Bond-fund classification can be an arbitrary practice. It is also very important. And Bill Gross has some thoughts on it.
In the US, at least, mom-and-pop investors and advisers build portfolios with the categories used by Morningstar et al. This straitjacket isn’t always popular with asset managers, but these classifications have become standard because of their simplicity and popularity with financial advisers.
Since 2019, the “intermediate core” bucket has included funds that are sensitive to interest rates, and very little credit risk. “Core plus” bond funds also have significant duration risk, plus a sprinkling of credit risk. (But those funds don’t have as much credit risk as a high-yield bond fund, and even then, high-yield bond funds have more duration risk than bank-loan funds. Simple, right?)
The interest-rate-sensitive funds have performed very poorly in 2022, after doing very well over the past 15 years. So far this year, both core and core-plus funds have posted roughly 16-per-cent losses, via Morningstar, with core-plus outperforming by . . . two basis points.
Bond King emeritus Bill Gross thinks this defeats the purpose of the “total return” fund style he made popular during his heyday in the 1980s. He writes in his semi-regular investment outlook:
. . . sometime between my departure in 2014 and now, Pimco and other leading proponents of the concept including self-anointed “bond king” Jeffrey Gundlach at DoubleLine, have lost their total return “charter”, or vision, of what such funds should offer to investors in the form of capital preservation. YTD returns for that and Pimco’s fund are down between 16% and 18% with 50 basis points tacked on for your investment pleasure.
When I say these and other total return bond funds have lost their “charter”, I’m asserting that almost all of these funds have in the last five years become quasi “index funds”. And since most adhere to indices with six year and longer durations, their performance has reflected the increase in 10 yield Treasury yields from 1.5% to the current 3.9% level. Admittedly, even a low duration fund would have had trouble showing returns above the line this year. But -15%? These total return funds are actively managed with the ability to go low in terms of maturity duration, but they all seem to be chasing “index-plus” performance as opposed to “total return” management. Perhaps they should all change their names to “index plus” to reflect that reality.
This post is interesting for a couple of reasons. One is simply the entertainment value of seeing Gross go after rival Jeff Gundlach and his former colleagues at Pimco yet again.
Calling them index funds in expensive drag rather isn’t quite like calling his former partners a “cabal . . . driven by a lust for power, greed and a desire to improve their own financial position and reputation at the expense of investors and decency”, but it’s pretty good. No active manager likes to be dissed as expensive beta.
However, another interest fact is that Gross uses the Bloomberg screen showing the total return of the Barclays Aggregate bond index to make a point about the performance of Total Return strategies. He isn’t wrong about that, because of the characteristics of the big-name “total return” funds. These funds — run by Pimco and DoubleLine — really are categorised in the “index plus” (or Morningstar’s “core plus”) group.
So maybe they’re not doing exactly what Gross did back in the 1980s, but it doesn’t exactly follow that they have lost their charter, or drifted too far from their mandate. The question is what investors think they’re getting.
On one hand, yes, the name is Total Return. But it isn’t included in the categories of bond fund that are going for a positive return no matter what the risk.
And those classifications do exist, by the way: Morningstar calls them “multisector” and “non-traditional” bond funds. Non-traditional (or “unconstrained”) bond funds are slightly riskier than multisector, and include funds that make bigger interest-rate bets than multisector funds, which invest strategically across different fixed-income markets.
One problem with the multisector and non-traditional buckets is that US investors and advisers have not, as a general rule, loved them. (Remember when Josh Brown said they were a giant “mistake”?) When retirees put their money into bond funds, neither they nor their investment advisers really want to think about credit risk, relative-value mortgage trades, or shorting govvies. What they want is for yields to go up when prices go down.
When it comes to building a strategy, the market environment does matter, but what investors want matters more. And there are only a couple of riskier selections among the largest US bond funds, according to Morningstar: The BlackRock Strategic Income Opportunities Fund is the biggest non-traditional fund.
The biggest multisector fund? That’s run by Gross’s former colleagues at Pimco. But instead of the Total Return Fund, it’s called the Income Fund, manages $113bn (making it the biggest actively-managed bond fund in the world) and is controlled by Dan Ivascyn, Gross’s successor as Pimco’s chief investment officer. Sign of the yield-starved times, we suppose.
It is also telling that when Gross was ejected from Pimco and rocked up at Janus Henderson, he started an Unconstrained fund, rather than a Total Return fund.
One explanation for those two funds’ success could be that riskier categories have outperformed this year. The non-traditional bond fund category is down just 8 per cent, and multisector funds are down 12 per cent. The Pimco Income Fund is down 10.8 per cent.
Not a positive absolute return, by any means, but not that bad compared to the Agg’s 15 per cent loss, a 23 per cent drawdown for high-grade corporate debt and the S&P 500’s 22-per-cent puke.