Bond-management powerhouse Pimco has more than Bill Gross to crow about. We profile its seven best mutual funds. By Elizabeth Leary, Contributing Editor December 19, 2012 Call it the Pimco touch. The Newport Beach, Cal., firm seems to excel in just about every category of fund it offers -- from bonds to stocks to commodities. And even though Bill Gross, who manages Pimco Total Return, the world's largest mutual fund, is still the firm's most-recognizable name, Pimco employs plenty of other managers with star power in their own right.SEE ALSO: Our Favorite No-Load Mutual Funds With $2 trillion under management and new money pouring into Pimco's funds, you might worry that the company is bound to stumble. But there are reasons to believe Pimco can maintain its terrific record. Chris Sawyer, an analyst for Litman Gregory, which publishes the No-Load Fund Analyst newsletter, says that Gross and the Pimco team seem to be aware of the pitfalls of resting on their past successes. "He demands excellence of his colleagues and expects his colleagues to demand that of him," Sawyer says. And although Pimco has tended to excel in part by making superb calls on the big economic picture, its funds don't bet the farm on any one particular economic prediction. They'll hold a range of bets at any given moment -- making big flameouts unlikely. 1. Pimco Total Return (PTTDX) Advertisement Despite its immensity, Pimco Total Return continues to deliver stellar results. Among Pimco-labeled products, the $285 billion fund is the best option for accessing Gross's top investment ideas. In part because of his smooth calls on interest-rate movements and bond sectors, Total Return has returned 8.3% annualized over the past five years (all returns are through December 17 unless otherwise stated), beating the Barclays U.S. Aggregate index by an average of 2.2 percentage points per year. The fund yields 2.1%. (The Kiplinger 25, the list of our favorite no-load funds, contains Harbor Bond (HABDX), a cheaper near-clone of Total Return's class D shares, which are available through discount brokers without sales charges; Pimco's institutional-class shares are best of all, but they generally require large minimum investments.) Savvy as Gross is, Sawyer says he operates under one important constraint: He must generally keep the fund's duration, a measure of interest-rate sensitivity, close to that of his benchmark, the Barclays index. (Duration is a measure of how much a bond or bond fund's price will move with a change in interest rates. Because bond prices move in the opposite direction of interest rates, a fund with a duration of, say, 5 years could be expected to lose 5% of its value if rates rose one percentage point.) Because Gross must stick close to his benchmark's duration, his hands are largely tied in insulating the portfolio against a destructive rise in rates -- and with rates at near-record lows, the question isn't if but when rates will rise. (Litman Gregory agreed to provide complimentary access to its latest research on Pimco Total Return to Kiplinger.com readers.) 2. Pimco Low Duration (PLDDX) Advertisement Because of the maturity constraints on Total Return, risk-conscious investors may want to consider Pimco Low Duration, which Gross also manages, as an alternative. The fund recently held 65% of assets in bonds that mature in three years or less, meaning it should be a safe harbor in a rising-rate environment. To be sure, its track record hasn't matched that of Gross's better-known fund. Low Duration's 4.0% annualized gain over the past ten years trailed Total Return by an average of 2.6 percentage points per year, and the fund offers a lower 1.1% yield. But over that period, Low Duration beat 80% of its peer group (taxable short-term bond funds). 3. Pimco Commodity Real Return Strategy (PCRDX) At Pimco Commodity Real Return Strategy, manager Mihir Worah has a few levers he can pull to boost returns. Rather than build a portfolio of commodity-related investments from the bottom up, Worah uses derivatives to capture the performance of the Dow Jones-UBS Commodity Total Return index. (Derivatives are financial instruments that derive their price from something else. In the case of this fund, Worah is generally using derivatives that track the price of the Dow Jones-UBS index or the prices of particular commodities.) But he tweaks his bets to gain an edge over the index. For example, his allocation to precious metals is greater than the index's because Pimco believes inflation will pick up over the next year. Worah also knows a thing or two about Treasury inflation-protected securities -- U.S. government-issued bonds that are sold with a principal value that adjusts with inflation. In fact, he also manages the $26 billion Pimco Real Return fund (PRTNX), which invests almost exclusively in TIPS. Because the derivatives don't tie up all of Commodity RealReturn's assets, Worah invests the bulk of the fund's remaining cash in a portfolio of TIPS that he actively manages. He also has the leeway to dip into other sectors of U.S. and foreign bond markets. He says he likes inflation-linked government debt issued by Australia, Mexico and Italy, all of which pay higher interest rates, after accounting for inflation, than U.S. debt. Advertisement Over the past ten years, Commodity Real Return returned 7.5% annualized, besting the Dow Jones-UBS index by 3.3 percentage points per year on average. As with Pimco Total Return, a lower-cost clone is available: Harbor Commodity Real Return Strategy (HACMX) charges 0.94%, saving investors 0.25 percentage point per year. 4. Pimco Investment Grade Corporate Bond (PBDDX) Mark Kiesel, who runs Pimco Investment Grade Corporate Bond, is a bond manager who acts like a stock picker. He and Pimco's 90-person corporate-bonds team follow a three-step process to find the best corporate bonds, starting with a big-picture assessment of the most-promising countries and industries to invest in, followed by a search for the best companies within those countries and industries, and finishing with a search for bonds that represent the best value. "Our