Fixed-income firms scramble to capture funds unleashed by Pimco turmoil

If there was ever an example of the power and influence of a single portfolio manager, it was what happened when Bill Gross said he was leaving Pimco, a company he had built into the world's largest fixed-income manager, to join Janus Capital Group Inc., a fund company known for equities. What has continued to unfold amounts to a tectonic shift in fixed income that has put billions of dollars of investor assets in motion — much of that money leaving funds linked to Mr. Gross at Pacific Investment Management Co. With nearly $2 trillion under management, Pimco is not likely to be knocked from its perch anytime soon. But losing a man who for decades was affectionately known as the Bond King to a business managing $33 billion in fixed-income assets is jarring enough to cause a good amount of speculation about where those shifting dollars will eventually land. (Related read: Bill Gross explains his decision to join Janus Capital Group) A lot of the initial punishment was inflicted on the $171 billion flagship Pimco Total Return Fund (PTTAX), which suffered a record $23.5 billion in net outflows in September. An estimated $20 billion of those outflows occurred during the three trading days after the Sept. 26 news of Mr. Gross' departure, news that the industry now refers to as “the announcement.” The fund lost another $27.5 billion in October. “There's never been a bond fund that lost $20 billion in one month; there's nothing to even compare that to,” said Morningstar Inc. senior analyst Tim Strauts. While the knee-jerk reaction by bond fund investors was both dramatic and historic, September actually marked the 17th straight month of net outflows for the fund. In essence, even though there is little indication anyone outside Mr. Gross' inner circle had advance notice about his plans to join Janus, the challenges facing Pimco in general and the Total Return Fund in particular were not news to bond fund investors. “All the money that has been set in motion since Bill Gross' departure tells you that a lot of people were already seriously considering leaving Pimco prior to the news of the move, and you can see that by all the money that had been leaving over the prior 16 months,” said Lipper Inc. analyst Jeff Tjornehoj.

FESSING UP

With that in mind, it's not surprising to hear bond fund industry competitors fessing up to their efforts to place products and strategies directly in the path of fixed-income assets looking for a new home. Suddenly, everybody has a bond fund that looks, feels and acts like something an investor might find at Pimco. “Even before Sept. 26, there was some switching going on because of all the earlier publicized management disagreements and issues,” said Charles Melchreit, director of investment-grade portfolio management at Pioneer Investments, who oversees half of the $40 billion in fixed-income assets there. Among those well-publicized issues was the March departure of Pimco chief executive Mohamed A. El-Erian, Mr. Gross' heir apparent. “The asset flows for us have been noticeable for a while but our daily inflows have doubled since September,” Mr. Melchreit added. “We've been having a huge number of conference calls, and we're learning that a lot of the flows are coming in from advisers that already had Pimco on their watch lists.” A search for a pure replacement for the Pimco Total Return Fund produces a predictable short list of highly regarded intermediate-term bond funds. Among the strongest and most likely beneficiaries, according to Morningstar Inc., are Dodge & Cox Income (DODIX), Fidelity Total Bond (FTBFX), Loomis Sayles Investment Grade Bond (LSIIX) and Metropolitan West Total Return Bond (MWTRX). No doubt, DoubleLine Total Return Bond (DBLTX) would also be on that list if a rift between Morningstar and DoubleLine Capital had not led to the fund's being deemed “not ratable.” But investors are looking for more than proxies for the openly vulnerable fund that Mr. Gross built from the ground up. A glimpse of that can be seen in the asset flows into the fledgling Janus Global Unconstrained Bond (JUCAX), which Mr. Gross is now managing with a skeleton crew from his new Newport Beach, Calif., office. The five-month-old fund, which had just $13 million the day before Mr. Gross joined Janus, has since swelled to more than $80 million. That's still chump change by Bill Gross standards, but the asset growth surge says a lot about both the market's confidence in the 70-year-old portfolio manager and where the bond fund space sees the next wave of opportunities. “It has been fun to watch,” said Gibson Smith, the chief investment officer overseeing Janus' $33 billion fixed-income business. “We've had a lot of conversations over the past several weeks with people who did not know we had this kind of a fixed-income business.”

