Several of the world’s largest bond funds, including products from investment powerhouses Pimco and TCW, have been stripped of coveted four- and five-star ratings after Morningstar rejigged its ranking system for $1.5tn of fixed income funds.
The research group, whose star ratings are highly influential on the fund choices made by investors and their advisers, has split its core bond fund category in two, separating out $730bn of riskier funds that it now calls “core plus”.
Core bond funds, also known as intermediate term bond funds, are a key building block of retail investors’ portfolios, particularly for conservative investors. The lower star ratings on many core-plus funds raises the possibility that they will be snubbed by investors and advisers who buy only the highest-ranked products.
Morningstar downgraded the main share class of Pimco’s $65bn Total Return bond fund, the asset manager’s flagship fund when it was run by “bond king” Bill Gross before his acrimonious departure in 2014, from four stars to three.
TCW suffered similar downgrades on two funds, the MetWest and TCW total return bond funds, which combined have assets of close to $80bn
Money that goes into bond funds is meant to be the most secure of an investor’s portfolio, said Faris Chesley, chairman of Chesley, Taft & Associates, an investment adviser in Chicago managing $2bn of assets.
“We do not want to take risk there,” he said. “When you get a change in rating, you move. You do not stay. It’s important to us . . . If you are not in a four or a five [star fund] then you better watch out.”
Morningstar calculates star ratings based on a fund’s short, medium and long-term performance ranked against other funds in the same category. Backward-looking by nature, they have been a controversial way to decide which funds to buy, but they retain significant market influence.
The bond category split, introduced by Morningstar this month, aims to differentiate between core funds that overwhelmingly buy investment-grade debt and core-plus funds that take a more flexible approach to investing, often buying more high-yield bonds or structured products.
Over the past decade, with low interest rates and easy credit conditions, riskier core-plus funds have generally outperformed, leading them to be awarded higher star ratings when compared against safer, core funds, said Sarah Bush, director of fixed income strategies at Morningstar.
“In the past you could argue it was easier for a core-plus fund to get a higher rating. The new star ratings do a better job of comparing apples to apples,” said Ms Bush.
Laird Landman, who co-manages the MetWest total return bond fund, said its lower rating stemmed from it being one of the more conservative to have found its way into the core-plus category.
“We are not going to change our investment style because Morningstar makes universe changes. That would lack discipline and not be the right thing for our clients,” he said. “Could we be screened out of searches for a year or two? Possibly. Will we continue to thrive? As long as we do the right thing for our investors.”
Several funds slipped from five-star ratings to four. Investment company Voya, whose $4.3bn intermediate term bond fund now has four stars, said it was supportive of Morningstar’s changes.
One share class of PGIM’s $40bn total return bond fund also dropped to four stars, although most share classes were kept at five stars. “Any fund that was moved from four to three stars may have to answer some questions,” said Rich Woodworth, vice-president of product management and investment analytics at PGIM. “You are certainly in a better position if you remained four or five star than if you went down to three.”
Additional reporting by Robin Wigglesworth
Get alerts on Investing in funds when a new story is published