PIMCO’s BOND: Active Management Warning

Bill Gross’ departure is a wakeup call for active management fans.

In case you’ve been under a rock, one of the few rock stars of investment management has jumped to a new band. Whether or not it has anything to do with the pending SEC investigation, Bill Gross is moving to Janus, to run, it would seem, the Janus version of a PIMCO Total Return strategy.

That was the Friday news. The Monday news is that PIMCO has moved fast in re-filing a prospectus for the PIMCO Total Return ETF (BOND | B) dated Sept. 29. That’s a long weekend’s work for some lawyers. There are two things to note in the refiled prospectus.

Heavy Turnover

The first is that the firm acknowledged its most recent fiscal year featured 450 percent turnover. I’m guessing that was disclosed in the last semiannual report, but it caught me off guard. Put in perspective, that means the average position in BOND is held less than a quarter. I’ll be honest, I find that somewhat shocking.

We’re not talking about a 90-day Treasury fund, we’re talking about a go-anywhere fund with an effective duration of more than five years. That’s a lot of “no, wait I meant to buy this, not that” going on every quarter.

But of course the more relevant news bite is the re-establishment of the investment manager. The old prospectus just had (literally) a picture of Bill Gross in it. The new prospectus has pictures of Scott Mather, Mark Kiesel and Mihir Worah. Each holds the title of “chief investment officer” for a different asset class (core strategies, global credit and real return, respectively). The prospectus includes the encouraging comment that “Messrs. Mather, Kiesel and Worah have jointly managed the Fund since September 2014.”

Problem With Active Management

Now, I’m sure that these three gentlemen are extremely good at their jobs. But this whole thing highlights one of the key problems with active management, whether in an ETF wrapper or anywhere else: human beings.

I don’t believe active-management, risk-adjusted outperformance is impossible. I just believe it’s extremely, difficult to deliver in a consistent, cost-effective way. I believe it’s even more difficult when the underpinnings of the outperformance are based purely on human insight. Again, it’s not because I don’t think human beings can have insights, it’s because I know too many human beings.

Human beings have bad days. Human beings act on insufficient information and “gut feelings.” Human beings are susceptible to influence and argument. Human beings can get hit by a bus.

Human beings can jump ship.

Does that mean it can’t possibly work? Of course not. But with a fund turning over its entire portfolio every quarter, it’s reasonable to look at it from a “what have you done for me lately?” perspective:

And the unfortunate answer is “not much.” For a substantially higher amount of risk, BOND investors have barely squeaked past the world’s most boring ETF, vastly cheaper, saner and analyst pick iShares Core U.S. Aggregate Bond ETF (AGG | A-97), and has trailed well behind two sectors of the market it once beat regularly—high-yield corporates and munis.

Outflows Follow Underperformance

This consistent underperformance hasn’t gone unnoticed by investors, and over the past year, just less than $500 million has flowed out of the fund. Maybe the new team will shoot the lights out, right the ship, correct the course or whatever tortured metaphor you like.

But then again, how will you know? They are, after all, still human beings. And human beings, when it comes to investing, are often the problem. I doubt more than a handful of investors can name a single individual on the BlackRock fixed-income portfolio management team.

That’s not because they’re not all also very good at their jobs, it’s because they’re part of an investment management process that doesn’t depend on the brass plaque on the door remaining identical year after year.

At the time this article was written, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.