Our August 18 article, Actively Managed TIPS?, contained a glaring factual error that I need to correct. In addition, a reader has challenged some of my assertions, and I want to respond to those challenges.
The error was my statement that the Vanguard fund VIPSX is the only actively managed TIPS fund. PIMCO also has a large actively managed TIPS fund, PRRIX, as do as many as 25 other fund companies. Vanguard’s and PIMCO’s funds are by far the largest.
The performance of PRRIX is notably better than that of VIPSX, as Bob Marshalla of Marshalla Asset Management in Los Altos, CA, points out:
Robert Huebscher’s article in today’s Advisor’s Perspectives rips PIMCO’s contention that active management of TIPS makes sense. It seemed strange to see that he compared the performance of a Vanguard active fund to that of the passive TIP ETF, but did not show the returns for the PIMCO fund itself. So I looked it up on Morningstar.com. Now I see why he left it out. It turns out the PIMCO Real Return (PRRIX) has outperformed TIP for each of the past one, three and five year periods. For one year, the score is +0.65% for PIMCO, to -1.16% for TIP. For three years it is 5.15% to 4.83%, and for five years, 4.60% to 4.20%. These returns are after fees. And, by the way, the OER for PRRIX, which is the fund I use for my clients, is 0.45%, a far cry from the 75 to 100 basis points that Huebscher quotes. Huebscher’s article is dishonest. It appears he had a point to make and he made it without letting any inconvenient facts get in the way. I am mystified as to why he would try to dissuade people from using this fund/approach.
To understand the source of this outperformance, I reviewed the fund’s prospectus and fact sheet and spoke with John Cavalieri, the primary author of the study cited in my article and the Real Return Product Manager at PIMCO.
Cavalieri explained that PRRIX, by its prospectus, holds at least 80% in inflation-linked bonds at all times, which are primarily US TIPS. PRRIX can also hold limited amounts of inflation-linked bonds of other developed countries, as well some non-inflation-linked bond and derivatives including options, forward contracts, or other derivatives tied to TIPS. These positions are used to express short-term relative value views versus TIPS.
When PRRIX uses certain derivatives, it must also post cash and cash-equivalent collateral so as not to create leverage. Morningstar, when it displays portfolio holdings, incorrectly includes this collateral as part of the fund’s holdings. This was the reason for my misclassification of PRRIX; Morningstar’s data incorrectly indicates the fund currently has only 35% of its assets in TIPS.
PIMCO manages the PRRIX fund in the same manner as its other actively managed bond funds, which Cavalieri explained in an email:
Conceptually, you can think of it as a two-step process (though in practice these steps happen simultaneously). First, we seek to gain more cost efficient exposure to the TIPS market by gaining TIPS positions that match the risk exposures of the TIPS index, but we do so in a way that navigates around the structural inefficiencies in the TIPS market that were the topic of our paper. Second, we incorporate our active views as modest relative value deviations from the index-specified positions. These views come in two groups – macro "top-down" views and more micro "bottom-up" views. Top down strategies include duration, curve positioning, break-even inflation widening/narrowing, country rotation among developed inflation-linked bond (ILB) issuers and sector rotation. Bottom up strategies include seasonality trades, on the run/off the run premiums, general issue selection and relative value based on implied optionality in the embedded deflation put within TIPS (at maturity, TIPS return not less than original principal value, which means TIPS buyers can put inflation risk back to the government at that time).
