Pimco Fund Beats S&P 500 With Bonds
By Karen Damato

12/06/1996 The Asian Wall Street Journal Page 8

A self-confessed "bond geek" is beating many stock-fund managers at their own game.

David Edington runs Pimco StocksPlus Fund, whose three-year performance ranks fourth among 309 "growth and income" funds tracked by Lipper Analytical Services Inc. The three-year-old fund has achieved its stated goal of beating Standard & Poor's 500-stock index in 1994, 1995 and so far this year -- all with an unusual strategy of picking bonds, not stocks.

Selecting the stocks or stock sectors that are going to outperform the index "is just a really tough thing to do," Mr. Edington says. And it certainly isn't what Pacific Investment Management Co., the big bond manager in Newport Beach, California, is all about.

Hence the rather complicated nonstock strategy that the $180 million-asset Pimco StocksPlus and a few smaller funds employ. With a small amount of the portfolio, they buy S&P futures contracts or related derivatives to capture the same price gains they would get by simply buying -- for much more money -- all of the stocks in the benchmark index. Roughly 4% of fund assets are set aside in U.S. Treasury bills to collateralize those futures contracts. Then the manager runs the vast majority of the portfolio as a short-term bond fund.

How that approach pays off basically comes down to this: S&P futures typically are priced so that a portfolio combining futures with risk-free U.S. Treasury bills will deliver the same overall return as the index itself.

StocksPlus and similar funds attempt to consistently beat the S&P index by venturing into securities that offer a little bit more yield than Treasury bills because they entail more interest-rate or credit risk. The Pimco fund is fairly adventuresome, nibbling, for instance, on below-investment-grade "junk" paper and debt of "emerging" nations.

While "it's not a free lunch," the Pimco manager says, the strategy seems more dependable than trying to beat the stock market by picking individual stocks. One of the biggest risks is a period of sharply rising short-term interest rates. StocksPlus trailed the S&P index for a while earlier this year and in 1994, when rates rose, but subsequently bounced back. The fund usually has an average maturity of about six months.

A lot depends on the details of a fund's investment plan and the particular manager's ability. Payden & Rygel Market Return Fund buys somewhat longer-term securities than does the Pimco fund and is running about four percentage points be hind the S&P after less than a year of operation. (Other funds of this ilk are Smith Breeden Equity Plus and DFA Enhanced U.S. Large Company Portfolio.)

The Pimco fund, which generally has been available to individuals only throughcorporate retirement plans and fee-paid investment advisers, is expected to be launched in a retail $1,000-minimum version next month.

But Pimco's fund will be available only to people investing through an Individual Retirement Account or other tax-sheltered vehicle. The reason: Most of the fund's gains are immediately taxable as ordinary income or short-term gains. By contrast, there are tax advantages to ordinary "index" funds that simply hold the stocks that comprise an index. Because those funds don't sell many securities, much of the tax hit is deferred until the investor sells the fund shares.

Mr. Edington, the 39-year-old manager of Pimco StocksPlus, certainly isn't an ignoramous about stocks. He has a masters degree in management with a concentration in finance and boasts that the Intel shares he bought at $52 are now at $129.50. Still, bonds are clearly his thing. "My wife hates it when people start asking me about bonds at a party," he says, "and I won't shut up for an hour or two."