The PIMCO Total Return Fund ("PTTRX") is an actively managed mutual fund that seeks high returns and capital preservation. Ben Gross, a fabled Wall Street bond investor, started the fund in 1987 and managed it until 2014, when he defected from PIMCO to a competitor, Janus Capital Group. As of 2016, Scott Mather, Mark Kiesel and Mihir Worah sat at the helm of the fund and continued to utilize many of the management strategies established by Gross.
The fund's bread and butter are medium-term, investment-grade bonds. These are debt instruments issued by government entities and corporations that have strong credit ratings, which means a low risk of default. They typically mature within three to 10 years of the date of issuance. Derivative investing also occupies a place in the fund's investment philosophy. A derivative is a security that derives its price from an underlying asset. Derivatives carry higher risks than traditional investments because they are zero-sum and thus tantamount to gambling – for each dollar earned by one party in a derivative bet, a dollar is lost by someone on the other side. Interest rate swaps and futures represent the most popular derivatives in the PIMCO Total Return Fund.
As of April 2016, the PIMCO Total Return Fund's top five holdings were as follows.
U.S. Five-Year Treasury Note Futures (6%)
Treasury note futures are derivatives whose prices derive from the value of Treasury securities. In the case of the U.S. Five-Year Treasury Note Future, the underlying asset is a Treasury note that matures in five years. The advantage of investing in Treasury note futures, as opposed to purchasing actual Treasury notes, is leverage. To go long on a futures contract worth $50,000 in Treasury notes, an investor must only lay out a small fraction of that amount, which represents the premium cost for the futures. The downside, of course, is the same as with purchasing securities on margin: utilizing leverage greatly amplifies risk as well as potential returns. As of April 2016, the fund allocated 13.8% of its assets to this financial instrument, which carried a coupon rate of 6%.
Mexican Peso Interest Rate Swaps (3.61%)
An interest rate swap is a type of derivative in which the parties on each side of the investment exchange interest rate cash flows. Often, a party exchanges a fixed rate of interest for a floating rate, based on the LIBOR. Offered by CME Group, Mexican Peso interest rate swaps are based on Mexico's interbank, called the TIIE. As of April 2016, the fund allocated 11.9% of its assets to this financial instrument, which carried a coupon rate of 3.61%.
U.S. Dollar Interest Rate Swaps, 30-Year (2.75%)
Also offered by CME Group, U.S. dollar rate swaps exchange an income stream based on a fixed rate of interest, with one based on a floating rate that tracks the LIBOR. The coupon rate, which is 2.75%, represents the premium received for taking on the uncertainty of a floating rate. As of April 2016, the PIMCO Total Return Fund allocated 11.2% of its total assets to U.S. dollar 30-year interest rate swaps.
Fannie Mae Mortgage-Backed Security (4%)
A mortgage-backed security (MBS) is a bond secured by a collection of mortgages. The interest payable on the bond comes from the interest paid by borrowers on their mortgage loans. As long as most borrowers keep up their mortgage payments, mortgage-backed securities can offer strong yields with little risk. During the late 2000s, mortgage-backed securities received heaps of bad press, when many of them went bad due to soaring mortgage default rates. This Fannie Mae MBS, to which the fund allocates 7.7% of its total assets, carries a coupon rate of 4%.
U.S. Dollar Interest Rate Swaps, 2-Year (1.75%)
This interest rate swap offered by CME Group carries a lower coupon rate than the 30-year interest rate swap described above, as its shorter term translates into lower interest rate risk. When the risk of an investment rises, its yield rises in concert to entice investors to take on the risk. This derivative instrument is allocated in the fund at 5.61%.