Morningstar Advisor - August/September 2013 - (Page 24)

In Practice Bond Market Behemoths By Jeffrey Ptak A look at a fixed-income market that is increasingly concentrated on just a few players. Plus, an update on tactical funds. PIMCO’s Bill Gross has been taking some heat this summer. His flagship fund, PIMCO Total Return PTTAX, saw almost $10 billion in assets head for the exits in June as investors started anticipating the end of the Federal Reserve’s quantitative easing. Investors don’t need to shed a tear for Gross. His fund still holds $260 billion. More important, Morningstar data shows taxable bond-fund assets have become increasingly concentrated among just a few big firms such as PIMCO over the last few decades. Whereas the five largest firms managed about 40% of taxable bond assets in 1993, that percentage recently stood at more than 50%. What’s more, PIMCO, one of the world’s largest bond firms, claimed nearly 19% of taxable fixed-income assets under management as of May 2013. That is nearly double the market share that the largest firm boasted in 1993. That concentration might seem odd since many bond firms and funds have opened their doors over the last 20 years. But those launches haven’t necessarily translated into a more competitive, diverse taxable-bond market. To measure this, we derived a Herfindahl index, which expresses the degree of industry concentration on a scale from 0 to 1.0. A low Herfindahl measure signals a competitive industry while a measure 24 Morningstar Advisor August/September 2013 exceeding 0.25 denotes heavier concentration. It is clear from Exhibit 1 that the U.S. bond industry, while not oligopolistic, has become more concentrated among the biggest fund families over the past two decades. If we’re examining changes in the taxable bond-fund market, we really need to focus on its largest category. The intermediate-term bond peer group accounts for the bulk of fixed-income assets and is home to behemoths such as PIMCO Total Return and DoubleLine Total Return Bond DBLTX. Accordingly, we repeated the exercise for that category, focusing on the market share of actively managed funds. As Exhibit 2 shows, this category has also become more concentrated, especially on the largest two funds. For example, PIMCO Total Return alone recently soaked up nearly one third of all actively managed assets in the category. Remarkably, this probably understates the fund’s footprint, because it doesn’t account for non-PIMCO funds that Gross subadvises in the same style, nor replica versions of the fund that PIMCO offers for distribution reasons. Like any investor, we are in the business of trying to pick skillful, active bond-fund managers for clients. What’s more, we are investing a significant amount of assets in some of the category’s largest funds, including the PIMCO and DoubleLine funds mentioned earlier. So, in view of this trend toward asset concentration and the largest funds’ increasing dominance, we increasingly find ourselves mulling over several questions. As a bond investor, what do you do when you are the market? This is a tad facetious. The taxable-bond market is large and diverse and there are other mitigating factors, such as the breakout growth of fixed-income exchange-traded funds. But it’s quite evident big funds have only gotten bigger and in investing circles that tends not to be a good portent. What’s the trade-off between scale and thought-diversity? Scale can benefit bond-fund investors in manifold ways. For example, PIMCO has parlayed its success into building a preeminent global research organization, earning our confidence and that of others. And size should yield economies of scale, which are vital in the low-return bond world. Yet, bond funds have been stingy in sharing economies of scale despite their tremendous growth in recent decades (“Fund Expenses through the Decades,” August/September 2012). So, absent that, do we overrate the importance

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2013

Morningstar Advisor - August/September 2013
Contents
Contributors
Letter From the Editor
Under Pressure
Has Your View of Bonds Recently Changed?
The Simple Life Cuts a Path to Prosperity
How Extended Is Your Bond Fund?
A Bond Contrarian Scours the Globe for Value
Investments á la Carte
Investment Briefs
Bond Market Behemoths
Shopping in the Digital Age
Shopping in the Digital Age
Diverse Crowd
Motor City Meltdown
Bond Convergence
Corporates Are Fairly Valued, but Opportunities Will Arise
A Legend Still Pines for the Good Fight
Greener Pastures
Forecasting Market Bubbles and Crashes
Forecasting Market Bubbles and Crashes
Home-Court Advantage
Overcoming Technophobia
These Funds Are Counting on Undervalued Sectors
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
What Price Advice?

Morningstar Advisor - August/September 2013