U.S. bond stars bet big on equities revival
(Reuters) - Some of the biggest U.S. bond firms are making aggressive pushes into the $5.17 trillion equity market business, spurred by fears the bull market in fixed income could end and anticipation of growing retail investor interest in stock funds.
After five years of monstrous cash inflows into fixed income markets, bond giants DoubleLine Capital LP, Loomis Sayles & Co and PIMCO are strategically targeting a bigger share of equities - an area that many investors have shunned in recent years.
"We have been in equities for a long time, but now we have a heavy focus on growing that business because we think it is a very good place to be in the years to come," said veteran bond investor Dan Fuss, vice chairman and portfolio manager at Loomis Sayles, which oversees $182 billion in assets.
The firm has united its fixed income and equity investment groups under new Chief Investment Officer Jae Park, who used to oversee fixed income only. It has $18 billion in equity assets under management and hopes to increase that through affiliate Natixis Global Asset Management's distribution network, Fuss said, without giving a target.
DoubleLine, the $53 billion bond firm run by Jeffrey Gundlach, announced in early January that it is rolling out a new division called DoubleLine Equity LP.
And PIMCO, home to the world's largest bond fund with $1.92 trillion in assets under management as of June 30, 2012, has in the last 12 months introduced the PIMCO EqS Long/Short Fund D (PMHDX.O), a long-short equity hedge fund.
"The big bond houses have been riding this huge wave in fixed-income for five years. They know not to rely solely on one asset class for revenues and fees. It can't last forever," said Gregory Peters, Morgan Stanley's Chief Global Cross Asset Strategist. "Mathematically, it is difficult to match the bond returns we have seen in recent years. Impossible."
Even for respected bond investors such as Fuss, Gundlach and PIMCO's Bill Gross and Mohamed El-Erian, a push into equities is not without risk. They have to compete with equities industry veterans such as Fidelity Investments, one of the biggest providers of 401(k) retirement savings plans, Vanguard Group, known for its wide range of index-tracking funds, and BlackRock Inc (BLK.N), which has dominated exchange-traded funds.
Money managers have also been plagued by a price war between ETFs and plain-vanilla mutual funds, which has pressured margins. ETFs are popular in part because they tend to charge considerably lower management fees. BlackRock, for example, has cut its fees on a handful of ETFs as competition heated up.
Still, that has not deterred bond fund managers who expect mom-and-pop investors to develop a bigger appetite for equities amid an improving economy after largely missing out on last year's 16 percent rally in the S&P 500 .SPX. The index is up more than 120 percent since March 2009, marking what many analysts have called the least celebrated bull market.
Gundlach criticized the "closet indexation" strategy that he said many influential equity portfolio managers use, which is to pick stocks to achieve returns similar to a benchmark index without replicating the index exactly. He called that passive investment management "masquerading" as active management.
"I like to think that at DoubleLine we've had some impact on shaping the fixed-income management business in terms of getting away from closet indexation; in terms of thinking creatively, managing actively," Gundlach told Reuters.
Last week, the firm registered the DoubleLine Equities Small Cap Growth Fund, the DoubleLine Equities Growth Fund and the DoubleLine Equities Global Technology Fund.
Gundlach has gained respect in the equity world since his March 18, 2009, forecast that the S&P500 .SPX would rise from 768 points at the time to finish the year at the 1,000 level. That forecast defied the prevailing market uncertainty and proved prescient - the S&P ended 2009 over 1,100 and his comments marked the start of the bull market.
ROTATION IN FIRST STAGES
About $1.1 trillion in net new cash has flowed into bond mutual funds since 2007, according to data from Thomson Reuters' Lipper service, reflecting investors' flight to safety from the U.S. and European debt crises, as well as expectations that bond prices will rise as interest rates fall.
From retirees to corporations such as Google Inc (GOOG.O), many investors sought higher investment returns by putting money in ever-riskier credits, including speculative "junk" bonds. Reflecting a rise in demand, the average junk bond yield has fallen to 5.975 percent from about 19 percent in January 2009.
"I hate to call it a 'bubble' per se, but most of these firms - as happy as they are because their bond businesses are doing so well - I think many of them are very worried that there is going to be a reckoning at some point when yields begin to spike and the credit rally peters out," said Eric Jacobson, director of fixed-income fund research at Morningstar.
Another issue is the management fees that bond firms can charge, which are much lower than in equities.
The average expense ratio on a U.S. open-ended equity mutual fund is 1.36 percent, while the average expense ratio of a U.S. open-ended bond fund is 0.98 percent, according to Morningstar.
"Hard to charge a lot when yields are so low," said David Schawel, a fixed income portfolio manager who writes for the CFA Institute.
PIMCO began expanding its equity business in earnest three years ago and launched its first actively managed equity mutual fund, PIMCO EqS Pathfinder Fund (PTHWX.O), in April 2010. It had a slow start, coming at a time of record volatility in global stock markets, which scared off investors already wounded by the housing bust.
El-Erian said the equities expansion was an essential part of PIMCO's "multi-year evolution" to become a one-stop shop for investors rather than a dominant firm only in bonds. In part because of the equities growth and other business expansions, PIMCO has outgrown its current headquarters in Newport Beach, California, and will be moving to a new 380,000-square-foot, 20-story office in the first half of 2014.
"Who is to say they won't be successful in 10 years?" Jacobson of Morningstar said. "I really like what PIMCO is doing by building their equities business from the bottom up, rather than going out and buying an equities firm. The history of doing that is very checkered."
Vanguard's principal in the portfolio review group, Dan Newhall, told Reuters he was keeping an eye on the competition and noted how crowded the market was becoming.
"For major bond players PIMCO and DoubleLine, it could be very challenging. There is room for a 'name player' to come and gather equity assets, but it is a very crowded field with many well-established names that are already there in active equity management," Newhall said.
When asked to respond to Vanguard's comments, Gundlach said: "They could have said the same thing about fixed income asset raising prospects four years ago."
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