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5 Mutual Fund Investing Lessons from the Bill Gross Saga

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The soap opera at PIMco that began with the departure of Co-CEO Mohamed El-Erian in January came to a head with the recent departure of PIMco flounder Bill Gross.   More than just being the founder of PIMco Gross managed the firm’s flagship mutual fund PIMco Total Return (PTTRX).  His high profile exit once again brings one of the pitfalls of investing in actively managed mutual funds to the forefront.  Here are 5 mutual fund investing lessons from the Bill Gross saga.

Know who is in charge of your fund 

Bill Gross was the very public face of PIMco and was known as the “Bond King.”  To his credit he built PIMco Total Return into the world’s largest bond fund and the fund did very well for investors over the years.  The question investors, financial advisors, and institutions are now asking themselves is what is the future of the fund without Gross?

While PIMco promoted two very able managers to take over at Total Return, the redemptions that have plagued the fund over the past several years as a result of its downturn in performance have continued and seem to be accelerating in the short-term.  Much of this I’m sure stems from the uncertainty over the direction of the fund under these new managers.

Succession planning is vital

While most fund manager changes don’t take place in this fashion if you invest in a mutual fund run by a superstar manager what happens if he or she leaves?  For example does Fidelity have a plan to replace Will Danoff when he decides to leave Fidelity Contra (FCNTX)?

One of the long-time co-managers of Oakmark Equity-Income (OAKBX) retired a couple of years ago.  This was planned and announced ahead of time.  Shortly after that the fund brought on four younger co-managers to help the remaining long-tenured manager manage the fund and more importantly to provide succession and continuity for the fund’s shareholders.

The investment process matters 

What makes an actively managed mutual fund unique is its investment process.  If the fund were to merely mimic its underlying index why not just invest in a low cost, passively managed index fund?  There have been a number of articles in the financial press in recent years discussing “closet index” funds.  These are actively managed funds that for all intents and purposes look much like their underlying benchmark.  This is fairly prevalent in the large cap arena with many funds mimicking the S&P 500.  Why invest in an actively managed fund that is really nothing more than an overpriced index fund?

An institutionalized investment process is key when a manager leaves a fund.  I can think of three small cap funds I’ve used over the years that transitioned to new managers seamlessly via the use of a solid investment process.  While it is expected that the new managers may make some changes over time, I’ve also seen well-known funds replace a superstar manager and essentially have the new manager start over.  The results are too often not what shareholders have come to expect.  To a point this is what has happened to Fidelity’s one-time flagship fund Magellan since the legendary Peter Lynch left a number of years ago.  Subsequent managers have never been able to come close to replicating the fund’s former lofty position.

Even the best managers have down periods 

Bill Gross has made a lot of money for shareholders in PIMco Total Return and other funds he managed over time.  However Total Return has lagged its peers over the past several years which has led to a lot of money flowing out of the fund and the firm in recent years.  It is not uncommon for a top manager to go through a few down years over the course of a solid long-term run.  The trick is to be able to determine if this is a temporary thing, or if this manager’s best days are in the past.  For example if the fund has grown to be too large the manager may have more money to manage than he or she can effectively invest.

Is an index fund a better alternative? 

To be clear I am not in the camp that indexing is the only way to go when investing.  There are a number of very good active managers out there, the trick is to be able to identify them and to understand what makes their strategy and investment process successful.

However before ever investing in an actively managed mutual fund, ask yourself what will I be gaining over investing in an index mutual fund or ETF?

It was sad for me to see Gross’ tenure at PIMco end as it did.  It is not always easy to go out on top.  Michael Jordan should have quit after sinking the winning shot to secure the Chicago Bulls’ last championship.  Perhaps the role model here is the late Al McGuire whose last game as the men’s basketball coach at Marquette ended with the Warriors winning the 1977 NCAA championship.

For more on Bill Gross and PIMco please check out my two most recent articles for Investopedia:   What To Expect From Pimco After Bill Gross and Pimco Investor? Consider This Before Bailing.  

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Shake-Up at PIMco – Should Investors Care?

