You may have heard the controversy and consternation since PIMCO Total Return lead investment manager Bill Gross resigned from the firm he helped start.

 

Should investors sell, stay or buy some more?

 

Gross is described as “legendary” and the “king of bonds” in various media reports. He is probably the most recognizable person in the investment industry, except for Warren Buffett of Berkshire Hathaway.  Among other awards, Morningstar named him Fixed Income Manager for the Decade 2000-2009.

 

Total Return is the largest bond fund in the world, held by individual investors, 401ks, pension funds, charities and others.

 

Gross just resigned from PIMCO and has gone to work for Janus Capital, a much smaller firm. PIMCO replaced him with other managers.

 

PIMCO Total Return investors (shareholders) – and investment managers who recommended the fund to their clients – must now decide whether to stay with PIMCO, follow Bill Gross to Janus or reinvest in some other bond fund.

 

Fortunately, my clients do not need to worry. I began transferring assets from PIMCO funds two years ago. None of my clients have owned shares in any PIMCO funds for quite some time.

 

Reasons why I made the change from PIMCO Total Return to other mutual funds included the fund being too large for individual security selection to drive performance and management problems.

 

My concerns began about three years ago. I was at a conference where two investment managers described their reasons for leaving PIMCO to start their own fund company. They said that Total Return had grown so large that they could no longer find many bonds investments that were big enough to make an impact on the fund.

 

As a result, many of the investments at PIMCO Total Return involved buying derivatives instead of bonds. Also, Gross was trying to outperform by making bets on interest rate fluctuations and whether US Treasury bonds would perform compared to corporate bonds.

 

For instance, as of yesterday, less than 50% of PIMCO Total Return was invested in bonds. The rest was in derivatives and cash.

 

That was not what I wanted from a bond fund.

 

Forecasting interest rates is extremely difficult and Gross got it wrong several times. For instance, at the end of 2010, PIMCO had 22% of its assets in the US Treasuries.  In February of 2011, Gross announced that he had reduced that percentage to zero because he was certain that US Treasury bond prices were going to decline significantly.  Unfortunately, for Gross, PIMCO and his investors, Treasury prices actually went up. The fund significantly underperformed its category that year.

 

In February of 2012, PIMCO introduced an Exchange Traded Fund based on Total Return and also managed by Gross. It had a much smaller asset base and outperformed the mutual fund by a significant amount. That seemed to confirm that the PIMCO Total Return had become too large.

 

There were management problems at PIMCO.  The heir apparent to Gross (who is 70) unexpectedly resigned in early 2014. Other key managers had already departed. The Wall Street Journal ran articles about disarray and infighting.

 

Finally, I found other bond funds that have performed extremely well that didn't have same issues as PIMCO Total Return. I saw no reason to stay in PIMCO just because it was popular or had a famous manager.

 

Note: Investor News recently quoted me on these developments. You can read the article here.

 

Always remember, past performance is no guarantee or indication of future performance.

• Past performance is no guarantee of future performance;
• Investments involve the risk of loss of principal and earnings;
• ETFs, mutual funds, including money market funds, etc. are not guaranteed in any way by the US Government, the FDIC, a bank or anyone else.
• “Average annual return” evens out variations in the actual year-to-year returns.
• ETFs, mutual funds and individual stocks and bonds fluctuate in value and there will always be times when they lose value.
• None of the information provided by Arthur Stein is necessarily relevant to anyone’s particular situation. Situations differ among individuals and you should not assume that these generalizations or information apply to you.
• Investments mentioned may not be suitable for all investors.