ETF sponsors getting active in bond arena

Jun 23, 2013 @ 12:01 am

By Andrew Osterland and Jason Kephart

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With interest rates rising and volatility increasing in fixed-income markets, exchange-traded-fund sponsors are looking to launch actively managed funds for bond investors.

A survey conducted by Cerulli Associates Inc. in the first quarter found that 57% of sponsors intend to introduce actively managed fixed-income ETFs this year.

“Investors and financial advisers want strategies beyond the typical intermediate-term-bond fund,” said Alec Papazian, an associate director at Cerulli. “In a period of rising interest rates, they see value in active management.”

The success of Pimco's Total Return ETF, which mirrors the manager's mutual fund of the same name, likely has sparked much of the interest, Mr. Papazian said.

Since launching the Total Return ETF in February 2012, Pacific Investment Management Co. LLC has attracted nearly $5 billion from investors. That is a tiny sum compared with the more than $290 billion in the firm's Total Return mutual fund, but it is a huge success, nonetheless.

Pimco has plans to introduce another three actively managed ETFs in the near future: Pimco Diversified Income, Pimco Real Return and Pimco Low Duration. All three funds will mirror other fixed-income mutual funds at the firm.

FIDELITY'S PLANS

Meanwhile, Fidelity Investments has received the OK from the Securities and Exchange Commission to launch actively managed bond ETFs, but it still is working out the kinks in the corporate-bond and mortgage-backed securities ETFs that it has proposed to offer, said Ron O'Hanley, president of asset management at Fidelity.

At the heart of the problem is concern about how the funds would be affected during any upheavals in the bond market, he said.

“Active bond ETFs haven't been tested under stress yet,” Mr. O'Hanley said. “We've still got some stress testing to do.”

Other sponsors are betting that active ETFs can handle the stress.

First Trust Portfolios LP, for example, launched a high-yield long/short ETF in February that has taken in about $25 million so far, according to Mr. Papazian.

Columbia Management Investment Advisers LLC has filed to launch 17 active ETFs in fixed-income and equity market segments. New fund offerings are expected in the municipal and taxable-bond-market segments.

With total assets in active ETFs at just over $10 billion at the end of last year, compared with $1.3 trillion in passive funds, the products could be a significant source of growth for the industry.

Sponsors, however, aren't likely to have the kind of immediate success that Pimco did with the Total Return ETF, Mr. Papazian said.

“Pimco comes with a strong brand name and star fund managers,” he said. “I'm interested to see how the Columbia product launches go.”

UNDER STRESS

Mr. O'Hanley is particularly concerned about how active bond ETFs will perform under stress, because broker-dealers have been shedding their bond inventories since the financial crisis.

“Broker-dealers have all turned into brokers,” he said.

The average broker-dealer held about $250 billion in corporate bonds before the crisis. Now the average is about $40 billion.

“If B-Ds are unwilling to buy in times of stress, the markets will become less efficient,” Mr. O'Hanley said.

But even with those concerns, he is excited about the potential of ETFs.

“We've seen the end of Chapter One in ETFs, but there's a lot more to come,” Mr. O'Hanley said.

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