(Bloomberg News) Bill Gross's Pimco Total Return Fund, the world's biggest mutual fund, is trailing a low-cost Vanguard index fund this year as some of the top bond investors were blindsided by the rally in Treasuries.
Gross' fund returned 1.5 percent this year through Oct. 4, compared with 8.9 percent for the $10.4 billion Vanguard Intermediate Term Bond Fund, which outperformed 99 percent of intermediate bond funds tracked by Chicago-based Morningstar Inc. The Vanguard fund, which tracks an index rather than trying to beat it, topped managers including Loomis Sayles & Co.'s Dan Fuss and TCW Group Inc.'s Tad Rivelle.
"At the beginning of the year I don't think many managers would have said Treasuries are the place to be or that the yield on the 10-year would go to 2 percent," Douglas Swanson, manager of the $21 billion JPMorgan Core Bond Fund, said in a telephone interview from Columbus, Ohio. His fund gained 6.5 percent this year.
The Vanguard fund, which beat 95 percent of funds over the past five years, won because it held bonds with longer maturities than rivals and three times as many Treasuries. While that allocation may hurt returns when interest rates start to rise, the fund's performance highlights the growing challenge to fixed-income managers from the passive strategies that have already grabbed a fifth of U.S. stock fund assets.
Bond funds have been shielded from indexing competition because unlike stock funds, they showed steady gains over the past decade, Chris Philips, a senior analyst at Valley Forge, Pennsylvania-based Vanguard, said in a telephone interview. Intermediate bond funds gained an average of 5 percent a year in the 10 years ended Oct. 4, Morningstar data show.
Index funds account for about 9 percent of bond fund assets, Morningstar data show, compared with 19 percent for stock funds. Funds run by stock pickers including Legg Mason Inc.'s Bill Miller and Kenneth Heebner of Capital Growth Management LP have experienced redemptions of $290 billion since the end of 2007, after they failed to protect investors from two bears markets in the past decade.
Bond markets are harder to track because of the number of securities in many bond indexes, said Gregory Davis, a principal in the bond indexing group at Vanguard. The Barclays Capital U.S. Aggregate Bond Index has about 8,000 bonds, Davis said. The Vanguard fund that mimics it has about 5,000 holdings.
The bond market is also less efficient than the stock market, said Morningstar analyst Eric Jacobson, because of the number of bonds outstanding and the complexity of the instruments. In theory, that should give active managers an advantage over index funds, he said.
That hasn't happened over the past five years, when just 25 percent of bond funds beat their benchmarks. That compares with 52 percent of equity-fund managers who outperformed, according to Lipper, a Denver-based research firm. A majority of actively managed bond funds failed to match their benchmarks in 10 of the last 11 years, according to Lipper. Active funds with 10 years of performance lagged behind the benchmarks by an average of 0.45 percent per year, Lipper data show.
"They quietly disappoint," said Jeff Tjornehoj, senior research analyst at Lipper, in an e-mail.