As a retiree I have been drawn toPIMCO's bond funds due to their
excellent reputation.PIMCO has an extensive lineup and often the
same manager will be in charge of both open ended mutual funds and
closed end funds. I have received several comments from retirees
inquiring as to whichPIMCO offering is better: mutual funds or
CEFs.PIMCO's wide array of different funds provides a unique
opportunity to compare mutual funds against CEFs with similar
investment objectives. This article will review severalPIMCO funds
and assess their risk-adjusted returns over multiple time
However, before looking at specific funds, I will provide a
quick review of some of the difference between mutual funds and
closed end funds.
A closed end fund ((
)) is created when an investment company decides to raise a pool of
money by selling a fixed number of shares in an Initial Public
Offering (IPO). The public buys stock in the newly formed fund,
with each share representing a proportional ownership in the
investments that have been purchased with the IPO pool of money.
Note that the number of shares is fixed. The value of the
securities that the fund holds is called the Net Asset Value ((
)). However, the actual price of the stock associated with the
closed end fund depends on the market forces of supply and demand.
If there is a large demand for the stock, the price increases and
may even rise above the NAV. If this happens, the CEF is said to
sell at a premium. Similarly, the supply of shares offered for sale
may be greater than the demand and the stock may sell at a discount
to NAV. The shares of the CEF can be bought or sold throughout the
trading day, just like any other stock.
By contrast, a mutual fund (also called an open ended fund) does
not have any restrictions on the number of shares the fund will
issue. At the end of the day, the mutual fund buys back shares at
the NAV from investors that wish to sell. If there are more buyers
than sellers, the fund will issue more shares so that demand always
equals supply. Therefore, open end funds sell at the NAV
(calculated at the end of each day after the market is closed);
there is never any discount or premium. Shares of mutual funds can
only be purchased or redeemed at the end of each day.
AtPIMCO, Bill Gross manages both mutual funds and CEFs. Mr.
Gross is recognized as the "Bond King" and was one of the founders
ofPIMCO in 1971. He is a titan in the world of fixed income
securities. The funds he manages include:
Total Return D (
This is the largest mutual fund in the world with more than $250
billion in assets. Note that this fund consists of several
different investment classes that have basically the same
portfolio but slightly different yields and expenses. The fund
has grown over the years due to a long record of outperformance
with only a few miscalculations along the way. The fund will make
significant interest rate and yield curve plays based on the
macro judgments of the investment team. The fund also typically
makes more use of derivatives than other bond mutual funds. The
portfolio is a mixture of treasuries (including inflation
protection), corporate bonds, and mortgage backed securities.
Most securities are from US firms but about 15% are
international. Effective duration is a relatively short 4.7
years. The fund yields 3.6% and has an expense ratio of
Corporate and Income (
This CEF currently sells at a premium of 6.5%, which is low
compared to the 52 week average premium of almost 18%. The fund
has a high distribution of 9.14%, which has been achieved without
return of capital ((
)). The fund's 353 holdings have a focus on corporate bonds but
also invests in a wide variety of assets including floating rate
loans, asset backed bonds, and a few preferred stocks. About 30%
of the holdings are investment grade. The fund utilizes about 21%
leverage and also uses derivatives to manage risks and increase
returns. Bill Gross owns more than $1 million in shares of this
fund. The leverage adjusted duration in around 6 years and the
expense ratio is 1%.
Income Strategy fund (PFL).
This CEF sells at a premium of 1.8%, which is below the average
premium of 5%. This distribution rate is 9.4%, which has been
achieved without ROC. The fund holds 353 securities that are
distributed among floating rate loans, asset backed bonds,
corporate bonds, and a few preferred stocks. Note that in 2010,
the fund shifted focus from floating rate loans to a multi-sector
bond fund. About 68% of the holdings are investment grade. Bill
Gross also owns more than $1 million in shares of this fund. The
fund utilizes about 22% leverage and also uses derivatives to
manage risks and increase returns. The expense ratio is a
relatively high 1.9%, including interest payments.
PIMCO Income Strategy Fund II (PFN).
This CEF sells at a 1% premium, which is low when compared with
an average premium of over 4%. The fund has a high distribution
of 9.5% without any return of capital. The portfolio of 280
holdings is divided over a wide range of investments including
corporate bonds (investment grade and high yield), asset backed
bonds, municipal bonds, preferred stocks and floating rate debt.
About 75% of the portfolio is investment grade. Like PFL, the
fund shifted focus in 2010 from floating rate loans to a
multi-sector strategy. Although this fund has a similar
composition as PFL, the two funds were only 82% correlated over
the past 5 years. The fund also uses derivatives to enhance
return and provide risk control. Bill Gross owns more than $1
million in shares of this fund. The fund employs a relatively low
21% leverage and has an expense ratio of 1.5%.
High Income Fund (PHK).
This fund is well known for its high premium and sells for a
tremendous 49.5% above net asset value , which is slightly higher
than its average 43% premium. The distribution is an extremely
high 12.4%, which has been achieved with only a small (less than
10% of the distribution) amount of ROC. The portfolio consists of
338 holdings, distributed among floating rate loans, asset backed
bonds, corporate bonds, and Government bonds. About 10% of the
holdings are domiciled outside the USA (mostly Brazil) and about
half are investment grade. Bill Gross took over the management of
this fund in 2009 and it has been one of the top performers in
terms of total return. The fund utilizes 21% leverage and has an
expense ratio of 1.1%.
