Should Bond Powerhouse Pimco Jump into Stocks?

News reports from Bloomberg and Pensions & Investments say that fixed-income giant Pacific Investment Management Co. is considering a move into equity investing. Pimco may hire an existing management team with a track record, according to unidentified sources. But this isn’t exactly new news: In September, Kiplinger’s ran a profile of Pimco, in which Pimco’s bond guru Bill Gross as well as Pimco CEO Mohamed El-Erian talk about potential expansion into equities.

Expect to see Pimco introduce more stock, or quasi-stock, mutual funds. “We’re currently interviewing stock-fund managers from various firms — looking to start from square one with a new product and apply our philosophy to new areas,” Gross says.

The firm won’t say whether it plans to start offering funds for which managers buy stocks, a move that would mark a profound shift. “I would be nervous if Pimco hired managers” to pick stocks, says Morningstar analyst Lawrence Jones. “That would be departing from their long-standing traditions and approaches.” El-Erian says the new stock funds would indeed differ from existing Pimco stock funds, which purchase options and futures contracts on stock indexes but stash the bulk of their assets in bonds.

Pimco Total Return, Pimco’s flagship fund, is the biggest mutual fund of all, with more than $186 billion in assets. So why would Pimco, arguably the most powerful of all fixed-income shops, branch out into stocks? And why should you care? I posed these and other questions to Russ Kinnel, director of research at Morningstar, the Chicago fundtracker. Here are his thoughts.

According to Morningstar’s data, Pimco has just 5% of its assets in equities. Why do you think Pimco would expand into equities? Pimco’s parent company, Allianz, does have some equity expertise already. Its RCM unit offers some terrific stock funds. (Morningstar recommends the Allianz RCM Technnology fund.)

Pimco also has some stock-plus strategies, essentially letting a bond manager run a stock fund. The basic idea is that you buy futures in a stock index and combine them with a short-term bond strategy overlay. It may be they are picking up mortgages or short-term high quality bonds instead of Treasuries. If they beat Treasuries, the funds will beat the stock index. It’s their way of running equity funds without equity expertise.

An Allianz unit, incidentally, got in trouble with the market timing scandal a few years ago. Pimco was unhappy because their name was slapped on a mutual fund. So you can be sure that if Pimco does branch out into stock funds, it will be part of the Pimco operation as opposed to some branding campaign.

Another thing is that Pimco seems to be very aggressive about growing. Just look at how many new fund launches they are doing—it seems like they are coming out with a new fund every couple of weeks. They keep finding a new wrinkle on bonds or asset allocation. Some of these funds are cool, but it seems like there is an aggressive goal there.

Is this a good time to be launching stock funds? Pimco has done a pretty good job of sticking to what they do well, so I see that as a positive for investors. Given the massive inflows they are having, they could be buyers of equity teams when others are forced to be sellers. We’ve seen some fund shops sold or cutting staff recently. And very few places are hiring. It’s a decent time to be hiring equity managers, or a doing a boutique lift out. The wrong time to do that is when the market is raging, and you have pay obscene prices for every analyst and manager.

One criticism I’ve seen of Pimco is that its fund are expensive. We give Pimco good ratings as a fund family, but it’s true that Pimco funds are expensive. Now, they offer a reasonable value in institutional shares, as well as funds they subadvise for Harbor and other places.

But the retail share classes, such as Class A shares, are pricey. That’s partly the fault of Pimco and partly the fact that you have to pay up to have distribution in fund supermarkets and through brokerage channels. If you look at the Schwab or Fidelity supermarkets and pull up bond funds, the only good low price bond funds you’ll see are the proprietary funds from Fidelity and Schwab who don’t have to shell out a lot for to get onto their own platforms. Pimco is not giving retail investors a lot (of deals), other than the funds they subadvise.

Pimco Total Return, which is a bond fund, is the top-selling fund so far this year. Do you think the firm can grab equity investors, too? Pimco is taking in a lot of money this year, so it seems to make sense that the business plan would call for branching out into stock funds. Pimco has massive, massive amounts of inflows, but most of that money is going into the institutional share classes of Pimco Total Return. Some of the Pimco asset allocation funds run by Rob Arnott are doing well. Overall, it’s stunning how much money Pimco is taking in.

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