Bill Gross and his team of bond specialists at Pacific Investment Management Company built the Total Return Fund into the world’s largest mutual fund, with more than a quarter-billion dollars in assets. Can he (and they) repeat the trick, with a Total Return exchange-traded fund?
"There's certainly buzz about this because of the track record that Bill Gross and team have put up over the longer term and people are looking for ways to participate in the fixed income market,’’ said Todd Rosenbluth, ETF analyst at S&P Capital IQ, the research arm of Standard & Poor’s.
Rosenbluth says “over the longer term,’’ because the Total Return Fund had an off year in 2011. Its return was only 1.8%. Investors ran to the doors, pulling out $5 billion, by Morningstar's count.
There’s plenty of enthusiasm emanating from that long term. If you had put $10,000 into the fund on its inception date, May 11, 1987, you would have seen its value grow to more than $70,000 now.
Since inception, the fund has grown in value 8.2%, every year. In the past three years? 9.6%, per annum.
The Total Return Fund has done this by investing in bonds, not stocks. And that is where the fund action is at. Since the end of 2008, investors have poured $813.5 billion into bond funds, by the count of the Investment Company Institute. Meanwhile, they've pulled $276.8 billion out of funds that invest long term in U.S. stocks.
“With yields as low as they are, fixed income ETFS have been gaining investor attention because they are cheap compared to a mutual fund and you can get exposure to some of the higher-yielding asset classes than what you'd find in Treasuries or certainly money markets,’’ said Rosenbluth.
Enter the Total Return Exchange-Traded Fund (ticker TRXT), debuting today on the NYSE Arca electronic exchange.
It’s going to be, off the bat, the bellwether for a new form of exchange-traded fund, the actively managed fund. That is to say, funds that try to do better than the market, by picking bonds or other securities with above-average returns. And getting them, despite the risks.
PIMCO’s Total Return ETF will be the first brand-name active ETF with a well-known fund manager behind it, and so it will be an important test case for the potential popularity of the ‘active ETF’ product structure,” said Loren Fox, head of ETF research at Strategic Insight, a research firm for the mutual fund and wealth management industry.
The bread-and-butter characteristic of an exchange-traded fund has been that it allowed investors to pick a given sector of the economy or a particular index of stock market performance and sit back and relax. The components of the fund would automatically and passively match the composition and performance of the index.
Not so with “active” ETFs. With these, managers such as a Bill Gross, bring in rules that automate human judgment or use human intelligence itself to find bonds, stocks or other investments that outperform a given index and provide investors with above-average returns.
At the end of January, the U.S. had just $3.7 billion invested in 33 actively managed ETFs, according to Strategic Insight. That amounted to less than half of one percent of the $1.15 trillion ETF market.
By contrast, roughly $1.05 trillion was held in 1,030 index-based exchange-traded products at the end of 2011, according to statistics kept by the Exchange-Traded Fund Association.
Which is why managers of other active ETFs are applauding the entry of Gross and PIMCO. That puts a seal of approval on the idea that such funds, whose shares can be traded at any time of day, can beat their benchmark brethren.
How Gross and team will go about that is not yet known.
“We don’t know exactly what’s going to be inside until it launches, but it is still the same research that is behind the mutual fund that will be behind the ETF,” said Rosenbluth.
Which means that a lot more will be known at this time tomorrow, after PIMCO reveals at the end of Thursday’s trading session what the initial holdings in TRXT are.
Regardless, the Total Return ETF is not going to be an exact duplicate of the mutual fund. This is because the mutual fund edition has no limits on the amount of futures or options it can get involved in. The Total Return ETF, by contrast, will only be able to use forwards to boost returns.
There are risks to the Total Return ETF get big fast. State Street Global Advisors’ gold fund, GLD, picked up $1 billion in assets in its first few days of operation, with similar buzz.
If TRXT gets that kind of heft, or more, its turf could get squishy. Fox worries about front-running, where a broker or investment manager buys into a stock or sells into it because of the weight that he or she knows is about to be put into that stock in one direction or another. In the case of a fund where investors are pouring money, its own movement can be self-fulfilling.
“Because Bill Gross can move markets, the Total Return ETF will be the first active ETF that truly risks front-running,’’ said Fox. “If this ETF shows that it can successfully navigate that risk, it should ease some firms’ fears about daily portfolio disclosure in an active ETF – fears that have held some portfolio managers back from considering an active ETF,” said Fox.
If the Total Return ETF grows quickly and avoids front-running, that will “inspire more firms to launch active ETFs,’’ Fox said. And that potential makes the funds debut today, two months into the year, “the most important U.S. ETF launch of 2012.”
More than two dozen firms have filed papers and are waiting for the SEC approval needed to launch an active ETF, Fox notes. These include AllianceBernstein, Dreyfus, Janus, JP Morgan, Legg Mason, T. Rowe Price and Vanguard.
This much is known about the Gross plan: his active management won’t come cheap. At least not as cheaply as with passive management of exchange-traded funds.
PIMCO and Gross will charge 55 basis points on the overall value of a purchase of shares in TRXT, as its management fee. That compares to the equivalent of 85 basis points on the Total Return mutual fund.
But fees are much less on the biggest passively managed exchange-traded funds. BlackRock charges 20 basis points on its iShares Barclays TIPS Bond Fund (TIP) fund and 15 on its iShares iBoxx Investment Grade Corporate Bond Fund (LGD).
Vanguard charges 11 on its Total Bond Market Index ETF (BND).
How big TRXT will become remains to be seen.
Right now, the biggest actively managed ETF is also run by PIMCO. Its Enhanced Short Maturity Strategy ETF (MINT) holds $1.8 billion as an alternative to money-market funds.
“We expect it to easily surpass MINT in its first year to become the largest active ETF,’’ Fox said.
And Gross is thinking bigger. He says this will be the linchpin for the development of an “array of ETFs” at PIMCO.
As for the Total Return ETF, "we hope (it) will be the biggest as well," he said.