Bill Gross has yet to regain his dominance of the bond market as his Pimco Total Return Fund lagged most of its peers in the first quarter, raising the risk that more money could flee the firm's flagship fund.
In the latest setback for Gross, who has faced intense scrutiny since January when longtime colleague Mohamed El-Erian announced he was resigning as Pimco's chief executive officer, the Total Return Fund is trailing 87 percent of its peer funds this year, data from Morningstar showed on Friday.
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The $236.5 billion bond fund, the world's largest, has delivered a total return of just 1.28 percent through March 27, 75 basis points behind the 2.03 percent return so far for the sector's benchmark, the Barclays U.S. Aggregate index. The lackluster performance follows a dismal 2013, when misguided calls on how Federal Reserve policy would play out in the bond market led to a loss of 1.92 percent for the fund, its poorest showing in nearly two decades.
Underperformance is just one of many headaches for Gross, who co-founded the Newport Beach, Calif., firm in the early 1970s and until recently was revered as one of the greatest bond market investors ever, dubbed the "Bond King."
First, investors have fled his fund in the past year. In the first two months of 2014, $5.1 billion was pulled by investors. That followed $41 billion of outflows in 2013.
Then, the departure of El-Erian, who had also served as co-chief investment officer alongside Gross and was seen as his heir apparent, drew more unwelcome scrutiny.
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The shakeup raised questions about both the corporate culture at Pimco, which oversees $1.9 trillion of client assets and is now a unit of European financial services company Allianz SE, and about Gross's leadership style.
On Feb. 24, the Wall Street Journal published a report describing how El-Erian's previously close relationship with Gross had soured as the firm's investment performance deteriorated last year. Then Gross told Reuters that his one-time lieutenant was trying to "undermine" him, and that he had "evidence" El-Erian "wrote" the Journal article.
Last week, Morningstar analysts downgraded Pimco's overall stewardship grade by one notch to a C, reflecting a higher degree of uncertainty after the departure of El-Erian and other key personnel. Morningstar analysts also cited reports that Pimco's atmosphere has long been characterized as a "pressure cooker" and that Gross has demonstrated "at-times severe and reputed retaliatory temperament."
Wrong calls
February and March were brutal months for the Pimco Total Return Fund's investment strategy.
Morningstar senior analyst Eric Jacobson said the most important issue that hurt Pimco Total Return's performance in March "may have been that it was a blockbuster month for long maturity bonds and a lousy one for shorter maturities."
The Pimco Total Return Fund has been significantly overweight in shorter debt and correspondingly very underweight in long bonds, "so much so in fact that the fund has even been using swaps to achieve a modest short position on the longest maturity debt," Jacobson said in a phone interview in a phone interview.
The Barclays U.S. Treasury 20+ year Index is posting returns of 1.70 percent in March alone, while the Barclays U.S. Treasury 5-7 year Index is -0.61 percent for the same period.
The Pimco Total Return Fund also has long had a significant underweight to investment-grade corporate credit - 9 percent in the fund and 22.7 percent in the Barclays Aggregate - which Morningstar's Jacobson said "didn't help either given that the sector outperformed the broader market overall."
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Jacobson said the Pimco Total Return portfolio began struggling in February as the fund was "very underweight U.S. investment-grade corporate bonds. That would have been a detriment given that the overall investment-grade corporate index returned 104 basis points for February, and returns were better the farther down you went on quality."
The fund also cut its effective duration to 4.71 years in February from 5.05 years. Jacobson said the fund's shortening of duration and meaningful underweight to bonds maturing in more than five years and all the way out the yield curve "would probably have been a very meaningful detriment to returns because the 20-plus sector of the Treasury index returned 85-plus basis points for February."
All told, Morningstar's Jacobson reaffirmed its Gold Rating on Pimco Total Return last week as "Gross is still one of the best around; modest showings in 2011 and 2013 were disappointing, but expectations of perfection weren't realistic either."
Pimco did not return phone calls or e-mails seeking comment.
—By Reuters