Morningstar cuts Pimco fund rating from gold to bronze after Gross exit

Saying the Pimco Total Return Fund has lost luster now that bond king Bill Gross is gone, Morningstar Inc. downgraded its rating of the flagship offering from Pacific Investment Management Co.

Morningstar, a giant Chicago investment researcher, had previously bestowed a “gold” rating on Total Return, the largest mutual fund and a staple of retirement accounts across the country. The fund, which had been managed personally by Gross, is now categorized as merely bronze.

The action, taken Monday night, came as investors pulled what Morningstar said was “tens of billions of dollars” from Total Return, which caters to large investors such as pension funds.

A separate Pimco fund for everyday retail investors, which seeks to duplicate the Total Return strategy, saw investors withdraw more than $446 million the day after Gross departed, 12.5% of its shares, Bloomberg reported on Tuesday.

Gross, by far the world’s best-known bond investor, had also managed that fund, the Pimco Total Return Exchange-Traded Fund, or ETF. That ended with his abrupt exit from Pimco last week after clashing with other top managers at the Newport Beach money management firm. He signed on instead with far smaller rival Janus Capital Group.

The Securities and Exchange Commission is investigating whether the returns reported by the Total Return ETF were improperly inflated by discount purchases of debt securities that were then valued at a higher level.

Morningstar also dropped its rating for the boards of trustees overseeing Pimco’s bond funds and its smaller collection of stock funds from “C” to “D.”

One of the bond fund trustees, Southern California businessman William J. Popejoy, had departed the board under unexplained circumstances earlier this year after criticizing Gross’ $200-million salary and “bullying” management style in an interview with The Times.

Popejoy later told The Times that he had disagreed with the chairman of the board, Pimco executive Brent Harris, over the makeup of the board, with Popejoy saying it should have women and minorities instead of just white men.

Morningstar previously had criticized the board overseeing the bond funds for having Harris head the board rather than an independent trustee.

It also faulted the board for having just five independent trustees among the total of seven -- less than the three-quarters majority it said was a best practice for mutual fund boards.

The departure of Popejoy, longtime head of the board’s governance committee, and of another longtime trustee, Vern O. Curtis, leaves just three independents on the board -- “well below industry standards,” Morningstar said.

“Although Pimco says that board is seeking trustee replacements, most board members report it can take easily more than a year or even two to come fully up to speed as a new director,” Morningstar senior analyst Eric Jacobson wrote in a “Fund Spy” note to investors.

“That learning curve at Pimco seems particularly steep considering the firm’s large fund lineup and complex portfolios,” Jacobson said.

Morningstar could have dropped Total Return, Pimco’s flagship offering, to a neutral or negative rating. But it said the team of managers installed Friday to replace Gross was too accomplished to contemplate such an action.

“Pimco Total Return enters a new era with uncertainty but also a good deal of promise,” the giant Chicago investment research firm said in revising its ratings.

“Morningstar remains positive overall on Pimco Total Return after the departure of Bill Gross but is downgrading the fund to Bronze because of the resulting uncertainty regarding outflows and the reshuffling of management responsibilities,” Morningstar said.

The Total Return Fund is now run jointly by three of Pimco’s top fund managers: Scott A. Mathers, Mark R. Keisel and Mihir P. Worah.

“Mark, Mihir and I will harness our individual and collective skills to continue to deliver the same excellence to investors they have come to expect from Pimco’s Total Return Fund,” Mathers said in a statement.

Echoing comments of Pimco managers, Morningstar said Pimco’s funds appear to be able to handle the large numbers of investors cashing out their holdings, a trend that began before Gross’ departure in reaction to the spotty performance of the Total Return Fund in recent years.

“We are comfortable with how the fund’s portfolio could withstand outflows at least in the near term,” Michael Herbst, a Morningstar director of manager research, said in a video on the research firm’s website.

“By our accounting at least a third of the fund is in highly liquid securities. That’s before you even account for cash. That’s before you account for coupon payments into the fund as well,” Herbst said.

But he added: “That situation could change as we start to see flow data coming out of the firm in the coming days and weeks.”

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