PIMCO (Pacific Investment Management Company, LLC), the global fixed income investment behemoth, has had a hard year. It’s flagship bond fund (and the world’s largest bond fund), the Pimco Total Return Fund, is currently on track this quarter to underperform 87% of its peers. As Min Zeng of the Wall Street Journal explains, the $236.5 billion fund had only a 1.28% year-on-year total return according to data from the fund tracker Morningstar. Pimco’s Total Return Fund falls well short of the standard bond benchmark, the Barclays U.S. Aggregate Bond Index, which reportedly returned 2.03% over the same period.
A number of factors have negatively impacted PIMCO’s success in the past year. In January, in a high-profile management struggle PIMCO’s chief executive Mohamed El-Erian stepped down after the firm’s bond funds stumbled and investors fled from the firm. In 2013 investors withdrew a net $41.1 billion from the Total Return fund, which was a mutual-fund industry record. The firm also appears to be riding the wrong wave, as the Fed has begun unwinding its Quantitative Easing policy, namely by decreasing U.S Treasury Bond purchases and signaling that interest rate increases are likely to arrive soon. As Jon Hilsenrath of the Wall Street Journal writes, many Fed officials believe that the central bank will increase rates soon, perhaps as soon as the end of the year. In addition, Janet Yellen, the Fed Chairwoman, has hinted that an increase in the Fed funds rate could come soon as well. Evidence of increases to interest rates has already begun to accumulate, as the U.S. Treasury yield curve, a plot of current interest rates of bonds at different maturities, has already shifted upwards in the past month. In order to flatten out the yield curve, interest rates for 5 year and 10 year U.S. treasury bonds are increased. Since bond prices and interest rates move in opposite directions, this could be done by decreasing the price of bonds, which would occur if the Fed reduced the rate at which it purchased these bonds (demand for these bonds would go down, as would the price, and therefore the interest rate would increase). If we look at the Fed’s current holdings of U.S. Treasury bonds with yields around 10 years, we find that there is evidence that the Fed has reduced its purchases of bonds at this maturity. Here, we see the size of the Fed’s portfolio of 5-10 Year U.S Treasury bonds hasn’t changed much in the past year.
With interest rates set to rise, and bond prices therefore set to fall, PIMCO’s current investment manager Bill Gross is likely sweating bullets. However, Mr. Gross has weathered storms before at the helm of the Total Return fund, as he’s maintained a 5-year average annualize return of 6.9%, which is well above the benchmark’s 4.89% and above 55% of its peers. Only time will tell if Mr. Gross’s experience will be able to change the fortunes of his flagship fund in the face of turbulent bond markets ahead.