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Despite some noteworthy team turnover, Pimco Real Return's experienced management team and extensive supporting cast of global-bond specialists continue to give it an edge in the inflation-linked bond arena. Given the importance of low fees in this competitive field, the fund's cheapest institutional share classes earn Morningstar Analyst Ratings of Silver and Bronze, while its remaining shares are rated Neutral.
In December 2019, Pimco announced that Mihir Worah, longtime head of the firm's real-return team and a comanager on this fund since 2008, would retire in March 2020. That followed the January 2019 departure of comanager Jeremie Banet, who had handled much of the day-to-day decision-making here since 2015.
Still, the strategy remains in capable hands. Pimco veteran Steve Rodosky, who led the firm's U.S. Treasury trading desk in earlier years, took Banet's place here and now oversees the U.S. inflation-linked effort, while European rates head Lorenzo Pagani oversees global real-return accounts and contributes to this portfolio's non-U.S. positioning. Former agency mortgage specialist Daniel He joined the inflation-linked desk in early 2019 and became a comanager here in December. That follows the hiring of inflation-linked bond specialist Daniel Brhel in 2017 and macro expert Tiffany Wilding in 2016 to support the firm's inflation-forecasting efforts.
Pimco's resource depth beyond the real-return team also matters because the team has made full use of its wide latitude to invest beyond the Bloomberg Barclays U.S. TIPS Index, including modest exposure to non-U.S. inflation-linked bonds and currencies, and up to 20% in other sectors such as corporate, securitized, and emerging-markets fare.
While the current team lacks a lengthy track record to evaluate, the fund's institutional share class gained 3.7% annualized over Worah's tenure from January 2008 through December 2019, beating the benchmark by roughly 30 basis points per year and outperforming nearly all its peers. However, that slim margin of victory underscores the importance of keeping costs down in order to compete with the category's cheap passive options.
Process | High
To beat the Bloomberg Barclays U.S. TIPS Index, the team looks to obtain cost-efficient exposure to U.S. Treasury Inflation-Protected Securities and other inflation-linked bonds by seeking better execution than passive investors receive. It employs macro-driven strategies (driven by real growth, inflation, and country-specific analysis) and micro-driven themes (including Consumer Price Index seasonality, on-the-run/off-the-run premiums, and implied inflation volatility). Although U.S. TIPS and, to a lesser extent, other global inflation-linked bonds dominate the portfolio, the strategy can invest up to 20% in other sectors, such as corporates and securitized fare.
The approach has led to sizable off-index bets at times, a trait that distinguishes it from its more-constrained peers, including use of Pimco's bonds-plus techniques, by which the strategy gets exposure to its primary sectors via derivatives and invests the cash collateral in short-term bonds. The team may also make meaningful and swift maturity shifts, though the portfolio's overall duration has generally stayed within a year of the benchmark's. The strategy's adventurous nature can cause its performance to diverge from that of the U.S. TIPS market at times. But overall, its flexible approach, which benefits from the insights of Pimco's broad, deep bench of global-bond experts, earns a High Process Pillar rating.
The portfolio's overall duration stuck close to its benchmark's for much of 2019, with shorts at times in the United Kingdom and Europe offsetting a modest U.S. duration overweight. The team maintained an overweight in U.S. break-even inflation (long TIPS, short nominal Treasuries), with an emphasis on near-term maturities, where the team thought pricing was overly pessimistic given Pimco's inflation outlook. Starting midyear, the team reduced the size of the U.K. short--the portfolio's short nominal and inflation-linked gilts position had gotten as large as half a year of duration in late 2018--and shifted toward a short break-even inflation position (short inflation-linked, long nominal gilts) that was roughly duration neutral.
