Should You Dump Pimco Total Return?

Bill Gross' Pimco Total Return regularly outperforms its peers, but if you still hold it, you might want to sell.

Consider this: From the fund's inception in mid 1987 through May 23, it has returned an annualized 8.4%. That's an average of 1.1 percentage points per year better than its benchmark, Barclays Capital U.S. Aggregate Bond index.

Recent performance is even more remarkable. Over the past five years, Total Return (symbol PTTRX) returned an annualized 8.8%, beating the Barclays index by an average of 2.3 points per year and outperforming 97% of its peers (medium-maturity taxable bond funds). In the bond world, where performance is measured in basis points (a basis point is one one-hundredth of a percent), this kind of outperformance is stunning. (The numbers above are for Total Return's low-fee, high-minimum institutional shares, the class with the longest history.)

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What's more, Gross has continued to put up great numbers even as Total Return's assets have swelled to $241 billion, making it the world's biggest mutual fund (the figure includes all share classes).Total Return is now bigger than some of the bond-market niches it invests in. Its size is almost triple the $85 billion the fund held in mid 2005 and nearly double the $132 billion it held at the start of 2009.

In addition, another $243 billion resides in more than 65 public and private Pimco-managed funds, including Harbor Bond (HABDX), a member of the Kiplinger 25, that are virtually identical to Total Return. So Pimco is managing nearly $500 billion with one strategy. And now the company is getting ready to launch an exchange-traded version of Total Return.

I don't worry as much about asset bloat as some other fund analysts do. But enough is enough. If you hold Pimco Total Return, sell it. If you don't, but you want to own a solid bond fund, look for something else.

My hunch is that Gross will still be able to beat the market. But I think it will be by ever smaller amounts. It doesn't help that Total Return charges too much in light of its size. In particular, the annual expense ratio of 0.75% for Pimco Total Return D (PTTDX), the share class that's available without a load through many discount brokers, imposes a large hurdle for Gross and his team to overcome. The fee is way too high. Harbor Bond charges an annual fee of 0.55% (the expense ratio for the institutional class of Pimco Total Return is 0.46%, but the minimum investment is $1 million).

Previously, Gross had two ways to win: through his firm's uncanny big-picture predictions and via its skills at identifying undervalued bonds. In the future, it will be as if Gross is flying without that second engine. The fund is simply too big for individual bond picks to make a difference. Plus, with the fund so big, the natural tendency is to play not to lose. After all, if you give investors decent performance, they probably won't bail out, even if they can do better elsewhere.

Total Return Replacements

As his firm's assets have mushroomed, Gross, who founded Pimco in 1971 and is now its co-chief investing officer, has hired a lot of smart people. Among them: Mohamed El-Erian, the other co-chief investing officer; Mark Kiesel; Curtis Mewbourne; Michael Gomez; and Chris Dialynas. With all that brain power available, it's safe to say that Pimco still has some pretty good funds. Below are some of my favorites as candidates to replace Total Return in your portfolio:

Pimco Unconstrained D (PUBDX) is a smaller and more daring version of Total Return. While Total Return will only deviate so much from its benchmark index, Unconstrained gives you the full expression of Pimco's views. The fund, which launched in 2008, can even try to make money on falling bond prices.

Pimco Emerging Local Bond D (PLBDX) invests in bonds and currencies of emerging nations, many of which are growing rapidly and are in better fiscal shape than most countries in the developed world. This fund is as risky as many stock funds, but it returned a stock-like 9.5% annualized over the past three years through May 23.

Pimco Diversified Income (PDVDX) is a multi-sector bond fund. It invests in global bonds as well as investment-grade and high-yielding "junk" corporate bonds. It currently has about 40% of its assets in emerging-markets bonds. It gained 9.3% annualized over the past three years.

You can, of course, find superb bond funds run by other shops. I recently wrote about Loomis Sayles Bond (LSBRX) -- see Sell Commodities -- Even Now -- so I don't need to say much about it here. It's an aggressive multi-sector fund, but it has put up terrific numbers. Its three-year annualized return: 8.1%

A fund with no record to speak of but one worth considering nonetheless is DoubleLine Total Return Bond (DBLTX). Lead manager Jeffrey Gundlach has been investing primarily in mortgage securities since 1993. He posted a stellar record with TCW Total Return Bond (TGLMX) before he was fired in late 2009 in an acrimonious dispute that is still being fought out in the courts. Gundlach launched his new fund last year, and most of the analysts who worked with him at TCW joined his new firm. The fund returned an eye-popping 15.2% over the past 12 months.

Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area.