A Gross Paradox
PIMCO’s Bond King blasts high fund fees, something the King’s Court knows plenty about.
By Eric Jacobson | 08-06-09 | 06:00 AM
Bill Gross dropped a bomb last week, and it was called “Investment Potions,” the August edition of his Investment Outlook column.
About the AuthorEric Jacobson is a fixed-income specialist and former senior fund analyst with Morningstar.Contact Author | Meet other investing specialists
“…those who sell investment ‘potions’ must wrap their product with an extra large ribbon because history is not on their side. Common sense would dictate that the industry as a whole cannot outperform the market because they are the market, and long-term statistics revealing negative alpha for the class of active managers confirms it. Yet, what a price investors are willing to pay!”
If that was the shock wave, the blast was right behind. Gross quoted data citing 1% and 0.75% average expense ratios for stock and bond funds respectively, ripped money market funds charging 38 basis points, and called the whole thing an “extreme absurdity.”
“Paying for those potions during an era of asset appreciation with double-digit returns may have been tolerable, but if investment returns gravitate close to 6% as envisaged in PIMCO’s “new normal,” then 15% of your income will be extracted based on the beguiling promise of Madame Rue (…and her Love Potion #9).”
The whole thing drew cheers at Morningstar and undoubtedly set off alarms at the fund industry’s Investment Company Institute, but it must have really sent some folks reeling back at PIMCO. Because when it comes to egregious bond fund fees, there’s nobody better suited as the target of Gross’ invective than PIMCO itself.
Those fortunate enough to access his skills via an institutional share class of PIMCO Total Return (PTTRX
) –within a 401(k), for example–or clever enough to invest in one of Gross’ moderately priced subadvised offerings sold by Harbor ( Harbor Bond (HABDX
) ) or Managers Fremont ( Managers Fremont Bond (MBDFX
) ) might not understand why. But other “retail” investors, planners, or brokers who use any of PIMCO’s A, B, C, D, R, or administrative share classes understand the pain.
On average, the firm’s A-share taxable-bond funds charge a generous 1% per annum in expenses. The number is a little milder on an asset-weighted basis because behemoth PIMCO Total Return A (PTTAX
) charges 0.90%, though it does include a service fee that generally goes back to each client’s brokerage firm. But even if you examine the lowest-cost–but still pricey–PIMCO retail shares generally available through mutual fund supermarkets, and even if you asset-weight them, you still get 0.80%. Distribution costs borne by the shares of nearly all intermediary-sold funds pad all of those numbers, but they’re still too high at PIMCO either way.
That’s not to say PIMCO’s bond funds have failed their investors. By and large, even those stacked with extra administrative costs have performed well in recent years. After all, they have enjoyed some of the best bond management we’ve ever seen. But the fact is that Gross’ point is an excellent one, no matter whom it’s applied to.
And really the best part is that the message came from Bill Gross himself, and it came packed with investment logic. You can spend all day arguing whether the fund industry is competitive enough, but that’s a second-order question behind whether there’s going to be enough money left on the table for shareholders once fees are paid. And Bill Gross knows something that people within his own firm have sometimes glossed over in arguing that great management justifies great pay: Investment returns that are chewed up by high fees are going to be that much smaller, no matter how terrific the manager is who produced them.
More or Less Than Just a Flesh Wound?
As befuddling as this may all seem, there is one pretty good reason this episode may be embarrassing, but not entirely earth shattering, within the halls of PIMCO. Despite universal admiration for the way the firm has built its reputation and mutual fund business over the years, mutual funds only represent roughly one third of the firm’s assets–and a huge chunk of those are in reasonably priced institutional shares. So many, in fact, that the percentage of PIMCO’s overall assets represented by the costly share classes we’ve alluded to above is a relatively modest 8.8%. At more than $70 billion, that’s not chump change, and the profits it generates are undoubtedly fat. But if any firm can tolerate cutting retail fees in order to adjust for the conditions Gross predicts, it’s PIMCO.
Bill Gross has already stood on the soapbox Ronald Reagan style, and let’s hope others at PIMCO and its funds’ board of directors were listening closely. Maybe Gross has a little Mikhail Gorbachev in him too. If so, then he knows the rest of the message: Mr. Gross, tear down those fees!