This post originally appeared on Thursday, March 2, 2012
Today brings the most anticipated ETF launch of the last several years, with PIMCO debuting an exchange-traded version of its popular Total Return Bond Fund (TRXT). The new ETF, PIMCO’s fifth actively managed product, is managed by bond guru Bill Gross–who is widely regarded as the top fixed income manager in the world. The move by Gross and PIMCO into the fixed income space has been already been analysed from countless angles, including evaluation of the impact it will have on the active ETF space and the impact the resulting “cannibalization” could have on PIMCO’s bottom line.
The launch of TRXT has been a hot topic in recent days; Ari Weinberg at Forbes, Olly Ludwig at IndexUniverse and Tom Steinert-Threlkeld at Financial Planning have already put out great pieces highlighting the basics and some of the nuances of the potentially game-changing fund. Today, we’re taking a look at nine more aspects of the TRXT launch that have been flying under the radar, but that every investor should know [for more ETF insights, sign up for the free ETFdb newsletter]:
1. Total Return Fund Had A Rough 2011…
There is some sense among investors that Bill Gross cannot make a bad call, and certainly cannot have a bad year. But even the most successful bond investor of all time has a few stumbles along the way. In 2011, PIMCO’s flagship fund delivered a lackluster return of about 4.2%–well below the 7.8% return for the benchmark Barclays U.S. Aggregate Bond Index. That means that TRXT can’t be expected to always beat its benchmark; in some environments–such as those when bets against Treasuries don’t pan out–TRXT will lag the market [see Better-Than-AGG Total Bond Market ETFdb Portfolio].
2. But A Stellar Two-Plus Decades
The rough patch Bill Gross encountered in 2011 can’t even begin to overshadow the remarkable run this fund has had over the past two decades or so. Since inception in 1982, the PIMCO Total Return Fund has delivered average annual returns of about 8.35%–beating the BarCap Agg by about 100 basis points. It’s also worth noting that the Total Return Fund has snapped back so far in 2012, besting its benchmark by a material margin in the first month of the year.
This explains why investors are lining up down the block and around the corner to get into TRXT; the new product offers an opportunity to gain access to a legendary bond management strategy while also enjoying all the benefits of the ETF structure. Past results are never indicative of future returns, but they can be indicative of manager’s skill.
3. TRXT Can’t Use Derivatives
At this point, investors are well aware that there are differences between ETFs and mutual funds, specifically relating to tax efficiency, intraday liquidity, and transparency. In the case of TRXT, there is one additional difference; the ETF version doesn’t have the flexibility to use derivatives in its portfolio, while the mutual fund does. That could result in slightly different execution strategies between the two structures, since Gross has historically utilized derivatives regularly to accomplish his objectives [see Bond ETFs For Every Objective].
What remains to be seen is just how significant the disconnect between the ETF version and mutual fund version of the Total Return Fund is; if the use of derivatives are critical to the strategies Gross and his team employ, it would be possible for a wide gap to arise. But it seems unlikely that PIMCO would be going down this road if it expected the challenges presented by the inability to use derivatives to be overwhelming, so we wouldn’t expect this nuance to be significant.
4. TRXT: dialling Up The Risk?
After betting against Treasuries last year–a move that led to significant underperformance in 2011–Gross has been slowly dialling up exposure to debt of the U.S. government. At the end of January government and agency bonds represented 40% of the portfolio–up from only about 30% the prior month. Also increasing is the allocation to mortgage-backed securities, which now makes up about 50% of the portfolio. That’s a significant overweight compared to the underlying index; iShares’ AGG has only about 33% of its portfolio in MBS and CMBS [see Bond ETFs That Steer Clear Of Interest Rate Risk].
It should also be noted that the Total Return Fund recently had a short position in cash and money market equivalents equal to about 35% of the portfolio–meaning that the mutual fund has been utilising a fair amount of leverage recently. Again, it will be interesting to see how this strategy translates into the ETF wrapper given the restrictions on derivatives.
5. TRXT Charges 0.45% More Than SCHZ
PIMCO’s TRXT will be benchmarked against the Barclays Capital U.S. Aggregate Bond Index, a benchmark that measures the performance of the investment grade bond market in the U.S. Currently, there are four different ETFs that seek to replicate that exact same index, including funds from Vanguard (BND), iShares (AGG), State Street (LAG), and Charles Schwab (SCHZ). Of those, SCHZ is the cheapest option available with an expense ratio of just 0.10%. By comparison, TRXT will charge 0.55%.
In other words, TRXT needs to beat its benchmark by about 55 basis points every year just to match the returns that SCHZ can be expected to deliver. That’s a potentially tall “alpha hurdle” to clear, especially in a low interest rate environment where returns to investment grade fixed income securities are relatively low.
6. More Expensive Than Mutual Fund Version?
It is generally assumed that ETFs are cheaper than mutual funds, a result of the lessened administrative burdens as well as the differences between active and passive management strategies. But that’s not always the case, and the Total Return Fund is a great real life example. The Institutional class shares of the mutual fund version come with an expense ratio of just 0.46%, or nine basis points less than the ETF [see Q&A With Mathew Patterson: Are Bond ETFs Broken?] .
7. Largest Active Bond ETF: $1.4 Billion
Though the active ETF industry is generally thought of as a disappointment so far, there are actually a handful of fixed income products that have been rather successful at gathering assets. PIMCO already holds the distinction of being the issuer behind the largest active bond ETF; the Enhanced Short Maturity Strategy Fund (MINT) has about $1.4 billion in assets. So for TRXT to claim the title of biggest active bond ETF, it will have to knock off another PIMCO ETF.
8. Unprecedented Access
The launch of TRXT is exciting not only because it gives investors a new way to access the legendary Bill Gross, but because it will deliver unprecedented access to one of the greatest investing minds in the world. The transparency of the exchange-traded structure will provide a real-time window into the portfolio decisions being carried out by Bill Gross and his team, a luxury that has previously been hard to come by [see Bond ETF Drawbacks: The Case For Active Management In Fixed Income Arena]. Big moves by hedge fund managers are often only revealed months in advance, and the quarterly or monthly disclosures of mutual funds also creates a significant lag. The daily disclosures PIMCO makes on its ETFs–assuming it continues to do so for TRXT–will deliver unprecedented access to the mind of the bond king.
9. Bill Gross Turns 68 In April
Bill Gross is not only the manager of the Total Return Fund, but also a co-founder of PIMCO back in the 1970s. In other words, he’s no spring chicken; the bond fund giant will turn 68 in a couple months, so it’s logical for investors to question how much longer he’ll be around calling the shots. Gross has said that he has no plans to retire in the near term, so that should give investors some peace of mind. But it’s worth keeping an eye on in the coming years, as talks for a succession plan come into focus and talk of life after a Gross retirement becomes more meaningful.
So it turns out Warren Buffett might not be the only legendary investor whose succession plans are a topic of discussion in coming years; investors will no doubt be keeping a close eye on Gross and any intentions to step aside in the future [see Why Warren Buffett Hates Gold].
Disclosure: No positions at time of writing.
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