Bill Gross, the manager of the largest bond fund in the world, has abruptly left the firm that he co-founded 43 years ago and that is nearly synonymous with his name: Pacific Investment Management Co.PIMCO. The firm manages about $2 trillion and Gross’s Total Return Fund alone has $222 billion. There are perhaps more individual shareholders of the Total Return Fund than any other actively managed bond fund. In fact, I suspect that many of you reading this article today actually own this fund in your retirement accounts. (Check those statements!) Now that he is leaving after a stretch of poor investment performance, what are investors to do?
Before starting my own firm here in Coronado in 2002 I actually worked for PIMCO as an analyst and co-portfolio manager (on the equities side, however, not fixed income). I am thus quite familiar with the company, its fund offerings and how it operates.
Gross’s resignation, however, presents no problem for us here at Orion: since our founding in 2002 we have never bought for any client a single share of any PIMCO bond fund. Why? Because, in our view, it doesn’t make sense to do so. The fees for PIMCO funds, in our opinion, are way too high, leaving too little on the table for the investor. Turnover (buying and selling) is also very high within PIMCO funds (and most other actively-managed funds) adding a further tier of unpredictable cost and tax burden. Investors that use mutual funds to get exposure to the bond market are much better off getting this exposure through highly diversified, low-cost, low-turnover funds such as those offered by State Street, Dimensional Fund Advisors, iShares, or Vanguard.
But the reasons we have not invested in the PIMCO Total Return Fund actually extend to the entire industry of actively managed mutual funds, both for bonds and stocks. Except for a few rare instances, we have committed virtually no client money to actively managed mutual funds in our 12-year history. On a whole, active funds are overpriced, tax-inefficient and offer poor investment performance to boot.
While at PIMCO I saw firsthand why the active mutual fund industry has largely failed investors. Fund flows are particularly damaging. Because many investors chase returns, funds that are doing well receive the vast majority of new money. (These are the only funds the marketing folks can sell.) Meanwhile, the funds that are not doing well receive a steady flow of redemptions, forcing the manager to liquidate positions at unfavorable prices. What ends up happening is that the fund manager with the good (recent) track record does not have enough brilliant new ideas into which to deploy the torrent of new money, and the fund’s investment returns head quickly toward mediocrity. Because money tends to pour into funds that have just had excellent recent performance, winning funds often turn into losers just after they get a bunch of new money and investors.
By the way, this is also why investing with funds that have achieved a Five-Star (or similar) rating by firms and newsletters that monitor the fund industry does not work. Almost very manager has a good run from time to time (and a bad run as well). Why begin investing with a manager right after he or she has just had a phenomenal run and received industry accolades for it? Such a manager will probably be contending with large cash inflows that will very likely water down future performance . . . and probably be due for a sub-par stretch of performance as well.
To see a detailed analysis of why active mutual funds don’t work, visit our website at www.orionportfolios.com. Click on “Blog” and then read the piece entitled “The Mutual Fund Landscape.” There is an intriguing part about “A Case of Disappearing Funds” and very interesting analysis about how “winning” funds perform subsequent to their anointment as “winners.”
As usual, I welcome your comments and feedback.
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Peter C. Thoms, CFA
Orion Capital Management LLC
1330 Orange Ave. Suite 302
Coronado, CA 92118
Tel: 619.435.1701
Email: [email protected]
About the Author:
Peter C. Thoms, CFA, is the founder and managing member of Orion Capital Management LLC, an independent Registered Investment Advisor based in Coronado, California. The firm manages assets for individuals, families, trusts, corporate pension plans and non-profit organizations.
Disclosure:
This document is for informational purposes only. Nothing in this report is to be construed as a specific investment recommendation. This document does not constitute the provision of investment advice, which is only provided by Orion Capital Management LLC under a written investment advisory agreement and only in states in which Orion Capital Management LLC is registered or is exempt from registration requirements. Orion is not a tax advisor and does not provide tax advice. For tax advice individuals should consult their CPA.
