By Sam Forgione
NEW YORK, Jan 3 (Reuters) - The Pimco Total Return Fund, the world's largest bond fund, saw its assets sink by a record $41.1 billion last year after a mistaken bet on U.S. Treasuries resulted in the fund's worst annual performance in nearly two decades.
Investors pulled $4.2 billion from the fund in December, marking the eighth straight month of outflows and reducing the fund's assets to $237 billion. The fund fell 1.9 percent last year, marking its first annual loss since 1999 and its worst performance since 1994, according to preliminary Morningstar data.
Pimco had outflows of $10.4 billion across all of the its U.S. open-end mutual funds in December, resulting in outflows of $31.1 billion for the year. That marked the first annual outflows from those funds since Morningstar began tracking them in 1993.
The fund's status is closely watched because Pimco, a unit of European financial services company Allianz SE, is one of the world's largest bond managers and had $1.97 trillion in assets as of Sept. 30, 2013, according to the firm's website.
Investors also pulled $147 million from the Pimco Total Return Exchange-Traded Fund in December, and the ETF saw net outflows totaling $197 million in 2013, Morningstar data showed on Friday.
The ETF, which is actively-managed and designed to mimic the strategy of the mutual fund, fell 0.85 percent in December, marking the worst performance among its peers, according to preliminary Morningstar data. For the year, the ETF fell 1.2 percent but still beat 80 percent of peers.
The Pimco Total Return Fund had a large holding in Treasuries last year when Federal Reserve Chairman Ben Bernanke told Congress on May 22 that the central bank could reduce its $85 billion in monthly bond-buying stimulus later in the year, which triggered a selloff in Treasuries and other bonds.
"They were on the wrong side of the direction of U.S. interest rates," said Todd Rosenbluth, director of mutual fund research at S&P Capital IQ.
The Total Return Fund had a 37 percent exposure to Treasury securities at the end of May, according to data released on the Pimco website, making Treasuries its largest holding. The fund maintained the high exposure to the debt through November.
The yield on the benchmark 10-year U.S. Treasury meanwhile spiked about 140 basis points from 1.62 percent on May 2 through the end of the year. Bond yields move inversely to their prices.
The benchmark Barclays U.S. Aggregate bond index fell over 2 percent in 2013 in the wake of the bond market selloff, also marking its first annual loss since 1999 and its worst performance since 1994.
Investors pulled cash out of other U.S. intermediate-term bond funds last year, although the Pimco Total Return Fund took up much of the net outflows. All U.S. intermediate-term bond funds had outflows of $73.2 billion last year through November, according to Morningstar data.
Gross sought to reassure bond investors in a July letter to investors after seeing $9.6 billion in outflows from the Pimco Total Return Fund in June, a monthly record according to Morningstar.
"Don't jump ship now. We may have reached an inflection point of low Treasury, mortgage and corporate yields in late April, but this is overdone," Gross wrote.
Investors continued to pull cash from the fund, however, and by October it lost its title of world's largest mutual fund to the Vanguard Total Stock Market Index.
In recent letters to investors and posts on social media platform Twitter, Gross has recommended that investors buy shorter-dated Treasuries on expectations that the Fed will keep short-term interest rates low until 2016 or later.
Gross has also recommended Treasury Inflation-Protected Securities (TIPS) in recent months on expectations that the Fed's easy money policies will spur inflation.
Bets on TIPS also likely hurt the Pimco Total Return Fund's performance in 2013 given the underperformance of those bonds, Rosenbluth of S&P Capital IQ said. The Barclays U.S. TIPS index fell 8.6 percent in 2013, marking its worst yearly performance on record.
On Friday, Gross wrote on Twitter that short-dated bonds could outperform stocks this year. U.S. stocks rallied to multiple record highs in 2013 largely as a result of the Fed's stimulus, and the Standard & Poor's 500 index rose 29.6 percent, its best performance since 1997.
"Don't be so sure a risk adjusted position in 1-5 year bonds won't outperform stocks in 2014," Gross wrote.