Bill Gross is starting a new version of his PIMCO Total Return Fund that will rely less on derivatives and leverage, two of the tools that he used to build Total Return into the largest mutual fund.
The new fund, identified as PIMCO Total Return Fund IV in a February regulatory filing that details the changes, will forgo high-yield debt, borrowing to create leverage and investing in options. It will serve as an alternative to rather than a replacement for PIMCO Total Return, which had $237 billion of assets as of last month.
Gross, the co-founder of Pacific Investment Management Co. in Newport Beach, Calif., is tinkering with a strategy that helped him beat 98% of rivals over almost 24 years and attract $25.1 billion of new deposits last year. With Gross forecasting an end to the three-decade bond rally, PIMCO may be targeting investors who prefer a more conservative approach over the risks associated with excess yields, according to Francois Otieno, a senior fixed-income analyst at Hewitt EnnisKnupp, which advises institutional investors.
"The Total Return Fund is the largest mutual fund in the world, yet very few underlying investors have a clue on how their strategy is executed," Otieno said in an interview from Chicago. "There is an appetite for a more conservative strategy in the marketplace."
Mark Porterfield, a spokesman for PIMCO, said the company cannot comment on the new fund while its disclosure documents are being reviewed by the Securities and Exchange Commission. Gross didn't respond to telephone calls and e-mails seeking comment.
PIMCO Total Return has produced average annual returns of 8.42% since starting in May 1987, a performance that ranks it seventh out of 353 bond funds, according to Morningstar Inc., the Chicago stock and fund research company. Its benchmark, the Barclays Capital U.S. Aggregate Index, has had average annual returns of 7.26% from April 30, 1987, through Feb. 28 of this year, according to data compiled by Bloomberg News. The fund benefited from a bond market rally that dates to the early 1980s as well as Gross' ability to discern macroeconomic trends and the wide latitude he has to boost returns through complex instruments and strategies.
PIMCO Total Return may invest "without limitation" in derivatives, including options, futures contracts or swap agreements, according to the fund prospectus.
The restrictions imposed on PIMCO Total Return IV would create an alternative that more closely mirrors the benchmark Barclays aggregate index, said Adam Cohen, director of fixed-income research at Fortigent LLC.
It will seek to invest at least 80% of total assets in bonds and other debt securities, according to a Feb. 11 SEC filing, whereas the main PIMCO Total Return has a lower target of 65% that can be met through the use of forwards or derivatives, including options, futures and swap agreements.
While PIMCO Total Return seeks to maintain an average portfolio duration that is within two years of the Barclays aggregate index, the new fund will try to stay within one and a half years of the benchmark.
"This is for investors who are looking to hold a more traditional fixed-income fund," Cohen said. "It makes the fund more constrained and more targeted towards" the Barclays aggregate index.
Gross set up two other versions of his flagship fund in 1991. PIMCO Total Return II is barred from investing in high-yield bonds, while PIMCO Total Return III is a socially conscious fund that avoids investing in industries such as gaming and spirits. Apart from those limitations, their terms are identical to those of the initial Total Return Fund, including the ability to make unlimited investments in derivatives, subject to applicable securities laws and any caveats in their governing documents.
The $3.3 billion PIMCO Total Return II produced average annual gains of 7.9% during the past five years, compared with 8.3% for the original PIMCO Total Return, according to data compiled by Bloomberg. Its management fees are 0.50% of assets, compared with 0.46% for institutional shares of the larger fund.
PIMCO Total Return IV, the latest edition of Gross' fund, will hold only investment-grade securities, cannot have more than 15% of total assets invested in securities denominated in foreign currencies and will, under normal circumstances, limit its forex risk to 5% of total assets, the filing showed. The comparable ceilings for the existing PIMCO Total Return are 10% of total assets in high-yield securities, 30% in foreign-denominated debt and a 20% ceiling on overall currency exposure.
The new fund may not borrow to create leverage, though it can take out temporary loans equaling as much as 10% of assets to meet redemptions or for emergency purposes. In contrast, the existing PIMCO Total Return may borrow money "to the extent permitted under the 1940 Act," generally defined as 33% of net assets.
While PIMCO Total Return may invest "without limitation" in derivatives, the new version of the fund will "seek to limit" exposure to interest rate swaps to 10% of total assets and will cap its credit-default swaps at 5% of total assets. The new fund "may not invest in options," according to the SEC filing, nor can it engage in reverse repurchase agreements.
