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Saturday, December 18, 2010

When Is A Bond Fund Not Exactly A Bond Fund ?

Seems like the answer is most of the time when it comes to actively managed bond funds. I have long been a critic of the Pimco Total Return Fund. I pointed out that due its lack of transparency and mandate to go anywhere in the fixed income arena, one never really knows how one's bond allocation is invested,

Bloomberg reports that the "go anywhere " fund can know venture into securities directly linked to the equity market:

Bill Gross’s Pimco Total Return Fund, the world’s largest mutual fund, is expanding its policy to allow investments in equity-linked securities for the first time since 2003.
Pimco Total Return may put as much as 10 percent of assets in securities including preferred stock and convertible bonds as early as the second quarter of next year, according to a filing today with the U.S. Securities and Exchange Commission. The fund won’t invest in common stock, the Newport Beach, California- based firm said.
The article mentions a point I have been making for quite a long time. Holding this fund is more of a act of faith in Bill Gross's asset management skill than a choice of bond allocation. Gross can pretty much invest in any type of bond he wants dollar or non dollar denominated:

Gross, who said in October that asset purchases by the Fed will probably signify the end of the 30-year rally in bonds, has invested the Total Return fund in a mix of government-related debt, mortgage securities and emerging market bonds. A top performer over the past five years, the fund trailed most of its large rivals during a debt selloff in the past month.
What was particularly strking to me was that according to Morningstar venturing into convertible bonds and preferred stock is commonplace among actively managed fund. And the Morningstar analyst whose role is supposedly to look out for the interests of the retail investor sees nothing wrong with this:

“This brings Pimco in line with other bond funds in the same category and gives them more flexibility,” Miriam Sjoblom, an analyst with Morningstar Inc. in Chicago, said in an interview. “In moderation, this could increase returns without adding considerable risk to the portfolio,” she said.

Despite all the evidence that Morningstar research produces on the advantages of indexing somehow their analysts always seem to repeat the party line of the active managers : in this case the assertion that it is possible to increase returns without adding risk.. I would look at this fact as more evidence that a proper allocation should include the exact opposite of these "go anywhere " bond funds, The use of index instruments with clear limitations on what they hold is the better path to transparency and managing risk.

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