Recent events at Pimco illustrate how things can change even at the best of firms. We discuss how this illustrates the monitoring required if you use active managers, the limitations of many 401(k) plans, and how it relates to our philosophy on using mostly passive investment in client portfolios.
This month’s post covers:
- Background on Pimco’s Organizational Upheaval
- Putting Events in Context
- Kulig Financial’s Recommendation
- Limitations for Clients Who Only Invest in 401(k) Plans
Background on Pimco’s Organizational Upheaval
Pimco is an amazing firm with a long and successful history. It is a colossal global financial company with more than 2,000 professionals in 12 countries; as of year-end 2013, it managed $1.91 trillion assets in a variety of strategies, but mostly in bond funds. Bill Gross, the founder and chief investment officer, has built Pimco into a powerhouse and been the force behind its successful long-term bond fund performance.
Pimco realized that Bill Gross, who is 69, could not run the firm forever. So in recent years, they brought back Mohamed El-Erian, who had previously been an emerging markets bond fund manager at Pimco, as CEO. He was widely viewed as Gross’s successor. However, in recent months, El-Erian left Pimco as his relationship with the “notoriously prickly” (as Forbes put it) Gross began to deteriorate.
This leaves Pimco with the risk of having an aging, one-man band running the firm. Coupled with some recent underperformance, this has led to a myriad of reactions in the investment and advisor communities. For more, please see http://www.reuters.com/article/2014/03/07/us-pimco-gross-el-erian-idUSBREA2603X20140307. This is more attention than has been focused on Pimco in decades, and its mutual funds have experienced outflows.
Putting Events in Context
As bad as the bickering looks at Pimco, it is important to remember several things about the organization:
- It has many other professionals with deep experience, so the team’s bench strength is significant.
- On a longer-term basis, the firm has delivered significant outperformance.
- The outflows at Pimco are small relative to the overall size of the organization.
While no firm is infallible, the bickering looks bad, and they definitely need to come up with a plan post-Bill Gross, Pimco is not going away overnight. It is also difficult to believe that Bill Gross was the only source of investment ideas with so many talented people around him.
Moreover, frequently, these issues get attention when they have existed for some time. Now that they are more public, it could be that the proverbial horse is out of the barn, and everyone is reacting too late, and perhaps, too strongly.
Kulig Financial’s Perspectives
Most of the time, we recommend using passive/indexed investments whenever possible. Index funds have tended to win the performance game versus active managers over the long haul, largely because their fees are lower. Also, as the Pimco situation demonstrates, it eliminates the need for a high level of monitoring investment funds and streamlines the portfolio management process. This makes index fund and ETFs perfect for our do-it-yourself clients who manage their own portfolios, and if we manage them for you, it means we can offer that service at considerably lower cost.
Having said that, we selectively use active managers, and the bond market is one area where we have been doing so recently. This has been covered in previous newsletters and blog posts, but the bond indexes are troublesome right now. Due to the large issuance of debt by the U.S. Treasury, the Vanguard Intermediate-Term Bond Index Fund Admiral Shares (VBILX) consists of over 50% US Treasury debt, a sector that many analysts consider the most overvalued portion of the bond market. This proportion has come down over the last year along with the underperformance of government debt, but remains higher than over the longer term history. This has the effect of reducing the diversification benefits of using a bond index fund.
For this reason, we have felt forced to use active bond managers in portfolios. However, where possible, we recommend using more than one active bond manager, since as Pimco illustrates, they can experience organizational difficulties or simply underperform, which means you need more than one player to carry the ball.
We have not generally recommended that clients leave Pimco, but we have recommended that they consider sending new bond money elsewhere. If you are managing your portfolio yourself and need an additional fund recommendation, please get in touch with us.
Limitations for Clients Who Only Invest in 401(k) Plans
The strategy just mentioned works well for those who have portfolios in addition to their 401(k) plans at work. But many of you do not. Moreover, when we review 401(k) plans, we find them woefully short on choices for bond portfolios. Frequently we find that a stable value or guaranteed fund plus Pimco are the only choices!
So how to handle this situation? If you have a stable value or guaranteed fund, you could put new money there. If you have bond choices above and beyond this, you could spread your bets around. If you can use a brokerage option to more fully diversify your bond holdings, consider doing so, but only if you know how to put the components together. But each investor’s situation is different, and if you need a review of yours, please get in touch.
In addition to figuring out where to put your money in the current plan, if your 401(k) bond fund options are limited, consider raising this issue with your employer. Relying on a single active manager for bonds makes little sense, and yet it is much more common than with 401(k) stock fund choices. To fully diversify a bond portfolio, many types of funds can be added beyond a plain vanilla intermediate US bond fund—for example, non-US developed markets (hedged), emerging markets debt (hedged) and others. But these are rarely offered in 401(k) plans. Make your voice heard to help protect your capital.
We hope this review of the Pimco situation is helpful, and if you need assistance in evaluating the impact on your portfolio, please get in touch.