The following funds are managed by Dan Ivascyn, who joinedPIMCO
in 1998 and is a managing director of the firm.
Income D (PONDX).
This is a go anywhere mutual fund and has its portfolio spread
over many sectors including mortgage backed securities, non-US
developed markets, emerging markets, and Government bonds. About
15% of the portfolio is in non-US based securities. The effective
duration is a short 3.7 years. Expenses are 0.75% and the yield
is 6%. Note that there are other classes of this fund with
different yields and expense ratios. In particular, PIMIX is the
institutional class for this fund.
PIMCO Income Opportunities (PKO).
This CEF sells for a discount of 2%, which is well below the
average premium of 3.6%. The distribution is a relatively high
8.4%, which has been achieved without any return of capital. This
fund has 474 holdings that are divided among four primary asset
classes: mortgage backed, investment grade corporate, high yield,
and Government bonds. This fund utilizes a high 36% leverage and
also has a high 2.3% expense ratio.
PIMCO Dynamic Income Fund (PDI).
This fund was not launched until May, 2012 so it does not have
sufficient history to be included in my analysis. I mention it
because it currently sells for a discount of over 9% (compared
with an average discount of 2%) which is unusual forPIMCO funds.
The distribution is 7.6%, which is achieved without ROC. The
portfolio is mainly asset backed bonds. The fund uses a large
amount of leverage (47%) and has a very high 2.9% expense
To analyze risks and returns, I used the Smartfolio 3 program (
.com) over the past 5 years. The results are shown in Figure 1,
which plots the rate of return in excess of the risk free rate of
return (called Excess Mu on the charts) against the historical
(click to enlarge)
Figure 1. Risk versus reward over past 5 years
As is evident from the figure, thePIMCO mutual funds are
significantly less volatile than the CEFs. However, generally the
CEFs have higher absolute returns. Were the returns associated with
the CEFs commensurate with the increased risk? To answer this
question, I calculated the Sharpe Ratio.
The Sharpe Ratio is a metric developed by Nobel laureate William
Sharpe that measures risk-adjusted performance. It is calculated as
the ratio of the excess return over the volatility. This
reward-to-risk ratio (assuming that risk is measured by volatility)
is a good way to compare peers to assess if higher returns are due
to superior investment performance or from taking additional risk.
In Figure 1, I plotted a red line that represents the Sharpe Ratio
associated withPIMCO's Total Return fund PTTDX. If an asset is
above the line, it has a higher Sharpe Ratio than PTTDX.
Conversely, if an asset is below the line, the reward-to-risk is
worse than PTTDX.
Some interesting observations are apparent from Figure 1. Even
though the mutual funds have a lower absolute return, they have a
much better risk-adjusted return than the CEFs over the past 5
years. PONDX had a slightly better Sharpe Ratio than PTTDX since it
had a higher return and about the same volatility. Of the CEFs, PKO
had the best risk-adjusted return and PFN the worse. PHK had an
excellent total return but achieved this by taking excessive
The correlation matrix associated with these funds is shown in
Figure 2. As you might expect, PTTDX was moderately correlated
(82%) with PONDX but for the most part, the CEFs were relatively
uncorrelated with the mutual funds. This means that the CEFs would
provide diversification to a mutual fund portfolio. Somewhat
surprising, the CEFs were only moderately correlated with each
other (correlations between 50% and 80%).
(click to enlarge)
Figure 2. Correlation matrix over past 5 years
I next looked at the past 3 year period to see if the
performance had changed. The results are shown in Figure 3.
(click to enlarge)
Figure 3. Risk versus reward over past 3 years
As you might expect, the volatilities during the past 3 years
were much smaller than those over the 5 year period, since the 3
year look-back period did not include the volatile 2008 and 2009
years. The volatilities associated with the CEFs were still much
higher than the volatilities associated with the mutual funds. Over
this period, PONDX was the best performer on a risk adjusted basis,
handily beating PTTDX. Of the CEFs, PKO was still at the head of
the pack. Generally, the other CEFs were relatively close to the
"red line", indicating that their risk-adjusted performance was
similar to PTTDX.
The investment landscape became even murkier in the more recent
past. Since early this year, the fear of rising rates has taken its
toll on many investments, includingPIMCO funds. To get a more near
term view, I ran the analysis from the beginning of 2012 to the
present, a little over 1.5 years. This data is presented in Figure
(click to enlarge)
Figure 4. Risk versus reward since January 2012
The last 1.5 years have not been kind to PTTDX, with most of the
CEFs performing as good as or better than this high profile fund.
In contrast, PONDX had excellent results and is still leading the
pack in terms of Sharpe Ratio. PKO maintained its high performance
but lost its leadership position to PFL and PFN. However, on a
relative basis, all these funds performed relatively well in an
environment where treasuries were being plummeted.
Ivascyn's mutual fund (PONDX) was clearly the winner on a risk
adjusted basis over all the time periods and his closed end fund,
PKO, also had outstanding performance. Based on this limited
sample, Ivascyn's funds provided better risk-adjusted returns than
the funds managed by Bill Gross. However, it should be noted that
all thePIMCO funds did reasonably well and a retiree interested in
income should give these funds serious consideration.
I am long [[PKO]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
Capital One Financial Corporation Discusses Q3 2013