Value Added


A Bolder and Better Pimco Fund

Steven Goldberg

Unconstrained Bond promises the same excellence as Total Return -- but makes much bigger bets.



Suppose you could turn back the clock to 1987 and invest in Bill Gross’s newly hatched Pimco Total Return. You’d be one happy investor. From inception through December 11, the fund’s institutional share class (symbol PTTRX) returned an annualized 8.5% -- an average of one percentage point per year better than the Barclays Capital Aggregate Bond Treasury Index.

Obviously, you can’t go back in time. But Pimco Unconstrained Bond D (PUBDX) may be more appealing at this point. For starters, it’s a much more manageable fund, with assets just north of $3 billion . (Total Return, by contrast, holds $193 billion .) Plus, Unconstrained’s manager, Chris Dialynas, has much more flexibility with his fund than Gross does with Total Return. Unconstrained, as Dialynas puts it, is charged with implementing “the full expression” of Pimco’s core investment themes.

The fund’s name is dead-on accurate. If Pimco’s investment committee concludes that interest rates are heading higher, Unconstrained can position itself to make money from that scenario -- a rarity among bond funds. If Pimco believes the dollar will collapse, Dialynas can place big bets on foreign bonds and currencies.

For all of its virtues, Total Return is a fuddy-duddy of a bond fund (the same applies to Harbor Bond, a near-clone of Total Return and a member of the Kiplinger 25). To some extent, it’s a prisoner of the Barclays index.

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The fund’s duration, a measure of interest-rate sensitivity, can be no more than two years longer or two years shorter than that of the index. (A duration of four years, for instance, means a fund’s price should fall about 4% if interest rates climb by one percentage point and rise 4% if rates fall by the same amount.)

Over the years, Gross has had far more hits than misses in his market predictions. But Total Return, the firm’s flagship fund, almost never fully reflects those views. Compared with his bold pronouncements, Total Return’s positions are often tepid. Gross may roar like a lion, but Total Return meows like a house cat.

Total Return is now the world’s largest mutual fund. Sheer girth makes it impossible for Gross to invest in any but the biggest, most liquid bond markets (see Pimco Total Return’s Hidden Risks). It’s even difficult for Gross to buy many corporate bonds.

Dialynas, 55, faces none of those obstacles. The fund’s duration can vary from negative three years (a significant bet that rates will soar) to eight years (a reasonably big wager on rates falling). “The fund isn’t married to an index,” Dialynas explains. “It depends on the level of conviction we have in any particular theme.”

Since Unconstrained’s inception in mid 2008, the differences between it and Total Return haven’t been huge, because Pimco’s investment view has remained relatively conservative.

But Unconstained is now starting to show its stripes. Dialynas has placed a big bet (13% of assets) against mortgage-backed securities (the fund effectively has a short position in mortgages). With the Federal Reserve preparing to stop buying up these securitized bundles of home loans, Dialynas thinks mortgage yields will rise more than the yields of other bonds. If he’s right, that could mean higher rates for home buyers.

In the early going, Unconstrained’s bigger positions haven’t paid off. Over the past 12 months through December 11, Total Return’s Class D shares (PTTDX) returned 16.7%, while Unconstrained gained more than two percentage points less. But returns over such a short period are meaningless as an indicator of how the two funds will perform in the future.

Most Pimco funds key off the conclusions of the firm’s investment committee, of which Dialynas is a member. Pimco currently believes the dollar will fall against many emerging-markets currencies. With 5% of its assets, Unconstrained is shorting the dollar.

Dialynas and Pimco likewise believe that Asia -- particularly China -- will grow faster than the rest of the world. They also think growth in most developed nations will be slower than the market expects, forcing Uncle Sam to run the printing presses even faster to stimulate the U.S. economy. “We’re looking for a rebalancing of the global economy toward emerging markets,” Dialynas says.

The dollar, he says, may fall at a rapid pace. “The new normal,” Gross’s name for expectations of a long period of anemic growth in the U.S., “would suggest that the dollar falling into an abyss is a real risk.”

Scary words. Is that really what Pimco’s brain trust thinks? I’d pay less attention to Dialynas’s words and more to his fund’s positions. Currently, the fund has about the same duration as the Barclays index, and 95% of the fund’s assets are in dollars. That’s not the positioning I’d expect of a fund whose manager thinks the U.S. economy and the dollar are going down the tubes.

Bottom line: Unconstrained has most of the ingredients to be a first-class fund. However, expenses for the Class D shares, which are available without a sales charge at many discount brokers, are high at 1.3%.

Despite the high cost, I view Unconstrained as a good core bond fund for aggressive investors and, in smaller helpings, a fine addition to most portfolios. It’s a lot less risky than Loomis Sayles Bond (LSBRX), another Kiplinger 25 fund that gives its managers wide berth, and it implements to the utmost the views of some of the smartest bond-fund managers on the planet.

Steven T. Goldberg is an investment adviser.



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