Total return funds mean different things to different people. There are about 75 mutual funds with "total return" in their names, according to Morningstar. Nearly half of those funds were started in the past 10 years, including eight last year and this year. Since total return funds span more than a dozen Morningstar categories, the name of the fund might not indicate much about the assets it holds or the strategies it pursues.
When clients want a total return fund, it may be difficult for advisors to sort out the options. Determining what role a total return fund can play in a client's portfolio requires a deeper understanding of this confusing category.
BIGGER AND BETTER
For the most part, total return funds are fixed-income funds. Morningstar mutual fund analyst Miriam Sjoblom says funds with "total return" in their title typically land in the intermediate-term bond category. She credits Bill Gross, founder and co-chief investment officer of Pimco, with popularizing the name as well as the concept.
"In the 1980s, bond managers wanted yield," Sjoblom says. "Bill Gross said that total return is more important. Bond managers must take risks to maximize current income, so investors might lose capital. Gross said bond managers should think holistically and try for capital gains as well as yield, thus producing a total return."
Of course, Pimco Total Return has been a huge success since its inception in 1987. It's the world's largest mutual fund, with more than $245 billion in assets. With annualized returns over 8%, this fund has beaten its benchmark, now called the Barclays Capital U.S. Aggregate Bond Index, by more than a percentage point per year, placing it near the top of all bond funds with a 24-year track record.
Seven other Pimco funds, with about $20 billion in additional assets, also carry some form of "total return" in their names. The latest entry, Pimco Total Return Fund IV, was introduced earlier this year with a strategy of downplaying high-yield debt, options and other leverage used by the original fund. In addition, Pimco also plans an actively managed total return ETF.
"We use the main Pimco Total Return fund, and have done so for years," says Erika Safran, founder of Safran Wealth Advisors in New York. "It now accounts for about 10% of client assets, but that will vary. We keep an eye on the fund and react accordingly. When we thought it was too heavily exposed to U.S. government bonds, for example, we reduced our clients' holdings."
THE FAST TRACK
No other total return fund comes close to Pimco's main offering in asset size. Metropolitan West Total Return Bond Fund is the next largest, with $13.7 billion in assets, followed by funds from Federated and DoubleLine, each with around $7.5 billion in assets. All of these funds are in the intermediate-term bond category.
While the Metropolitan West and Federated funds started in the 1990s, DoubleLine's total return fund has accumulated its assets since its April 2010 inception. DoubleLine's fund has attracted assets because it is co-managed by Jeffrey Gundlach and Philip Barach, who formerly co-managed TCW Total Return Bond Fund, which had been the top-performing intermediate-term bond fund for the 10 years through 2009.
They co-founded DoubleLine with the motto, "Like a careful motorist on a winding mountain road, the manager must not cross the double line into the oncoming lane of risk," and have focused on mortgage-backed securities. The results have been "stunning," according to Morningstar, including a 12-month total return through June of 13%, ranking at the top of the intermediate-term category, which averaged a 5.3% total return.
For the decade through the middle of this year, Pimco's flagship fund returned 7.4% annually, neck and neck with the TCW fund for the best performance among intermediate-term bond funds with a total return label. Both topped the category average by about 1.6 percentage points each year. At the low end of 10-year annualized returns among intermediate-term funds was Fifth Third Total Return Bond Fund, which averaged 4.1% annually.
Some total return bond funds are in categories other than intermediate term, and fewer have 10-year records. The best of those measured by returns has been Prudential Global Total Return, a global bond fund dating to 1986 with a 7% annualized return over the last decade. That essentially matches the category average.
Nearly every total return bond fund had positive returns for the past three years, including some in double figures, with the category holding up well during the recent financial crisis. The lone laggard was YieldQuest Total Return Bond Fund, a small fund with just $24 million in assets that guessed wrong about interest rates and the U.S. dollar, leading to losses in three of the last four years.
Many total return funds move among bond market sectors, which can create challenges for advisors. "Financial planners who are concerned about asset allocation should keep track of total return funds," Sjoblom says. "If you only want a certain portion of your portfolio to be overseas, for example, you might have to adjust clients' portfolios when a total return fund buys foreign bonds."
While more than two-thirds of all total return funds are bond funds, two dozen fall into other categories. Among those oriented toward equities, by far the largest is Royce Total Return, with more than $5 billion in assets and a track record stretching almost 20 years.
"We have used Royce Total Return for years," Safran says. "It fits well in the small-blend category." Although small-cap funds aren't the place to turn for big dividends, Royce Total Return manages a 1% yield, compared with an average yield of 0.4% for the small-blend category. The fund holds hundreds of small-company stocks that do pay dividends to help boost the total return.
