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PIMCO Total Return: a review

Some of our members have called to discuss the bond fund exposure we recently recommended for their individual circumstances. They’ve pointed to the losses some bond funds experienced during the fourth quarter of 2010 and to potential interest rate increases.

We know interest rates could go up, and we’re certainly monitoring market conditions. But we have a long-term investing philosophy. At this time, we believe good bond fund managers will be able to handle gradual interest rate increases – if and when they come.

One specific fund our members have called to discuss is the PIMCO Total Return fund, which is offered frequently in employer plans. While the fund is not right for every investor, here are some of the positive elements we’ve seen in recommending it to some of our members.

Please note that this is not a recommendation for PIMCO Total Return. This fund may not be appropriate for you, based on your risk level or investment objectives. Please be sure that any fund you purchase meets your individual needs or circumstances. Call the Smart401k team to find out more about choosing appropriate investments for your individual situation.

Bill Gross is the founder, managing director and co-CIO of PIMCO. He’s been associated with PIMCO for more than 39 years and oversees the management of more than $1 trillion of fixed-income securities. Mr. Gross’ widely-known investment philosophy1 is “to spread risk and avoid becoming emotional while staying focused on the odds.”

Morningstar named Mr. Gross and his investment team Fixed Income Manager of the Decade for 2000-2009. He was also Fixed Income Manager of the Year for 1998, 2000 and 2007, making him the first three-time recipient of Manager of the Year. Among his numerous other awards, in 1996 Mr. Gross became the first portfolio manager inducted into the Fixed Income Analysts Society’s hall of fame.

The PIMCO Total Return fund seeks maximum total return, consistent with preservation of capital. The fund invests mainly in higher quality bonds. (‘Higher quality’ bonds have earned better credit ratings because rating agencies have determined that the bond debtor has a higher probability of being able to pay the bond’s principal and interest in a timely fashion.) This strategy makes PIMCO Total Return less susceptible to volatility than bond funds investing in lower-rated issues.

The fund is an intermediate-term bond fund, which means it focuses on purchasing bonds that will mature in one-to-10 years. This range gives the fund manager flexibility to select bonds that are appropriate, considering market trends. When interest rates rise, the ability to move toward shorter duration bonds is beneficial because they’re less susceptible to rate changes. For example, a fund with a 10-year duration is expected to be twice as volatile as a fund with a five-year duration. Right now the average effective duration of the bonds in PIMCO Total Return Admin (MUTF:PTRAX) is less than 5 years. As interest rates increase, which we feel they will do over the long-term, the average effective duration of a fund becomes an important factor to track.

Historically, an intermediate-term bond portfolio has offered a balance of risk and reward. This is because intermediate-term bonds generally have a greater return potential than short-term securities without the volatility and interest-rate-sensitivity often associated with long-term bonds.2

PIMCO Total Return’s core holdings are in domestic bonds, but the fund parameters allow the manager the ability to invest across global bond markets to increase potential returns and reduce overall risk. According to Morningstar, the fund currently has roughly 17% of its portfolio in foreign holdings. In contrast, the average foreign exposure for intermediate-term bond funds currently sits just under 9%. PIMCO Total Return has increased exposure in global bond markets because fund manager Bill Gross is concerned about US deficit spending and a weakening dollar.

In his February Investment Outlook, Mr. Gross wrote:

Instead of accepting historical durational risk and the prospect of a barbershop quartet of possible haircuts, bondholders should recognize that yield or “spread” comes in different varieties. Maturity extension is just one of them, yet if yields are too low based on historical example, an investor should analyze other yields or other “spreads” which are not. That is what we call “safe spread” – the recognition that credit spreads, or emerging market returns, or currencies with positive and high real interest rates are more attractive than those old-fashioned gilts and Treasury bonds offering 2–3% … It is still possible to produce 4–5% returns from a conservatively positioned bond portfolio – you just have to do it with a different mix of global assets.

We’ve felt comfortable recommending PIMCO Total Return for portfolios when we believe intermediate-style bond exposure is needed because of Mr. Gross’ leadership and the fund’s flexible strategy for avoiding volatility. With consideration for current market conditions and the possibility of rising interest rates, we continue to believe fund managers’ long-term track records are very important in selecting high-quality investments.

If you have any questions please contact our team of advisers at 877.627.8401 or email info@smart401k.com.

Jeff Studebaker, Smart401k Adviser

1Quote from a biography of William Gross.  http://www.moneymasters.com/default.aspx?page=GrossWilliam

2Zephyr, based on a comparison of 10-year annual total return and volatility (standard deviation) as of 9/30/10 for Barclays Capital Long-Term Treasury Bond Index, Barclays Capital U.S. Aggregate Index and the BofA and the Merrill Lynch 91-Day Treasury Bills Index. Of course, past performance of the bond markets is no indication of the past or future performance of any bond mutual fund.

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About Smart401k

Smart401k is a web-based investment adviser providing unbiased advice to help employees invest in their employer-sponsored retirement plans.  Smart401k provides service to almost 11,000 clients who collectively have more than $1.5 billion in assets. Individuals receive personalized investment recommendations based on the funds in their plan and support of professional investment advisers available to answer all investment questions. Based in Overland Park, KS, Smart401k can be found at www.smart401k.com.