Pimco's active ETFs are flying high

By Jason Kephart

Aug 12, 2012 @ 12:01 am (Updated 5:24 pm) EST

Exchange-traded funds have always been synonymous with passive investing, but Pacific Investment Management Co. LLC is doing its best to change that.

With nearly $500 billion in assets, making it the fourth-largest mutual fund firm, Pimco turned the ETF world on its head this year when it launched the Pimco Total Return ETF (BOND), the ETF version of the $270 billion Pimco Total Return Fund (PTTAX), the world's largest mutual fund.

Actively managed ETFs had struggled to catch on with investors. Prior to the launch of the Total Return ETF, actively managed ETFs held about $5 billion in assets, or less than 1% of the industry's $1 trillion total.

But the Total Return ETF completely bucked that trend, thanks in large part to the star power of portfolio manager Bill Gross. Since its March 1 debut, the Total Return ETF has grown to more than $2 billion, knocking the $1.8 billion Pimco Enhanced Short Maturity Strategy ETF (MINT) from its spot as the largest actively managed ETF.

“The issue was, are investors choosing ETFs because they like passive investing or because of all the other positive attributes of ETFs?” said Douglas Hodge, Pimco's chief operating officer.

Among those attributes are intraday trading, being able to monitor the ETF holdings daily, and the ease of buying and selling ETF shares.

Also, fees for ETFs generally are less than those for mutual funds. Pimco's Total Return ETF, for example, has an expense ratio of 0.55%, 30 basis points lower than the retail share class of the mutual fund.

ALL ABOUT PERFORMANCE

“I think we've proven that they're choosing the vehicle,” Mr. Hodge said. “It's not about active versus passive. As long as you can deliver performance, that is what investors want.”

Performance certainly has been a key to the success of the Total Return ETF. Not only has it handily trumped the Barclays Aggregate Bond Index by more than 600 basis points since its launch, it also has outperformed its mutual fund sibling by 400 basis points.

Ryan Ely, an investment adviser at Capital Investment Advisors LLC, is put off by the performance variance between Pimco's Total Return Bond Fund and its ETF version. Even though ETF investors have benefited, he reasons that they just as easily could get hurt if the ETF underperforms the mutual fund.

“It's unpredictable,” Mr. Ely said.

“There's been quite meaningful outperformance, and we can't explain it. We were expecting the performance of the fund but with less of an expense ratio,” Mr. Ely said.

“It's important to remember that you're getting the Total Return strategy, not the Total Return Fund,” Mr. Hodge said of the difference in returns between the ETF and the mutual fund.

He attributes the short-term outperformance of the ETF to the sequencing of security selection and the general volatility in the markets.

Mr. Hodge expects that over the long term, the two will track one another more closely.

Thanks to the success of Pimco's actively managed ETFs, the firm is plowing ahead and bringing more of its mutual fund strategies to the ETF format.

Pimco has filed with the Securities and Exchange Commission to launch ETF versions of its $23.8 billion Pimco Real Return Fund (PRTNX), the $21.3 billion Pimco Low-Duration Fund (PTLAX) and the $5.7 billion Pimco Diversified Income Fund (PDVAX).

“Both MINT and BOND are proof we can add value through an ETF vehicle, and there's demand for it,” Mr. Hodge said.

BUILDING A NICHE

Active ETFs present an opportunity for firms that missed out on the initial rush of passive, or beta, ETFs, which are dominated by companies such as iShares, State Street Global Advisors and The Vanguard Group Inc., said Tom Lydon, president of Global Trend Investments.

Global Trend Investments has been investing in ETFs on behalf of its clients since 2001.

Although a number of traditional mutual fund firms, including Fidelity Investments, Janus Capital Group Inc. and T. Rowe Price Group Inc., have filed with the SEC to offer actively managed ETFs, none has followed in Pimco's footsteps to date.

To be successful, a firm needs to have both a good active-management track record and a good brand name, both of which Pimco enjoys, and of which others such as T. Rowe Price could take advantage, Mr. Lydon said.

One potential drawback to going the active-ETF route is the fear that it could cannibalize the mutual fund business, industry observers noted.

Mr. Hodge doesn't share those concerns.

“We're completely agnostic when it comes to which vehicle investors choose,” he said.

“We've had tremendous flows into both the ETF and the mutual fund. We think they can grow together,” Mr. Hodge said.

The Total Return ETF had more inflows than the mutual fund in May, attracting $585 million, compared with the fund's $124 million. Overall, the fund has attracted $4.8 billion of inflows since March, while the ETF has attracted $1.6 billion.

jkephart@investmentnews.com Twitter: @jasonkephart

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