PIMCO made the call this year that treasuries were being supported by massive buying of them by the Fed, called “quantitative easing” (QE I and QE II). Bill Gross publicly predicted that after June 30, when QE II would end, treasury rates would go sharply higher. In effect, the credit quality was lower and people would demand higher rates of interest to keep buying them.
This view caused them to sell virtually all of the treasuries in the Total Return bond fund. As it worked out, they were dead wrong. All the worry caused a traditional flight to quality –people were buying treasuries, not selling them. Prices went up as rates fell. The Total Return fund underperformed by several percentages points, a large margin. This was a significant issue in client portfolios holding the fund this past quarter.
As a side note, PIMCO was not alone among bond managers in underperforming. Only 8% of the funds in Callan’s core bond database were able to beat the Barclays Capital Aggregate Bond index in the third quarter. Active bond managers tend to underweight treasuries in favor of corporate or other “spread product” that offer higher yields, and the rally in treasuries took many by surprise.
We will be discussing this issue with all of you in our quarterly meetings soon enough. Let us say here for the record that we do not think this one mistake makes PIMCO a bad bond manager, and we are not pulling the plug, but we are certainly watching closely. Long-term performance is still good, but we are hoping to see some recovery over the next few years, and not recovery coming from incremental risk. Stay tuned.