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The big news in the mutual fund world this past week was the announcement that PIMco Co-Chairman Mohamed El-Erian will be resigning from the firm effective in March.  El-Erian is a frequent guest on CNBC and a really smart guy.  This has been a huge story in the financial press.  As an investor should you care?

Mohamed el Erian - World Economic Forum Summit...

Some background 

PIMco was founded by the soon to be sole Chairman and Chief Investment Officer Bill Gross.  PIMco is perhaps the preeminent bond mutual fund shop.  Many financial advisors, including yours truly, have client assets invested with them.  Their flagship bond fund PIMco Total Return (PTTRX) has had middling results the past couple of years and experienced significant fund outflows in 2013.

El-Erian is the second key executive to leave the firm recently preceded by the retirement of Paul McCulley in 2010.  Some say El-Erian’s departure is an outgrowth of PIMco’s rough year in 2013.

What others are saying 

Jeff Benjamin of Investment News wrote:

“Even as speculation ranges from whether the highly regarded and high-profile economic strategist was forced out or simply burned out, the general consensus is that Mr. El-Erian’s departure will not hurt Pimco‘s reputation or asset management prowess. 

“The news was an incredible surprise, and we have a number of clients with investments in Pimco funds,” said Richard Konrad, managing partner at Value Architects Asset Management. 

 “But at the same time, the issue of talent within the Pimco organization is unquestionable,” he added. “Even without [Mr. El-Erian], the essence of the firm remains, along with a track record that has been established over many years.”” 

The New York Times Dealbook said:

“The move was surprising because Mr. El-Erian, 55, has been the public face of Pimco since he rejoined the company in 2007, taking some of the spotlight from the company’s famous founder and co-chief investment officer, William H. Gross. 

In 2012, Mr. Gross said, “Mohamed is my heir apparent.” On Tuesday, by contrast, Mr. Gross took to Twitter to announce: “I’m ready to go for another 40 years.” That would take Mr. Gross to his 109th birthday. 

Mr. El-Erian’s resignation underscores the upheaval in the investment world as rising interest rates put an end to a bond bull market that lasted for decades and helped build industry giants like Pimco and BlackRock.” 

My take on the PIMco announcement 

PIMco is a very solid fund company with a deep bench of talented managers and researchers that offers a number of very solid mutual funds, closed-end funds, and ETFs.  They are best known as fixed income managers, which going forward will be a tough place to be for any firm.

On the other hand company literature has often mentioned the use of a consensus model called their Secular Outlook developed as the result of an annual meeting of PIMco personnel.  One has to wonder with El-Erian and McCully gone will Bill Gross dominate the discussion here or will others within the organization be able to step up and balance Mr. Goss’ views?  More importantly does PIMco have or are they in the process of developing a succession plan? As youthful as Mr. Gross looks at 69 I’m not counting on him being around PIMco for another 40 years as he indicated he is “… ready to go…”

This situation brings to mind Janus Funds, one of the preeminent go-go growth mutual fund houses of the 1980s and 1990s.  Beginning with the departure of star manager Jim Craig in 1999 and followed by the market drop of 2000-2002, several corporate restructurings, involvement in the mutual fund scandal of the early 2000s, and an awful lot of fund manager and executive turnover this company has never been the same.  I’m not saying PIMco will follow suit, but the potential parallels are there.

My strategy is simple.  I plan to watch the overall situation with the firm and to continue to evaluate my client’s PIMco holdings in the same fashion as before this announcement.  In my opinion this management shake-up is not a cause for any immediate or drastic action, but time will tell.

Personnel issues with a mutual fund and or its parent company are a valid reason to place a fund or a family of funds on your watch list.  This is generally a component of an Investment Policy Statement.  Do you have an orderly due diligence process in place to react to changes in your mutual funds and those in charge of managing them?

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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Mutual Funds and Alabama Football – Does Past Performance Matter?

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As most of you know, The University of Alabama is once again the king of the college football world.  They recently vanquished Notre Dame to win their second consecutive BSC Championship and their third in the past four years.  Including a BCS title while coaching LSU, Alabama coach Nick Saban has won four BCS titles in the last eight years.

