Bill Gross, manager of the Pimco Total Return fund, is arguably America's best known money manager. Called the Peter Lynch of the bond world, Gross's three-decade investment record — in which he has beaten a key bond benchmark in 23 of 29 years — has attracted the notice of financial advisors and retail investors alike. Pimco's Total Return fund, in fact, is now the largest mutual fund in the world, with about $72 billion in assets. Many clients are clamoring to invest with Gross, but before you deposit your clients' money in the Total Return fund, it is fair to ask: Is the Pimco fund the only game in town?
The answer, of course, is no. Although Gross gets all the press and seems to reside at the CNBC studio, there are actually other excellent bond funds managers out there. Take Daniel Fuss, lead manager of Loomis Sayles Bond Fund, the top-performing diversified bond fund over the past 10 years, returning 10.1 percent on average annually (about 2 percentage points ahead of Pimco's Total Return). Style purists may say that it is unfair to compare Fuss and Gross. Often taking sizable positions in junk and foreign issues, Fuss swings for the fences — and sometimes strikes out. Gross, on the other hand, aims to beat his benchmark by a percentage point or so by focusing on investment-grade issues. Still, it is notable that Gross has become famous, while Fuss is familiar only to dedicated readers of the financial press.
The point is: Many clients might be better served by less popular managers. For example, aggressive clients may prefer Calvert Income A, which has returned 8.5 percent annually for the past five years, outpacing Pimco Total Return A by six basis points. In some respects, the two investment-grade funds resemble each other. Both regularly shift sector allocations, sometimes overweighting mortgages one quarter and corporate bonds the next.
But Calvert takes on slightly more risk. When senior portfolio manager Gregory Habeeb spots a bargain, he jumps in with both feet. Worried about the deteriorating prospects for corporate securities, Habeeb shifted 30 percent of his portfolio to mortgages in the second half of 2000. Now, with high volumes of refinancing muddying the outlook for mortgages, Habeeb has no assets in the sector at all. In contrast, Gross only makes limited plays, often shifting 10 percent of assets to a sector that seems undervalued.
Beneath the Radar
Habeeb is also willing to hold some lower quality securities. “We like to buy names that aren't well known when they provide extra yield,” Habeeb says. While Pimco's portfolio has an average credit quality of AA, Calvert's portfolio is currently rated A, one step lower on the credit ladder.
Advisors seeking a fund that has outperformed Gross — while taking less risk — should consider TCW Galileo Total Return Bond I, which returned 8.0 percent annually for the past five years. Compared to Pimco's offering, TCW has lower volatility as measured by standard deviation and a higher Sharpe ratio, which measures an investment's return in relation to the risk it takes. The low risk scores stem from TCW's policy of only holding AAA-rated mortgages. “People are looking for safety, and this mortgage fund lets them sleep at night and not worry,” says Harold Kirschner, a financial advisor with Integrated Concepts, a registered investment advisor in Lakewood, Colo.
Safe but Not Sorry
Although mortgages provide a margin of safety, they might be expected to lag behind Pimco Total Return, a fund that can juice its returns by holding higher-yielding issues such as low-quality bonds and foreign issues. So how does TCW stay ahead? Portfolio manager Jeffrey Gundlach combs through obscure corners of the mortgage market in search of undervalued securities. Recently, he has been buying hybrid adjustable-rate mortgages. These permit a homeowner to pay a fixed mortgage rate for five years, and then the interest payments begin to float along with market rates. “The mortgage market is very complicated, and that makes it fertile territory for active managers to find bargains,” says Gundlach.
Another fund that has better risk-adjusted returns (as measured by the Sharpe ratio) than Gross's offering is Delaware Diversified Income A. Returning 8.7 percent annually for the past five years, Delaware ranks as the top performer in the multi-sector bond category, a group that holds a mix of high-grade domestic issues, foreign bonds and junk securities. Because individual bond sectors are not tightly correlated, Delaware provides a diversified package that can prove resilient in bear markets. Portfolio manager Paul Grillo varies the mix. Early last year, he had only 20 percent of assets in junk. Then, with default rates dropping, he gradually raised the figure to 30 percent. The move proved well-timed, enabling Grillo to profit from a junk rally.
For conservative investors, a solid choice is Dodge & Cox Income, which lagged behind Pimco during the past five years (but not by much), although it posted a lower standard deviation. To rein in risk, Dodge & Cox carefully avoids bonds with questionable outlooks. That caution has proved vital lately. In the past year, Gross and many other managers suffered setbacks when telecom bonds weakened. “In the last few years, the most important thing was to stay out of bonds that blew up,” says Dodge & Cox portfolio manager Dana Emery. “We avoided most of the trouble, because we did not have WorldCom or Enron or any of the other big issues that collapsed.”
When interest rates rise, long bonds suffer big losses. To avoid problems, Dodge & Cox emphasizes shorter issues when its managers fear rate increases. Lately the fund has shortened its duration, preparing for a change in interest rates. That cautious stance should protect shareholders from big losses and ensure that the fund continues producing results that are competitive with top funds.
|Fund||Ticker||One-yr. Return||Three-yr. Return||Five-yr. Return||Standard Deviation||Max. Front-End Load|
|Income A |
|Income A |
Dodge & Cox
|Return A |
Total Return Bond I
|Source: Morningstar. Returns through 4/30/03.|