PIMCO Fundamental IndexPlus (PXTIX) ranks as one of the most outstanding stock funds. During the five years ending in May, the fund returned 13.1 percent annually, topping the S&P 500 by 7 percentage points, according to Morningstar. Noted portfolio manager Bill Gross made the feat look easy, relying on mechanical futures strategies and some shrewd bond picking. Gross is not the only fund to top the benchmarks without doing much active stock trading. A number of unorthodox funds used mechanical approaches to excel. But can these managers continue to outperform? Some seem poised to remain on top, while others are likely to slip.
Permanent Portfolio (PRPFX)
In the 1990s, the Permanent Portfolio fund lagged the markets badly. Then after the downturn that began in 2000, the fund caught fire. During the past 10 years, the fund returned 9 percent annually outdoing 99 percent of peers in the conservative allocation category. Can the winning streak continue? Probably not.
The fund keeps fixed allocations in a variety of assets, including gold, Treasuries, and Swiss francs. The aim is to provide a portfolio that can survive hard conditions and deliver some gains in bull markets. In the turmoil of 2008, the fund worked beautifully, but these days many of its holdings are sinking fast. If interest rates rise in the future, Treasuries will languish. Gold is not likely to thrive at a time when investors are gaining confidence and favoring stocks.
PIMCO StocksPLUS Absolute Return (PTOAX)
Bill Gross operates a group of StocksPLUS funds that aim to outdo benchmarks. This one has returned 8.8 percent annually during the past five years, topping the S&P 500 by 3 percentage points. To appreciate how Gross uses futures to work his magic, consider an investor who has $100,000 and wants to track the S&P 500 for the next three months. The investor purchases futures that rise and fall along with the benchmark. To control the full $100,000 worth of stocks, the investor will only give the broker part of the cash. After buying the futures, the investor can put the rest of his money into money market funds or other investments.
For StocksPLUS Absolute Return, Gross buys S&P 500 futures and puts the extra cash into bonds. If the bonds earn nothing, the portfolio will lag the S&P 500 by an amount that is roughly equal to the cost of the futures. If the bonds earn more than the futures cost, Gross can top the benchmark. The strategy may look easy, but competitors have failed miserably.
If rates rise in coming years, bond returns will sink, and PIMCO will have a harder time topping the S&P 500. But don’t count out Gross. PIMCO StocksPLUS Absolute Return has the flexibility to sell bonds short, betting that prices will fall. That could enable Gross to continue beating the S&P 500. Still, new investors should expect that the margin of victory will be smaller in coming years than it was in the past.
Parametric Emerging Markets (EIEMX)
While iShares MSCI Emerging Markets Index ETF (EEM) lost 2.1 percent annually during the past five years, the Parametric fund declined 0.6 percent annually. Parametric was also much less volatile than the MSCI index. The mutual fund accomplished the feat by using country weights that are very different from the approach of standard benchmarks. Because the MSCI weights stocks according to their market capitalizations, a handful of big emerging markets account for most of the assets in the benchmark. China represents 18 percent of the assets, and Brazil is 9 percent. The Parametric portfolio managers argue that the standard approach is too concentrated. The hazards of market-cap weighting became clear in the past year as China and a few other big countries lagged, bringing down the benchmark.
To provide better diversification, Parametric divides the universe into four tiers according to the size of the countries. In the first tier—which includes the biggest markets, such as China, Brazil, and Russia—each country has a target allocation of 6 percent of assets. The second tier has countries, such as Chile and Malaysia, which each get 3 percent of assets. Tier three is made up of smaller emerging markets, such as Colombia and The Philippines, which each account for 1.5 percent of assets. The fourth tier includes the frontier markets, such as Kenya and Latvia, each holding 0.75 percent.
Compared to the benchmark, Parametric has a smaller allocation to the big countries. The emphasis on small countries has helped recently as the biggest markets have slowed. Parametric’s approach is likely to continue winning because the growth prospects of the big countries are moderating as the economies mature. The smaller countries seem likely to enjoy a surge of growth as they modernize.
Guggenheim S&P 500 Equal Weight (RSP)
This passive fund puts 0.2 percent of its assets in each of the 500 stocks in the benchmark. That is very different from traditional index funds, which weight stocks according to their market capitalizations. While Apple, the biggest stock in the S&P 500, accounts for 3 percent of the benchmark, small holdings—such as First Solar—only have 0.01 percent of assets. Lately the equal-weight approach has won the race. During the past 10 years, the Guggenheim fund returned 9.8 percent annually, compared to 7.6 percent for the conventional S&P 500.
The equal-weight strategy will likely remain on top during the next decade because it underweights the mega-cap stocks that dominate the standard S&P 500. Many studies have shown that small stocks outdo large ones over long periods. Of course, there are times when mega caps shine, but such periods are exceptions.
ING Corporate Leaders Trust (LEXCX)
This remarkable fund is a ship without a captain. The fund started in 1935 as a basket of 30 dominant companies. As holdings merged or went out of business, no new stocks were added. Today 22 familiar names remain in the portfolio, including Exxon Mobil and Procter & Gamble. This static approach has worked beautifully. During the past 10 years, the fund returned 10.9 percent, outdoing 99 percent of large value peers. The fund has big overweights in utilities, energy, and basic materials. But that may not be a recipe for success in the coming decade.