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Portfolio > Economy & Markets > Fixed Income

PIMCO Leaders Address Bill Gross Departure, Big Outflows

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At last year’s Morningstar Investment Conference, a sunglassed Bill Gross was the star for how he looked and what he said — the dark glasses and a dark mood, in which he criticized the media while defending his stewardship, and the recent performance, of the PIMCO Total Return Fund (PTTRX).

(See Sunglasses-Wearing Bill Gross Says He’s a ‘Cool Dude,’ Forecasts 3%-5% Return and What’s Up With Bill Gross? Morningstar Crowd Baffled.)

During the Friday keynote at the Morningstar show, CEO Doug Hodge and Group Chief Investment Officer Daniel Ivascyn bravely flew the PIMCO flag.

“We all owe Bill Gross accolades, but nine months after his departure … our narrative is back to where it’s always been,” Hodge said. “Clearly we had a pivotal moment in our history; Bill Gross was an iconic investor,” but now PIMCO’s narrative includes delivering risk-adjusted investment performance and service, he said, both of which are crucial as investors approach a time of “heightened volatility; we’re at an inflection point” regardless of when the Federal Reserve raises rates.

As for where PIMCO stands nine months after Gross left for Janus — and 18 months after Mohammed El Erian resigned as CEO and co-chief investment officer — Hodge said first that “we all knew Bill Gross was going to leave at some point” and that “we were ready for his departure.”

However, Hodge said “we’ve retained key talent” at the firm. Ivascyn noted that “we’ve added some resources, most notably Ben Bernanke” — the former Federal Reserve chairman, who is now a consultant to the firm — and that with its 250 portfolio managers, “the team is functioning quite well.”

Hodge joked that in fact “Bernanke might have been our best marketer between 2009 and 2014” with the Fed’s appetite for bonds. Bernanke participates in PIMCO’s quarterly investment forums, Ivascyn said, is a regular participant in investment committee meetings and holds “private conversations with individual portfolio managers” in which he discusses likely Fed actions.

It was at that last forum, Ivascyn said, that the theses of PIMCO’s ‘New Normal’ were affirmed. That is, “despite the large amount of deleveraging” that has been accomplished, especially in the U.S., “debt is still high,” Ivascyn said, and “demographics remain unfavorable across the developed world.”

PIMCO expects volatility to “pick up in the U.S. later this year,” after the Federal Reserve raises rates “in September or a little later, so that means more volatility to come.” In their funds, he said PIMCO is “building up liquidity not because we’re alarmists,” but rather so that its portfolio managers can “go on the offensive for investors” when that volatility arrives.

However, under the deft questioning of Jon Hale, Morningstar’s director of manager research, North America, Hodge spoke of the outflows that PIMCO has suffered since Gross left. (Morningstar published a special report on PIMCO’s issues earlier this month; see ThinkAdvisor’s take on the report, PIMCO Outflows After Gross’ Exit ‘Staggering’: Morningstar.)

Following “this extraordinary demand for fixed income from 2009-2013,” Hodge said, “our asset growth was extraordinary,” though he argued that “we were also winning market share.” At the high point, in March/April 2013, PIMCO was the largest asset manager in the world, with $2.1 trillion in assets, though he admitted that the “trajectory of those flows has changed significantly.” Hodge said PIMCO now has $1.7 trillion in AUM.

Hale mentioned that the big outflows, especially from Total Return, “don’t seem to have had a major impact on the performance” of Total Return or PIMCO’s other major funds. “That hasn’t surprised us,” said Hodge, since “our funds are very liquid, so we’ve been able to navigate this period quite easily.”

Referring obliquely to Gross and the outflows since his departure, Hodge said “change creates anxiety, which is expressed when people move their money from one strategy or one manager to another.” However, he said, “that anxiety has come down dramatically” as PIMCO demonstrated its “ability to execute and perform, so the money begins to come back,” though “not necessarily into Total Return” because of fixed income’s low yields. Now “we’re seeing investors crowd into the front end of the yield curve, Hodge said, “so we’ve been seeing inflows into our income funds,” such as the $46 billion Income Fund (PONAX).

As for the current and near-future markets, Hodge said “we’re reaching an area of heightened volatility; we’re at an inflection point” regardless of exactly when the Federal Reserve moves to raise rates.

He took a moment to criticize the Fed and other central banks. “Good regulation inspires trust in the financial markets,” and the tighter regulation of bank balance sheets has “strengthened the system, but it’s not the role of central bankers and regulators to protect investors from losses.” Looking out at the crowd of advisors, he said “that’s our job; that’s your job.” Moreover, “you have markets dominated by central bank flows, which are very different than flows within fixed income.” So PIMCO believes that there will be “continued dislocation in markets, which provides opportunities for fixed income” investing.

Answering a question from Hale about the role of active management, a theme of the Morningstar conference, Hodge said that the coming advent of “heightened volatility is wher active management should and will perform; PIMCO is ready.” Ivascyn pointed out PIMCO manages $50 billion in equities and that PIMCO has won Lipper’s large-cap manager of the year “four years running.” He said that PIMCO’s income fund has “put up strong risk-adjusted returns” and that there has been “tremendous interest” in all the firm’s bond strategies.

Referring to the Total Income fund, he stressed that “there will be a time when the merits of core bonds return,” and that the “natural home for bond investors is Total Return.” That time may well come soon he said, so “when the yield curve steepens,” PIMCO will be ready for the opportunities. “We’re by no means giving up on that strategy.”

When asked by Hale how PIMCO’s relationship has been with parent company Allianz, Hodge said that “we’re 18% to 20% of the assets in Allianz Group. We complement the insurance business, since we’re a service business,” and finally, Allianz has been a “very supportive partner for 15 years.”

As for the markets, Ivascyn said “interest rates will continue to be range-bound” between 2% and 3%, with “mid-single-digit” returns for equities. “Investors,” he said, “must be more realistic” when it comes to expected returns. Looking at the economy “on a more cyclical basis, we expect stronger growth in the U.S. and parts of Europe as well,” he said, of 1% to 1.5% over all. PIMCO expects U.S. GDP to “continue to grow at a pace that’s meaningfully stronger than the rest of the world, including developing nations.” In addition, the dollar will continue to strengthen against most currencies. Finally, he repeated the mantra that “we think there’s opportunity in the front end of the yield curve.”

Asked by an attendee where the current opportunities are in fixed income, especially in emerging markets, Ivascyn said “we’re more diversified than we’ve ever been in the past” and that “segments of the fixed income market are fairly valued compared to each other, so it’s not picking one sector” over another. As for EM, Ivascyn argued that “it’s increasingly difficult to talk about emerging markets as an asset class,” though “we like Mexico, and Mexican government bonds, while for income, “we hold Brazilian government bonds,” which haven’t been hurt by rising inflation in Brazil.

— Check out Bond Investing: Finding Opportunities Takes Patience on ThinkAdvisor.


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