As a sign of the times, two of Pimco’s bond funds have been downgraded by Morningstar while its non-bond related fund, the actively managed Commodity Plus Strategy, received an upgrade.

Bill Gross PIMCO

What is working for Pimco with upgrade was source of dispute

Interesting to note is that the Commodity Plus actively managed fund was one of the alternative strategies that caused tension between Pimco founder Bill Gross and former #2 in command Mohamed El-Erian.

The development of additional alternative strategies and the recent Morningstar downgrade are related in some very important ways. As previously reported in ValueWalk, when Gross and El-Erian parted ways we said there was significant disagreement among the two, which turned out to be accurate. The points of disagreement between the two legends in investing highlight the current problems Pimco faces and the downgrade.

Are redemptions about interest rate environment or about Gross and Pimco?

“The fund’s sensitivity to interest-rate moves makes it a less compelling option for investors seeking alternatives to conventional bonds, even though it has invested in less risky and speculative-grade debt,” Morningstar’s Michael Herbst, director of active funds research, and senior analyst Eric Jacobson were quoted as saying in a Bloomberg report.

What Gross was concerned about – the end of easy trades leaving the bond market – is now being expressed in the Morningstar ratings.  There is no indication as to Morningstar’s rating taking into account the personal turmoil at Pimco or the whispers both public and private that Gross is in a manic state.

The logical answer Gross devised for his business was build on the brand value of the Pimco name and enter investments that didn’t depend on lower interest rates to the same degree.  Gross built a quantitative division in the middle of a value-orientated shop which is like mixing punk rockers with the LA Philharmonic Symphony: Its either going to be a spectacular success or a monstrous failure.

The downgrades of the Pimco Unconstrained Bond Fund, along with its EqS Pathfinder, come as redemptions mount. The Unconstrained bond fund is $2.7 billion lighter in assets managed since March, for instance. The real question is the recent bout of redemptions due to the Federal Reserve’s timetable for reducing stimulus while interest rates could rise, or something more troublesome.  Are redemptions due to perceived instability from Pimco and their cat-loving leader?   One clue we can consider: comparable bond offerings from Goldman Sachs Group Inc (NYSE:GS), JPMorgan Chase & Co. (NYSE:JPM) and BlackRock, Inc. (NYSE:BLK) have seen a rise in assets during Pimco’s fall.

The overarching issue around Pimco was said to be the realization Bill Gross had made that the historic run in bonds, correlated with a steady trend in lower interest rates, may be over.  (We had reported that this was a cause of concern for Gross, something that now might be clinically diagnosed as a depression, perhaps egged on by the tragic loss of Gross’ gender-bending cat.)

Can the bond king re-invent himself as the king of the quants?  He may have to otherwise face a fate of being marginalized in an increasingly stimulus filled, quantitatively manipulated investment environment.