Adherents of dividend-paying stocks insist that the payouts provide downside protection in bear markets. That seems to have been the case with Royce Total Return-Morningstar reports that the fund's "15-year downside capture ratio of 63 is the lowest of any small-cap fund." That means when the small-cap Russell 2000 benchmark has lost a percentage point, Royce Total Return has lost only 0.63%. Its 15-year annualized return of 10.3% tops the small-blend category average of 9.2%.
Another offering-USAA Total Return Strategy Fund-illustrates the difficulty of evaluating funds bearing the total return label. With most of its assets in the SPDR S&P 500 ETF, this fund is in Morningstar's large-blend stock fund category. But USAA Total Return is by no means limited to shares of ExxonMobil, Apple and other giants.
"It's a diversified fund with a dynamic asset allocation between stocks and bonds," says co-manager Wasif Latif. "There's also a small allocation to a market-neutral strategy aiming for returns with low correlation to stocks or bonds, as well as active risk management through the use of options hedging."
Planners may not be able to use this fund to represent the large-blend category. "Our fund could be seen as part of an alternative asset allocation in a diversified portfolio of traditional stocks and bonds," Latif says. In 2008, the fund plunged 21%, added 12.25% in 2009 and 5% last year. This year, through July, the fund was up 2.9%.
Mutual funds may seek total return in unfamiliar places these days, a trend confirmed by Tom Roseen, head of research services at Lipper. "Traditionally, total return funds were bond funds such as Pimco offered," he says. "Now they come in different flavors."
Some total return funds are what Roseen classifies as "flexible portfolio funds." They can invest in a variety of asset classes: equity, fixed-income, commodities, real estate and more. The manager has a broad mandate to pick and choose investments. "Recently, investment assets have been flowing into flexible funds," he says. If a manager might be in commodities one quarter and real estate the next, planners may find it difficult to place such a fund in a client's asset allocation model.
Nevertheless, Roseen suggests two possible ways to use flexible funds. For conservative investors, it could be a core holding. A planner could trust the manager to produce solid risk-adjusted returns and use other investments to meet a client's goals and risk tolerance.
For aggressive investors, "Say that tech has been one of your satellite holdings and that the sector has been hot," Roseen says. "You decide to trim tech. Instead of putting the proceeds into cash, put that money into a flexible total return fund while you wait for the next appealing investment opportunity."
The breadth of a flexible total return fund can be seen in Catalyst/SMH Total Return Income Fund, which now has more than $90 million in assets since its inception in mid-2008. This fund has the ability to shift between fixed income and equities, and has considerable latitude within those broad asset classes.
"When we launched, we were heavily weighted toward fixed income," says Jerry Szilagyi, CEO of Catalyst Capital Advisors. "Now we're more in equity." Equities can range from 30% to 70% of assets; it's gone from the minimum to the maximum in the past three years.
On the fixed-income side, this Catalyst fund can hold high-yield bonds and high-yield convertibles, according to Szilagyi. On the equity side, it may hold high-dividend stocks, REITs, master limited partnerships and preferred stocks, as well as business development companies, which are essentially closed-end funds that hold interests in a portfolio of private businesses.
The fund can also try to generate income by writing covered calls. "We also hedge with options on an equity index," Szilagyi says. Catalyst/SMH Total Return Income Fund sizzled in 2009, gaining 45.8%, and added another 20.5% in 2010. This year through July, it is down 2.3%.
Some funds stick to the traditional approach. That's the case with MFS Total Return, which has $6.7 billion in assets. This balanced fund is aimed at investors seeking relative stability.
"Our basic allocation is a ratio of 60% equity and 40% fixed income," says Joe MacDougall, associate portfolio manager. "We'll rebalance if the fund moves too far from there. We were buying stocks after they fell in 2008 and 2009, for instance." The fund prefers large-cap stocks. Most are dividend payers or are involved in share buybacks. The fixed-income focus is high quality, not high yield.
MFS Global Total Return, an $800 million fund, follows a similar philosophy. "We recently added foreign corporate bonds to the global fund's foreign government bonds," MacDougall says.
MFS Total Return has provided investors with gains of 4.6% a year for the past 10 years and 7.1% for the past 15 years, topping the average return for Morningstar's moderate allocation category in both periods, with below average risk. Indeed, most funds with the total return label have lived up to their name, posting decent performance numbers over the past five and 10 years.
However, there is a wide variance in performance among total return funds, reflecting different management styles. "I wish the language in the investing world could be more definitive," says Safran, the New York advisor. "Why don't we identify vehicles by what they do?" Until that unlikely day arrives, planners seeking total return will have to dig to see how each fund aims to accomplish that result.