PIMCO Income Mutual Funds Delivered High Income At Very Low Risk

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Includes: PEMDX, PGNDX, PIXDX, PTTDX
by: Toma Hentea

Summary

A portfolio of four PIMCO income mutual funds managed with an adaptive allocation strategy delivered nearly 10% annual return over a 10 year period.

This portfolio exhibited extremely low volatilities and drawdowns even during the two bear market periods when S&P500 had a 55% drawdown.

• This study investigates the performance of the adaptive strategy for reallocation of the funds at one, two and three month intervals.

The four mutual funds considered for investment are the following:

  • PIMCO Total Return D (MUTF:PTTDX)
  • PIMCO GNMA D (MUTF:PGNDX)
  • PIMCO Fundamental Index PLUS AR D (MUTF:PIXDX)
  • PIMCO Emerging Markets Bond D (MUTF:PEMDX)

The PIMCO portfolio was constructed with the specific aim of delivering high income at very low risk. At such, this portfolio is directed at investors with a relatively short time frame, those who do not want to take chances with the risk associated with the equities market cycles. At the same time we would like the portfolio to produce decent returns, well above those obtained from fixed income investments. As the simulation results show, we are able to achieve those goals. As in many of my previous articles, three different strategies will be considered:

(1) Fixed Allocation - Portfolio is initially invested 25% in each fund without rebalancing.

(2) Target Allocation - Portfolio is initially invested 25% in each fund and is rebalanced when the allocation to any fund deviates by 10% from its target.

(3) Adaptive Allocation - Portfolio is invested dynamically among the four funds based on a variance-return optimization algorithm developed on the Modern Portfolio Theory (Markowitz). The allocation is re-balanced at fixed one-, two- and three-month intervals.

Basic information about the funds was extracted from Yahoo Finance and is shown in table 1.

Table 1

Symbol

Inception Date

Net Assets

Yield%

Category

PTTDX

5/08/1998

3.77B

3.70

Intermediate-Term Bond

PGNDX

5/31/2001

0.88B

1.84

Intermediate-Term Gov.

PIXDX

5/30/2005

3.79B

5.57

Large Blend

PEMDX

5/31/2000

2.49B

4.99

Emerging Markets Bond

The results reported in this article cover a period of 9 years and 5 months between October 1, 2005 and February 28, 2015. The starting day was selected based on availability of historical data of the four funds by adding a period of 65 trading days for initial estimation of the parameters used for optimization.

In table 2 we show the buy-and-hold results of investing in each fund.

Table 2.

Symbol

TotReturn%

CAGR %

maxDD%

VOL%

Sharpe

Sortino

PTTDX

58.76

5.04

-6.86

4.26

1.18

1.72

PGNDX

57.88

4.98

-5.59

3.79

1.31

1.84

PIXDX

183.04

11.70

-63.92

22.80

0.51

0.57

PEMDX

73.10

6.01

-32.50

6.88

0.83

0.91

SPY

109.38

8.17

-55.18

20.85

0.39

0.47

We see in table 2 that two funds, PTTDX and PGNDX, are typical bond funds with modest but stable returns and very low volatilities and drawdowns. PIXDX produced higher return than the US equity market as represented by SPY, but also had higher volatility and a huge drawdown of 64%. PEMDX performed somewhere in the middle, higher return than the bond funds with a slightly higher volatility and a high drawdown of 32.50%. The adaptive allocation strategy proved to be very successful with this combination of funds, producing higher returns than SPY with much smaller drawdown and volatility.

In table 3 we show the simulation results for the four mutual fund portfolios from October 1, 2005 to February 28, 2015. We applied five strategies:

  1. Fixed equal weight allocation
  2. Target allocation with re-balancing when an allocation deviates by more than 10%.
  3. Adaptive allocation for a LOW volatility target
  4. Adaptive allocation for a MEDIUM volatility target
  5. Adaptive allocation for a HIGH volatility target

Table 3.

TotRet%

CAGR%

NO.trad

maxDD%

VOL%

Sharpe

Sortino

Fixed allocation

96.23

7.23

0

-23.12

6.26

1.15

1.42

Target allocation

98.30

7.44

21

-25.32

6.92

1.07

1.27

Adapt. allocation LOW

141.30

9.82

113

-7.55

6.41

1.53

1.94

Adapt. allocation MED

176.11

11.41

113

-8.60

7.91

1.44

1.76

Adapt. allocation HIGH

214.16

12.95

113

-9.36

9.03

1.44

1.73

As can be seen in table 3, the adaptive allocation with a low volatility target realizes the highest risk adjusted returns, i.e. the highest Sharpe ratio.

In table 4 we show the performance of the adaptive allocation strategy for three different reallocation periods. We illustrate the effect of re-balancing less frequently, at 2- and 3-month intervals.

Table 4.

TotRet%

CAGR%

NO.trades

maxDD%

VOL%

Sharpe

Sortino

Monthly allocation

141.30

9.82

113

-7.55

6.41

1.53

1.94

At 2-month allocation

134.74

9.50

56

-7.55

6.29

1.51

1.91

Quarterly allocation

146.06

10.05

38

-9.03

6.95

1.45

1.82

As can be seen in table 4, there are only minor differences in performance at 1-, 2- or 3-month reallocation intervals. The highest risk adjusted return is realized by monthly reallocation.

In figures 1 and 2 we show the graphs of the portfolio equities.

Figure 1. Equity curves for a fixed allocation portfolio with no re-balance (blue color), a portfolio with fixed targets and re-balancing at 10% deviation (brown), and a portfolio with adaptive allocation with LOW volatility target (green).

Source: This chart is based on calculations using the adjusted daily closing share prices from finance.yahoo.com.

Figure 2. Equity curves for three portfolios adaptively optimized with a low , medium (brown) and high (green) volatility target.

Source: This chart is based on calculations using the adjusted daily closing share prices from finance.yahoo.com.

In figure 3 we show the time variation of the percentage allocation of the four funds with a low volatility target.

Figure 3. Portfolio allocation for a low volatility target.

Source: This chart is based on calculations using the adjusted daily closing share prices from finance.yahoo.com.

Here are the allocations for March and April 2015.

Volatility Target PIXDX PTTDX PGNDX PEMDX
LOW 40% 60% 0% 0%
MID 53% 47% 0% 0%
HIGH 65% 35% 0% 0%

Conclusion

The adaptive allocation strategy allows a very fine tuning of the portfolio risk even when some individual funds included in the portfolio have large volatility. In line 3 of table 2 we see that PIXDX had over 22% volatility and maximum drawdown of over 63%. In contrast, the portfolio with adaptive allocation strategies had volatilities below 9% and maximum drawdown below 10%. The lowest risk adjusted return was produced by the adaptive strategy with a low volatility target. The highest return was given by the adaptive strategy with a high volatility target.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.