Posted by on Sep 29, 2014 in Blog, Columns |

By Jason Zweig | 6:19 pm ET  Sept. 26, 2014

Bill Gross’s stunning departure from Pimco, the bond-fund giant he cofounded, on Friday reminded investors of something many of them might rather not know: Returns and performance sound like the same thing but can be drastically different.

Returns in the fund business are often called “performance” for a reason. Just like a theatrical or athletic event, managing a mutual fund can be a show—a performance put on not just to enrich the fund’s investors, but also to keep them entertained and to keep putting fannies in the seats.

Bill Gross understands this better than anyone since Peter Lynch, the great manager of the Fidelity Magellan fund from 1977 to 1990, whose avuncular charm and folksy sayings helped make Magellan the world’s biggest stock fund for a time. (Its assets peaked at $110 billion in 2000.)

You never knew when Mr. Gross would talk about his own belly fat, the death of his cat or the implications of demographic change on bond prices. In countless television appearances, he wore his necktie unknotted like a sash, a cowlick of sandy hair cantilevered off the side of his head. Other than Warren Buffett, Mr. Gross is the most recognizable investor in the world.

Make no mistake: Mr. Gross built his image on the back of spectacular returns. Since his Pimco Total Return Fund launched in May 1987, it has earned an average of 7.9% annually; the overall bond market, as measured by the U.S. Aggregate Bond Index, averaged 6.8% annually over the same period. Before expenses, Mr. Gross beat the index by nearly two percentage points annually.

In bond management, which is a game of inches, that margin is the equivalent of miles. What’s more, Pimco Total Return sailed through the financial crisis, earning a phenomenal 7.9 points more than the bond market in 2009 after lagging by only 0.4 point in 2008.

With the wind of those returns at his back, Mr. Gross became one of the most powerful marketing juggernauts the money-management industry has ever seen.

Between the beginning of 2008 and the end of 2012, according to research firm Morningstar, investors poured more than $101 billion of new money into Pimco Total Return. When coupled with solid returns, that influx more than doubled the fund’s assets to $285.4 billion from $112.7 billion.

In October 2009 alone, Total Return took in $5.8 billion—a sum greater than the assets of all but 51 out of the 1,059 bond funds then in existence. By year-end 2012, Mr. Gross’s fund, all by itself, constituted 10% of the total assets in all taxable bond funds combined.

Even at its low investment-advisory expense of just 0.25%, or a mere $25 per $10,000 investment, at its peak Total Return was generating fees for Pimco at an annual rate of more than $700 million.

Its investors, however, haven’t been so lucky lately. While Mr. Gross’s long-term returns are superb, he faltered in 2011, lagging the Barclays bond index by 3.7 points. After a strong 2012, Total Return beat its benchmark by only a whisker last year and, so far in 2014, is lagging by more than half a point.

In response to its flagging returns and Mr. Gross’s highly publicized spat with Pimco’s former chief executive, Mohamed El-Erian, who left the firm earlier this year, investors have been fleeing Pimco in droves. Since May 2013, $68.8 billion has flowed out of Pimco Total Return, Morningstar estimates—even as investors added $91 billion to other taxable bond funds.

Rarely has there been better proof that people who chase performance can end up with disappointing returns. Because so many investors rushed into Mr. Gross’s fund just as it was peaking—and then sold out as it sank—they earned lower returns than the portfolio itself.

Fund returns are conventionally measured as if every dollar in the fund were invested continuously from the beginning of the measurement period to the end, but that’s not how people invest: Often, they add money, and take it out, at just the wrong time.

Morningstar estimates that over the past five years, the average investor fell behind Pimco Total Return’s 5.6% annual gain by 1.6 points a year—largely as a result of buying high and selling low. That gap is among the widest of any large bond fund; at the Vanguard Total Bond Market Index Fund, for example, investors have earned returns only 0.4 point lower than those of the portfolio itself.

There’s little doubt that investors will fling billions of new dollars at Mr. Gross once he sets up shop at Janus. Nor is there much doubt that billions more could flee Pimco now that he is gone.

The performance of Total Return is likely to be a lot less entertaining without Mr. Gross. But if you still own the fund, you should ask yourself whether its returns could suffer enough from his departure to make it worth your while to move.

A wave of money could well rush out of Pimco Total Return. But chances are, the fund will end up being managed a lot less flamboyantly—and, in the long run, that might help investors break the cycle of chasing performance to their own detriment.


Source: The Wall Street Journal