(Bloomberg) -- Pacific Investment Management Co. said it’s cooperating with regulators examining how the firm assigned asset prices at Bill Gross’s Pimco Total Return ETF.
“Pimco has been cooperating with the SEC in this non- public matter, and we take our regulatory obligations and responsibilities to our clients very seriously,” Mark Porterfield, a spokesman for Newport Beach, California-based Pimco, said in an e-mailed statement. “We believe our pricing procedures are entirely appropriate and in keeping with industry best-practices.”
The probe is the latest hurdle faced this year by Pimco, which is dealing with record redemptions at its main mutual fund. The firm is also struggling with negative publicity stemming from the abrupt departure of its former chief executive officer, which was followed by the biggest management overhaul in its history. Gross’s Total Return mutual fund has experienced 16 straight months of redemptions as returns trailed rivals and investors sought alternatives to traditional bond strategies in anticipation of rising interest rates.
The exchange-traded fund, which employs a strategy similar to Gross’s $221.6 billion Pimco Total Return mutual fund, was started in March 2012 to attract what the firm described at the time as “mom-and-pop investors.”
Since March 1, 2012, the Pimco Total Return ETF had returned 16 percent through yesterday, compared with the 9.1 increase for the mutual fund and 5.6 percent return in the Barclays U.S. Aggregate Index for bonds, according to data compiled by Bloomberg. This year, Pimco Total Return ETF has advanced 5 percent, compared with 3.6 percent for the mutual fund and 4.1 percent for the index.
Limited Supply
The issues being probed by the SEC include whether the $3.6 billion exchange-traded fund bought investments at discounted prices while relying on higher valuations for the assets when the fund calculated the value of its holdings, the Wall Street Journal reported yesterday, citing unidentified people familiar with the matter. The SEC’s probe into pricing issues at Pimco has been going on for months, according to the newspaper, which also said SEC investigators have interviewed Gross.
Judith Burns, an SEC spokeswoman, declined to comment.
Pimco’s parent company Allianz SE “has been kept regularly informed by Pimco about the SEC investigation,” spokeswoman Petra Brandes said by telephone.
Standard Process’
“What they’re being accused of is in fact the industry standard accounting process,” Dave Nadig, the chief investment officer at ETF.com, a San Francisco-based ETF research and analysis firm, said in a telephone interview.
By law, fund managers have to come up with a price, either by asking dealers for quotes or by extrapolating from data points such as credit rating, size, structure, and comparable securities, Nadig said.
“Because Pimco is an 800-pound gorilla, they negotiate a really good price,” he said. “If the SEC wants to change how bonds are priced, then they can do that, but that’s going to change everybody.”
The ETF attributed some of its outperformance against its benchmark to “an allocation to non-Agency mortgages which benefited from limited supply and a recovery in the housing sector,” according to the latest quarterly report on its website.
Easily Valued
While securitized debt represented 47 percent of the ETF’s holdings as of March 2, 2012, more than three quarters of those securities were the most easily valued type of government-backed Fannie Mae and Freddie Mac bonds, which don’t trade at discounts in smaller sizes, according to data compiled by Bloomberg. The same was true at the start of the next month.
The fund is now 25 percent invested in securitized debt, mainly less liquid securities without government backing, the data show.
ETFs, which have turned into one of the most popular investing vehicles over the past decade, trade on an exchange and can be bought and sold like stocks. While the majority of them mimic broad market indexes, some like Gross’s Total Return ETF employ an active strategy in which the manager selects securities.
Narrowing Differences
The SEC approved the use of derivatives in the Pimco ETF in August, allowing it to invest in options, futures, or swap agreements. That narrowed one of the biggest differences between it and its mutual fund version.
Gross, 70, is co-founder and chief investment officer of Pimco, which manages about $1.97 trillion in assets. Investors pulled a record $41.1 billion from his Pimco Total Return mutual fund in 2013, and an additional $24.8 billion this year through August, according to estimates by Morningstar Inc. in Chicago.
“The inquiry comes at a time of mixed performance for Pimco’s franchise product, which has seen significant outflows for 16 consecutive months,” Citigroup Inc. analyst William Katz wrote today in a note. “We believe the probe highlights the increased regulatory environment while offers an opportunity for asset managers to take share from Pimco.”
Pimco bolstered its leadership team in January, in the biggest shakeup in its history, after former CEO Mohamed El- Erian unexpectedly announced his decision to leave the firm. The fund named six deputy chief investment officers and in May brought back Paul McCulley in the newly created position of chief economist, all reporting to Gross.