DIVERSIFYING

Say what you will about the messy infighting, personality clashes and high-profile departures at Pimco, the company seemed to keep its focus on diversifying out of its bread-and-butter core bond strategies toward the kinds of products that investors will need in a cycle of extended low or rising interest rates. Representatives from Pimco did not respond to multiple requests for comment for this story. According to Pimco data, core bond strategy holdings represented 65% of all assets in 2001. But, driven largely by an effort over the past half-dozen years, a deliberate and orchestrated focus on diversifying into more flexible bond alternatives, such as unconstrained, emerging-markets, inflation protection, distressed-opportunities, credit and liability-driven-investing strategies have trimmed Pimco's total core bond exposure down to 25%. This shift was happening at a time when assets were pouring into fixed-income managers, thanks to a combination of the global financial crisis and a major re-engagement of foreign capital in U.S. markets. It took Pimco 39 years to get to $1 trillion under management but only three years to reach the $2 trillion mark. The first major body blow to core bond strategies hit in May 2013 when investors overreacted to the Fed's first real move toward slowing the pace of its bond-buying quantitative easing program. As a whole, intermediate-term bond funds had $10.5 billion in net outflows that month — after $1.1 billion in net inflows in April. In June, net outflows more than doubled, leading to a 10-month string of net outflows before the category stopped the bleeding in March of this year with $4.2 billion in net inflows. If investors' reaction in what has been called the “taper tantrum” in May 2013 wasn't enough to get bond fund shops to diversify out of core bond strategies, exemplified by Pimco Total Return, Mr. Gross' move to Janus was a triggering event. Like a lot of fund companies, Fidelity Investments has jumped on the single-manager-risk argument, suggesting that Mr. Gross' profile at Pimco proved a liability when he walked out the door. “This has focused both retail and institutional investors on that risk associated with single managers, and we know that investors are now looking at firms that take a team-oriented approach to investing,” said Bob Brown, president of Fidelity's $850 billion bond division. Some see the institutional market, which tends to be more deliberate and often moves based on preset rebalancing schedules, as the next shoe to drop as far as fixed-income assets in motion. “We don't talk specific numbers here, but in terms of inflows, we're seeing a strong correlation to the Bill Gross move to Janus,” Mr. Brown said. “This will be our strongest year in terms of net inflows into our institutional business in 10 years, and we've seen our net flows into retail taxable bond funds [almost double] since the announcement.” Fidelity's institutional pipeline has grown by roughly 40% since the end of September, according to Mr. Brown.

PIMCO LOSES BUSINESS

Prudential Financial Inc. announced late last month that Pimco would be replaced as subadviser of the $6.16 billion AST Pimco Total Return Bond Portfolio by BlackRock Inc. and Loomis Sayles & Co. Pimco also was dropped as manager of the U.S. fixed-income portion of the $8.75 billon AST Advanced Strategies Portfolio. Other institutional portfolios that have moved away from Pimco since the announcement include Ford Motor Co., Massachusetts Mutual Life Insurance Co., Alabama's state treasury and Florida's state pension. “Some organizations will react very quickly, and some will take a more measured approach; there might be formal investment policy statements drafted for situations like this,” said Scott David, head of U.S. investment services at T. Rowe Price & Associates Inc., which manages $165 billion in fixed-income assets. “We are definitely seeing an increase in activity and requests for proposals from institutional in-vestors,” Mr. David said. Some analysts and market watchers expect a second wave of movement in fixed-income assets: After Mr. Gross' departure, a lot of money was tracked going into a couple of broad-benchmark exchange-traded funds. In the first three weeks following Mr. Gross' joining Janus, the iShares Core U.S. Aggregate Bond ETF (AGG) added $2.4 billion, while the Vanguard Total Bond Market ETF (BND) had $2.7 billion in inflows. Both ETFs are designed to closely track the Barclays U.S. Aggregate Bond Index. Though it might represent broad market exposure, it isn't the kind of fund most investors or financial advisers would migrate to in an environment poised for a cycle of rising interest rates. Low-cost ETFs are likely being used as placeholders. “If you lost faith in Pimco, the easiest thing to do was to move into an ETF where you could stay exposed to the bond market until you decided what to do next,” said Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ. For its part, the Vanguard Group Inc. acknowledges a recent rush of inflows into its $24 billion ETF but is intent on spinning it away from anything having to do with Mr. Gross. “We're attributing that to the long-term secular trend toward indexing,” said Josh Barrickman, Vanguard's head of bond indexing for the Americas. It's a different story with Vanguard mutual funds, however, which are trying to head off those assets looking for a placeholder, according to Mr. Barrickman. That sounds like an acknowledgement that the liberated bond money is not seeking a long-term relationship with an index fund. “On the mutual fund side, we've actually been taking steps to make sure we're screening inflows [so] we're not taking in money that might not be long-term focused,” he said. If nothing else, “the announcement” has given advisers and investors some freedom from the kind of bond-investing inertia that might not make as much sense now as it has over the past several decades. “If I'm a financial adviser recommending bond funds, you couldn't go wrong recommending Pimco Total Return — but that changes now,” Mr. Strauts said. “If there's some pressure to get out of that fund, it's very easy now for an adviser to go to clients and say, "Let's ... go to a different fund or strategy,'” he added. With interest rates still hovering near historic lows and signs pointing toward a new Fed tightening cycle beginning next year, the movement of money that was sparked by Mr. Gross' exit from Pimco might be the start of a major transitional period for bond funds. “It wouldn't surprise me to see some of that money stay in index funds or ETFs that are charging 12 basis points,” said Tim Clift, chief investment strategist at Envestnet Inc. “Maybe some people will be giving up on active management for a while,” Mr. Clift added. “Bond funds are definitely challenged right now.” (More insight: What's next for bonds? Experts weigh in.)