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Wednesday, February 10, 2010

Should This Really Be Your Core Bond Holding ?

Bill Gross (pictured at left) is a far brighter guy that me and is generally regarded as one of if not the top bond market investor. His Pimco Total Return Bond Fund is the largest bond fund in the world and has an impressive track record.

Nevertheless, I do not think it should be a core bond holding for any investors portfolio.In fact it probably takes the place (if there is one) of a hedge fund than bond mutual fund in a portfolio allocation. I say that because the fund literally can go anywhere in the area of fixed income domestic or interenational, treasury agency or corporate and any maturity. And because of the way actively managed mutual funds report their holdings one never knows in real time what it holds.

An example of this could be seen in the WSJ yesterday: my comments in blue

Bond-Fund Investors Can Rest Easy, Mostly


to Greece and Its Ilk Is Minimal

Most bond funds will dodge the debt meltdown in Greece, but about a dozen U.S. funds have at least five 5% of their assets there and in other financially troubled European nations, such as Portugal, Ireland and Spain....

Pimco Total Return Fund, often described as the world's largest bond fund with more than $200 billion in assets, recently increased its exposure to international bonds, to about 20% at Dec. 31, from about 9% a month earlier. Because the move was so recent, it wasn't clear precisely what kind of debt the fund bought. A spokesman says portfolio managers have been emphasizing the German government bonds, while issuing warnings about bonds of Greece, Spain and Portugal. So far this year, the fund has returned 1.8%
In my view the above is quite disturbing regardless of returns. For one the fund holds 20% foreign bonds, secondly the fund doubled its international holding in such a short period of time.

The bond allocation in a portfolio should be designed to provide stability and low risk returns. I like the terminology "umbrella" for the bond allocation: something that should shield a portfolio in times of market turmoil . The expected performance of the bond allocation should be low risk and low return.

Based on the above it seems clear to me that the Pimco Total Return should not be a core bond holding since its holdings often deviate from the guidelines for an "unbrella" holding. Furthermore I always strive for "style purity" and transparency in my portfolio holdings. For that reason I use only etfs and bond funds in my portfolios, funds in the appropriate category are available from all the major providers Vanguard etfs are the lowest cost alternative
Despite this I have seen many publications and websites recommend Pimco Total Return as the main bond holding.

 pimco itself describes its fund as follows on its website

Investment professionals recommend building a portfolio diversified with stocks and bonds to help achieve your long-term financial goals. Regardless of whether that diversification strategy leads you to invest in two mutual funds or twelve, PIMCO Total Return Fund can be the foundation of your portfolio's bond holdings. The Fund invests primarily in an intermediate-term portfolio of investment grade securities - a combination that offers investors an attractive risk/reward profile.

Even worse I have seen many 401k plans where Pimco Total Return is the only alternative as a bond holding. i advise readers to do what I do with my clients in such a situation: skip the total return bond fund, put the 401k funds in whatever stock index funds are available. Then put monies in non 401k accounts in the bond etfs or funds of the type described above. Ideally this can be done so the $ amount to be allocated in bonds in your total investment assets can be done through this methodology. If not, obviously things get more complicated.

Not surprisingly the bond ets carry far lower management fees than the Pimco Fund. The retail no load class of the Pimco fund  carries a management fee of . 93 %.The Vanguard bond etfs are around .15%. And a word to the savvy Pimco manages the Harbor bond fund with the same portfolio. The management fee is..76%.  .17% may be alot of money but on the other hand there is absolutely no risk in choosing harbor over the pimco fund..