Pimco fund trails peers in 2014 after missing rally

Pacific Investment Management Co.'s biggest mutual fund trailed a majority of peers for the second straight year after missing a rally in longer-term bonds and betting incorrectly that inflation would rise.

The $162.8 billion Pimco Total Return Fund, managed by Chief Investment Officers Scott Mather, Mark Kiesel, and Mihir Worah after the surprise departure ofBill Gross on Sept. 26, returned 4.7 percent in 2014, trailing 53 percent of comparable funds. In 2013, it lost 1.9 percent, lagging behind 65 percent of peers.

That didn't happen as Pimco, guided by an economic view called the "new neutral," predicted that shorter-term bonds will do better than longer-dated debt out of a belief that investors are overestimating how much the Federal Reserve will increase the benchmark rate. The managers were also stymied by sinking expectations for inflation amid a slump in oil prices. The new managers have said they're sticking with their holdings.

"Although the long end of the yield curve has rallied in recent months, we believe our underweight is justified from a secular viewpoint," Mather, Kiesel and Worah wrote in a Nov. 30 commentary posted on the firm's website. "We will continue to hold intermediate TIPS, as we believe policymakers will ultimately be successful in raising inflation expectations."

Agnes Crane, a spokeswoman for the Newport Beach, California-based firm, declined to comment.

Pimco Total Return Fund (PTTRX) suffered its biggest decline in almost two decades in 2013, hurt by similar positions in shorter-term debt and inflation-linked bonds. Under Pimco's "new neutral" thesis, the firm's outlook for the next three to five years set in May, global growth is converging toward lower, more stable speeds and interest rates will be stuck below pre-crisis levels.

The fund had 81 percent of its money in bonds with maturities of 10 years and less as of Nov. 30, according to the firm's website, with the biggest concentration, 32 percent, in bonds with maturities of five to ten years.

The fund had 6 percent in maturities of greater than 20 years. As of the end of the third quarter, the average fund in the same category as Pimco Total Return had more than one-third of assets in bonds with maturities of 20 years or more, according to data from Chicago-based research firm Morningstar Inc.

Treasuries maturing in five years returned 2.8 percent in 2014 through Dec. 30, compared with gains of about 11 percent for 10-year notes and 29 percent for 30-year bonds, Bank of America Merrill Lynch Index data show.

The fund has maintained lower interest-rate risk than its peers. As yields on 10-year U.S. government bonds declined about 85 basis points in 2014, "by having less interest rate exposure, they didn't benefit as much," Todd Rosenbluth, director of mutual-fund research for S&P Capital IQ in New York, said in a telephone interview. "More exposure to Treasuries would have helped, given how well Treasuries have done."

Performance also suffered from an allocation to TIPS, or Treasury Inflation Protected Securities. TIPS returned 4.2 percent in 2014 through Dec. 30, compared with 5.9 percent for the broader Treasury market, according to Bank of America Merrill Lynch index data.

Bond traders have lowered their inflation expectations as oil prices tumbled and the dollar climbed, making it cheaper for U.S. consumers to purchase goods from abroad. A measure of the outlook for annual inflation over the 10-year period derived from yields on TIPS, known as the breakeven rate, fell to 1.68 percentage points from 2.31 percentage points in January.

Gross still likes TIPS, telling CNBC last month that the securities "look great" as the Federal Reserve seeks 2 percent inflation. "You can buy a 10-year TIP with inflation expectations of 1.5 percent."