Positions away from inflation-linked debt have been modest. The strategy has retained a cautious stance toward credit, with single-digit stakes in corporate and structured credit, and a small high-yield short. The managers kept the portfolio's exposure to agency mortgage pass-throughs--which they view as a high-quality diversifier--between 10% and 20% in 2019. They also kept the portfolio's non-U.S.-dollar currency exposure minimal (roughly a couple of percentage points long and short), favoring select higher-yielding emerging-markets currencies over lower-yielding currencies in Asia and developed markets.
People | Above Average
Despite recent noteworthy departures, this strategy continues to benefit from experienced management and Pimco's impressive fleet of macro experts and global sector specialists. It merits an Above Average People Pillar rating.
In December 2019, Pimco announced the retirement of Mihir Worah, longtime head of Pimco's real-return group and a manager on this fund for more than a decade. That followed the January 2019 departure of comanager Jeremie Banet, who had handled the day-to-day decisions here since 2015.
The strategy remains in capable hands, though. Steve Rodosky, an experienced manager who led Pimco's U.S. Treasury trading desk from 2007 to 2016, took Banet's place on this strategy, while Worah's continued presence helped smooth the transition. Rodosky now oversees the firm's U.S. inflation-linked effort, while head European rates trader Lorenzo Pagani oversees global inflation-linked accounts. The two are supported by David Brhel, who backs Pagani on global accounts, and Daniel He, who backs Rodosky on U.S.-focused strategies and was named a comanager here in December 2019. Before 2019, He focused on agency mortgages (both the U.S. inflation-linked and agency mortgage teams are part of a larger liquid-products group), and Brhel joined Pimco in 2017 from Dutch pensions manager APG, where he ran a global inflation-linked portfolio.
Parent | Above Average
Pimco's investment culture has long been successful, if also rigorous, demanding, and intense.
Despite worries that the turmoil after Bill Gross' 2014 departure might lead others to follow, there has been notable stability among the firm's senior investors. Meanwhile, the firm is back to a faster pace of hiring following a rough patch of asset flight and has also been taking more proactive steps in succession planning, elevating the next generation of leaders in the investment ranks.
There are other evolutionary changes in progress. CIO Dan Ivascyn has facilitated efforts to inject more diverse views into the investment process, whether by rotating a wider range of investment staff through Pimco's Investment Committee or by incorporating more quantitative research and risk insights into the workings of that body. CEO Manny Roman has also driven significant technology investments since he arrived in 2016, intent on ensuring that the investment team's analytical tools remain cutting edge.
We have taken the firm to task for failing to share economies of scale for pricing, and while its expense profile is reasonable in the United States, it is decidedly not so in Europe. We would also prefer to see the firm give more attention to questions around closing fast-growing funds. That said, nearly all of the major factors relating to the firm's Positive Parent rating have been improving.
Performance
The managers who remain on this strategy following Mihir Worah's departure have a limited track record here. But because Steve Rodosky and Daniel He follow a similar process and rely on the same resources, its performance under Worah demonstrates its long-term potential. From January 2008 through December 2019, the fund's institutional shares gained 3.7% annualized, beating all its distinct peers except for its long-duration Pimco sibling, outpacing the Bloomberg Barclays U.S. TIPS Index and passive exchange-traded funds by roughly 20 and 30 basis points, respectively.
That slim advantage versus indexed strategies shows how difficult it is for active managers to outperform low-cost passive options in the limited U.S. TIPS investment universe. In recent years, the fund has struggled to maintain an edge over its benchmark after fees. Small relative value trades worked in its favor in 2017 but went against it in 2018, for instance, while the fund's 8.5% gain in 2019 beat its benchmark by just a handful of basis points.
Still, one of the chief tools that active managers in this category have at their disposal is to invest beyond the benchmark, and few are better equipped to augment their U.S. TIPS portfolios with modest helpings of global inflation-linked bonds, credit sectors, and currencies. As volatility returns to the bond market, expect this strategy to take advantage.
Price
It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar Category's second-cheapest quintile. Based on our assessment of the fund's People, Process, and Parent Pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Silver.
