Tuesday, October 07, 2014
Why the Gross vs Ivascyn comparison is misleading
A lot has been made of the track records of Bill Gross and Dan Ivascyn managed funds since the sudden departure of Gross from PIMCO. Mainstream media has covered the aftermath in great detail, but explanations of the performance have gone relatively untouched. Was the performance of Bill Gross really that awful? Was it entirely attributable to a poor call on US Treasuries? Is the Ivascyn magic touch now about to change all of PIMCO’s bond funds? Let’s sort through the facts and establish some pragmatic views on the subjects.
1. Ivascyn knocked it out of the park
Make no mistake about it, the management of Dan Ivascyn’s funds the since the crisis has been nothing short of superb. The PIMCO Income Fund (PIMIX) is up an average of 12.8% over 5 years versus the category average of 7.2%, ranking it better than 99% of peers according to Morningstar. Fund assets grew from $300mil in 2008 to $6.5bil at the end of 2011, and now $38.6bil at the end of September 2014.
Ivascyn and co-PM Alfred Murata targeted beat up credit assets that would benefit from a reflating of the financial markets. As central banks moved interest rates to zero and removed government bonds from the system, investors were forced to incrementally move out the credit curve.
An example of something that PIMIX has owned and done extremely well on is Spanish Covered Bonds. This is one the larger holdings in PIMIX. As shown, in three years, the price has risen from ~50 cents on the dollar to ~120 as the Euro debt crisis calmed.
Arguably the largest source of returns for the PIMCO Income Fund has been from non-agency MBS. There’s been arguably no better place for outsized returns in fixed income than non-agency MBS since 2009. Ivascyn and team made shrewd bets that these assets would recover and they did.
All in all, Ivascyn’s bets have been credit related and have centered around risk premium compression in the junkiest areas of credit. He has not been without misses - as his PIMCO funds held large amounts of Brazilian entrepreneur Eike Batista’s bankrupt OGX, as well Mexican homebuilder Homex. The point is not that he got a few wrong, but that he bet big on a recovery in the weakest areas of the credit markets and has largely been correct. Gross himself recognized & apparently liked this opportunity set as he is the largest owner of the Ivascyn managed PIMCO Dynamic Income fund (I consider it a leveraged version of PIMIX) with over 1.6mil shares held.
2. Gross’ Total Return Fund was not comparable to Ivascyn’s Income Fund
The objective of the PIMCO Total Return Fund is to "maximize total return, consistent with preservation of capital and prudent investment management. The fund invests at least 65% of its assets in investment grade fixed income".
The objective of the PIMCO Income Fund is to "maximize current income and to seek for long-term capital appreciation…"
These objectives are not anything similar to each other. The Gross managed Total Return Fund by mandate must seek preservation capital and may only hold a maximum of 35% in non investment grade bonds. In contrast, the Income fund is seeking to maximize current income and long term capital appreciation. Gross was forced to hold a substantially larger amount of government bonds and lower yielding IG credit.
3. Even if he wanted to, the Total Return Fund was too large to buy the bonds that Ivascyn bought
Peaking at $293billion, the Total Return Fund is an absolute behemoth. Bottom line is that the types of bonds which had the most outsized returns (such as non-agency MBS) were not able to be purchased in great enough size to move the needle.
The size of the entire non-agency universe has fallen to under $750billion. After accounting for legacy holders, hedge funds, and banks, the universe to buy is very small. As an example, the large Maiden Lane auctions where the Government sold off amounts of non-agency MBS were only around $7bil if I recall correctly. If the Total Return Fund bought that whole thing it still would’ve been a very small allocation to the fund.
4. The performance of the Total Return Fund was largely based on duration calls
With a fund so large as Gross managed, the relatively performance of it came down to his call on duration. It’s been well documented that he was wrong about US rates a few years ago and that lack of duration hurt his relative performance. Regardless of QE or “the new normal”, his views on how much duration to take was the big determinant. He bet that rates would rise and inflation would as well (Gross funds were heavily long TIPS).
Yes, Gross and team made some mistakes but comparison to Ivascyn’s funds are misleading. They were playing in very different areas of the bond market and the size of Gross’ Total Return Fund were a big headwind. Astute readers will note that Ivascyn isn’t on the PM team for the Total Return fund & that’s probably a smart choice. Ironically, as Gundlach mentioned yesterday, the biggest mistake that Gross made might have been letting his flagship fund get too large.
Posted by Bud Fox at 6:19 AM