(March 20, 2014) — Morningstar has reaffirmed its gold rating on PIMCO’s Total Return fund but warned the company was still being observed for further problems after it downgraded its stewardship score this week.

In a video interview, Morningstar Senior Analyst Eric Jacobson said the heightened uncertainty since the departure of CEO Mohammed El-Erian had left a lot of questions around whether the senior staffing transitions would ultimately be beneficial to investors.

“As individuals, they are terrific managers with great intellects but when you mix it all together there’s uncertainty,” he said.

Despite these concerns, Jacobson said Morningstar’s view on PIMCO’s Total Return—the world’s largest fixed income fund—remained extremely positive.  

“We still feel very, very strongly about the fund’s people, including Bill Gross, and we still have tremendous conviction about process,” Jacobson said. “We still think performance is quite good over the long term so all of that really outweighs—for now anyway—the kind of concerns that pushed the ‘parent’ score down a little bit.”

Morningstar moved the stewardship rating down from a B to a C this week.

Asked whether the size of Total Return was a concern, Jacobson said the issue was on Morningstar’s radar. “Size for a fund like this is always going to be a question mark as it’s such a large fund, and PIMCO—and Bill Gross—manage so much money in the same style, depending on what account you use, you’re looking at around $500 billion managed in the same style.”

Jacobson said even Gross admitted managing a larger portfolio was more challenging than a smaller one, but “he argues and makes a pretty good case that the performance of the fund has been pretty good, even when the fund has gotten so large and ultimately he has adapted over the years to managing a fund of that size by focussing on not just the macro level… but also moving amongst factors and so forth.”  

As Morningstar is not legally authorised to offer investment advice, Jacobson just said investors need not start thinking about leaving the fund just yet.

“A stewardship downgrade is not a reason to leave the fund. The central investment process in PIMCO doesn’t seem to be impaired. Taking all the plusses and minuses together, PIMCO Ttotal Return still rests on a very firm foundation.”

The investment process gave Jacobson so much confidence that he said even Gross himself could leave and it could still retain its strength.

“Gross leaving would certainly be a reason to revisit the rating; I don’t think it’s an automatic given that it would reduce the rating, especially as there are some tremendously talented people now on the deputy CIO list and frankly, even behind them.”

He said the depth of staff at PIMCO was sometimes hard to grasp as their numbers were “ridiculously large”.

“They have something like 240 portfolio managers, but we have met many of those, including those who are near the top, even if their names are not well known… they tend to be really, really sharp people and among the best in the industry.”

Gross’s departure would be “a real, noteworthy milestone” as Jacobson suspected a lot of investors would quickly be spooked, which would “have its own consequences”.

Amid all this goodwill, however, PIMCO’s “pressure cooker” environment remains a concern for Morningstar.

“We will keep looking at whether that culture will improve, or turn out to be a problem for some of these rising stars—the deputy CIOs and people on the investment committee,” said Jacobson.  “There’s a lot of concern about that as they are stepping up into very high visibility roles. Frankly, either the prospect of tougher bond markets or potential performance stumbles could actually itself cause that pressure cooker temperature to rise even further. We have seen that at other firms before so it’s something that we are always watching out for.”

To watch the interview, click here.

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