mission and directive is to find companies that are growing at two to three times the rate of the overall economies in which these companies operate and then to find the cheapest bonds and investments in those companies," Kiesel says. Although the fund focuses on U.S. companies, Kiesel says he's been increasing his stake in emerging-markets issuers in recent years, and expects that trend to continue. About 15% of the portfolio is invested outside of the U.S., primarily in Brazil and Russia. That process has resulted in some remarkably good forecasts, including Kiesel's call of the top of the U.S. housing market in 2006, within one month of the overall peak for home prices (Kiesel even sold his own home that year). Over the past year, Kiesel has turned bullish on real estate–related sectors, buying up the bonds of Weyerhaeuser, a real estate investment trust that builds homes and owns timberland; Masco Corp., which makes building supplies, such as windows and doors; and drywall-maker USG Corp. Advertisement Those picks have served shareholders handsomely. The fund recently yielded 2.7%, and its 10.5% annualized returns over the past five years place it in the top 1% of all taxable intermediate-bond funds. It even beat Pimco Total Return by 2.2 percentage points per year on average. Watch out, Bill. 5. Pimco All Asset (PASDX) Rather than buying individual stocks or bonds directly, Pimco All Asset invests in other Pimco funds. Manager Rob Arnott maintains a laser-like focus on inflation. Instead of measuring his fund's strides against a traditional market index, Arnott, the founder of Research Affiliates, which runs the All Asset fund, seeks to beat the consumer price index by at least five percentage points per year on average, over a full market cycle (generally one economic expansion and one recession). Why the singular focus? "I think most investors have the vast majority of their investments in mainstream stocks and mainstream bonds. That's served investors really well over the past 30 years," Arnott says. But he believes a burst of inflation is on the way, and rapidly rising prices typically wreak havoc on traditional investments. For bonds, that's because rising inflation generally pushes up interest rates, and bond prices move inversely with rates. And although stocks tend to be good inflation hedges in the long term, inflation also causes uncertainty and can crush stock prices over shorter periods (say, three to five years). Arnott relies on computer-driven models to determine how he allocates the fund's assets among Pimco's menu of funds. At the moment, he says, his models are forecasting a 46% chance that the pace of economic growth slackens in the next six months. "With flat economic growth, a slowdown and a recession are essentially the same thing," he says. He believes high-yield U.S. debt (that is, junk bonds) and emerging-markets bonds should hold up well as inflation accelerates, provided that the inflation rate doesn't explode (he says the CPI, which rose 1.4% over the past year through November, understates the current inflation rate. He likes to track the rates published using alternate methodologies at www.shadowstats.com, which say annual inflation is running at a rate of at least 5%). Although All Asset doesn't beat its self-imposed hurdle every year, it has done so over the long term. Over the past ten years, the fund returned 7.9% annualized. That compares with a 2.4% annual rate of inflation. 6. Pimco Global Bond Unhedged (PGBDX) The whole world is up for grabs for Scott Mather, manager of Pimco Global Bond Unhedged. Although Mather invests the majority of the fund's assets in the developed world, he can also take positions in the debt of emerging-market governments and corporations. And he expects emerging markets to only keep growing in importance for his fund. "A lot of the lines that created distinctions between emerging markets and the developed world have blurred," Mather says. Indeed, he says that in many instances emerging countries are now financially healthier than some developed nations. At the same time, Mather's fund is measured against an index with heavy allocations to developed-market government debt, including European government debt. Although the European Union may be cracking up and many of its members are struggling, Mather says he's finding attractively priced bonds and sectors in Europe. For example, he says, his positions in European covered bonds, which are similar to some types of U.S. mortgage-backed securities, have performed well in recent years. And he has found attractive value in the bonds issued by certain German government agencies, such as the KfW state-sponsored development bank. As the fund's name suggests, Mather doesn't hedge its currency exposure, meaning it should get an extra lift when the U.S. dollar is falling relative to other currencies. Judging by the numbers, he has done a skillful job of navigating through a choppy period. As the European storm has raged over the past three years, the fund has returned 7.4% annualized, beating its index, the JPMorgan GBI Global FX New York Unhedged index by an average of 3.9 percentage points per year. The fund yields 1.5%. 7. Pimco Income (PONDX) At Pimco Income, manager Dan Ivascyn has a clear mandate: Generate steady income, and don't take on too much risk. He has delivered. Since the find's inception in 2007, it has paid a steady, gradually increasing monthly dividend and recently yielded 4.3%. Meanwhile, the fund has been about one-third less volatile than the average multi-sector bond fund. Ivascyn can choose from a broad array of bond types, including government and corporate debt, U.S. and foreign bonds, and investment-grade and junk-rated issues. He recently held about 54% of assets in mortgages, 20% in developed-market foreign debt, and 16% in emerging-market bonds. Over the past five years, the fund returned 11.8% annualized, beating the typical multi-sector bond fund by an average of 4.7 percentage points per year. Kiplinger's Investing for Income will help you maximize your cash yield under any economic conditions. Subscribe now!