Can we infer anything about the future from this performance? I would argue yes based upon a couple of recent articles that I have read about Saban’s approach to coaching and managing the football program.  According to the articles, there is a process in place for just about every aspect of the program from recruiting to practices and so on.  While Alabama still has to go out and play the games (in arguably the toughest conference around) they generally seem to find a way to win under Saban as evidenced by his worst record of 10-3 in 2010.

A repeatable process is what sets Saban apart and in my opinion is the key factor in his coaching success.  A repeatable process is also a key element in investment success.

Clearly in the investment world a disclaimer on the order of “…past performance is no guarantee of future performance…” is often used.  And with good reason.  If we apply this to the world of mutual funds any number of factors can come into play.  I and many other advisor colleagues and self-directed investors have migrated in large part to passive, low cost index funds and ETFs simply because so few active managers deliver top returns year in and year out.

Two active mutual funds managers who consistently deliver superior performance 

Sequoia SEQUX is a large cap blend fund that started as disciples of Warren Buffet’s investing style and still has a very definite process in place for finding stocks that meet the management team’s criteria.  Over the 15 years ended 12/31/12 the fund ranked in the top 5% of its category and has beaten the return of the S&P 500 by an average of 308 basis points annually.  The fund ranks in the top 2% for the trailing 3 and 5 year periods and the top 22% for the trailing 10 years.  Moreover this fund is closed to new investors more than it isn’t the fund was closed for 25 years until 2008.  At that point I added this fund to the portfolios of a number of clients.  The fund closed again at the beginning of 2012.  This is a sign of a superior fund company in that they didn’t feel they can invest all of the new money that was flowing into the fund so they closed it.

PIMco Total Return PTTRX is an Intermediate Bond Fund run by famed bond fund manager Bill Gross.  This is the largest and one of the most successful bond funds around.  Gross is very visible in large part due to his regular appearances on CNBC.  Many thought he had lost his touch in 2011 when the fund ranked in the bottom 13% of its category; however the fund turned around and finished in the top 12% for 2012.  The fund ranks in the top 25% for the trailing 3 years ended 12/31/12; the 7% for both the trailing 5 and 10 year periods and the top 3% of its category for the trailing 15 years.  In all cases the fund has outperformed its benchmark the Barclay’s Aggregate Bond Index significantly.  Gross and the PIMco team clearly have a process in place that has been successful and this was reinforced by the success of the recently introduced ETF version of the fund.  I have client money in this fund.

Two active managers who used to deliver consistently superior performance

American Funds Growth AGTHX was at one time a preeminent large growth fund.  While fund had a very strong year in 2012, returning 20.54% and outpacing the S&P 500 by 454 basis points, the fund ranked in the bottom half of its category in 3 of the 5 calendar years from 2007 -2011.  This was after a five year run during which the fund had ranked in the top 18% or better of its category in each of those five years.  I suspect the fund’s bloated size followed by significant reduction in fund assets via withdrawals contributed to this recent mediocre run.

Legg Mason Capital Management Value Trust LMVTX was formerly managed by the legendary Bill Miller who had rattled off a string of 15 consecutive years of beating the fund’s benchmark the S&P 500 Index.  In recent years the fund has fallen off  to the point where the fund ranked in the 99th percentile for the 5 years ended 12/31/12 and the absolute bottom of it category for the trailing 10 years.

The point is that there are actively managed mutual funds who deliver consistently excellent performance.  Even here, the performance can be uneven as evidenced by the fact that Sequoia has ranked near the bottom of its category in several individual years over the course of its solid run.

I tend to use index funds and ETFs pretty extensively, but I still use a fair number of actively managed funds as well.  Finding funds that fit the needs of my clients takes work and ongoing monitoring, but I have found this to be worth the time spent.  Even with the best managers there are no guarantees about the future, but analyzing and understanding the details of their past performance can provide insight.

As for the Crimson Tide, they may not win a third straight national title, they might not even win their division of the SEC (LSU and Texas A&M are formidable obstacles) but I have no doubt that they will be in the mix in 2013 and as long as Saban is coaching due to his process and preparation.

Please feel free to contact me with questions about your mutual funds or to address your investment and financial planning advice needs. 

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