the time.
Perhaps this is the reason investors are moving away from star managers like Gross, preferring passive funds that mimic indexes instead. That is in effect risk averse investing and its a hell of a lot cheaper than paying a star fund manager.
Investors pay Vanguard 0.07% that’s $7 for every $10,000 invested for holding their flagship bond fund. Pimco’s BOND on the other hand charges 0.55%, that’s $55 for every $10,000 invested.
Pimco vs Vanguard
Now lets compare their relative performance. For the year to Friday May 1st, Pimco Total Return has returned 1.36%, while Vanguard’s Total Bond Market Index fund had returned 0.94%, according to Morningstar data.
While the headline figure is higher for Pimco, once their expense ratio has been taken into account, Vanguard comes out on top.
Extend the timeframe to three years and the difference is even more pronounced. Pimco’s Total Return fund has returned 3.24% over that timeframe, while Vanguard’s Total Bond Market Index fund has returned 244%.
If you invested $10,000 in Pimco Total Return three years ago, you would now have $10,159 after expenses. While $10,000 invested in Vanguard’s Total Bond Market Index Fund would now be worth $10,223.
So it’s easy to see why investors are favoring an index tracking approach. The challenge for Pimco’s new management team is delivering returns big enough to justify their high expense ratio.
Certainly, while Gross made all the headlines, there are still some very talented people at the firm. And there needs to be, because as we enter a period of rising interest rates they will need to call on every ounce of that talent to deliver the kind of returns Pimco investors have become accustomed to.
Ironically it could be just this kind of change in market conditions that makes the difference for Pimco in the coming years.