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An ETF Broadcasts PIMCO’s Latest Move

By Benjamin Shepherd on March 7, 2012

Despite the fact that Bill Gross’s flagship PIMCO Total Return (PTTAX) mutual fund had a tough 2011–he infamously bet against further gains in US Treasury bonds, particularly longer-dated issues–he remains one of the most respected investors in the world. Almost any fund with his name attached to it is going to do well in the marketplace.

As a result, the March 1 launch of the PIMCO Total Return ETF (NYSE: TRXT) has been one of the most anticipated exchange-traded fund (ETF) launches in years. The ETF will be actively managed by Gross himself, employing the same basic strategy as the mutual fund while offering more transparency and lower costs. The ETF carries an annual expense ratio of just 0.55 percent versus 0.90 percent for Class-A shares of the mutual fund. And PIMCO said that it will disclose the ETF’s portfolio holdings on a daily basis.

But the Total Return ETF isn’t exactly a carbon copy of the Total Return mutual fund. The biggest difference will be that because the Securities and Exchange Commission is leery regarding derivatives, the ETF won’t use futures, options or swaps like the mutual fund does. That will limit Gross’s flexibility to employ trading tactics which, in the past, have worked out well for the mutual fund and may create some tracking error between the ETF and the mutual fund. As such, it will be interesting to see the variance in performance between these two securities.

That difference isn’t likely to hinder the ETF in terms of garnering assets, however. Investors hold Gross in high esteem. And while the ETF’s tactics may differ from the mutual fund, the ETF’s strategy will still benefit from Gross’s top-down perspective, which will be visible in almost real time. In the past, investors had to wait months to learn the details of how Gross had managed his mutual fund. On that basis alone, PIMCO Total Return ETF will quickly become one of the most watched ETFs on the market.

Aside from offering greater insight into Gross’s investment strategy, the launch of PIMCO Total Return ETF is a watershed moment for actively managed ETFs generally.

So far, most mutual fund managers have been hesitant to transition their strategies into an ETF wrapper precisely because of the high level of transparency it requires. They want to avoid broadcasting their moves to the market for fear that some investors could exploit this information by copying their trades while not paying anything in management fees. Similarly, they don’t want their competition to profit from knowing the full details of their strategy. The fact that Gross is not afraid to embrace greater transparency could inspire other well-known fund managers to enter the ETF marketplace.

PIMCO’s move into ETFs is also recognition of the changing investment landscape. While ETFs have become a trillion-dollar industry, mutual funds have been experiencing slow, but steady outflows for years now. By launching the ETF, PIMCO will absorb some of these outflows instead of ceding that opportunity to other ETF sponsors. Indeed, this will likely be the first of many ETF launches from PIMCO.

But the death knell hasn’t sounded for mutual funds quite yet. For one, the 401(k) channel is still largely closed to ETFs, so investors who own shares of the PIMCO Total Return fund through their company’s plan are unlikely to switch to the ETF. And the institutional class of the mutual fund is actually 9 basis points cheaper than the ETF, so institutional investors will likely favor the mutual fund over the ETF.

But investors in the mutual fund’s retail share class and financial advisers who don’t have access to the cheaper institutional shares will likely contemplate a change. Investors with smaller portfolios who can’t meet the minimum required investment for traditional mutual fund shares might also be enticed by the ETF since it doesn’t require a minimum investment.

While Vanguard’s line of ETFs are essentially share classes of its existing mutual funds, look for other large mutual fund companies to take a play from Bill Gross and PIMCO in the future, especially if PIMCO’s experiment with ETFs proves successful.

In Other News

The Vanguard Group may insist it’s not firing another shot in the ETF price wars, but it slashed expenses on six of its ETFs last week.

Vanguard MSCI Emerging Markets ETF’s (NYS: VWO) annual expense ratio was cut from 0.22 percent to 0.20 percent, reinforcing its position as one of the cheapest emerging market ETFs available. Vanguard High Dividend Yield Index ETF’s (NYSE: VYM) annual expense ratio dropped from 0.18 percent to 0.13 percent, while the cost of Vanguard FTSE All-World ex-US ETF (NYSE: VEU) fell from 0.22 percent to 0.20 percent.

The broad market Vanguard Total International Stock Index ETF (NSDQ: VXUS) saw expenses fall from 0.20 percent to 0.18 percent, while the annual expense ratio of Vanguard Total World Stock Index ETF (NYSE: VT) declined from 0.25 percent to 0.22 percent. Finally, the annual expense ratio of Vanguard FTSE All-World ex-US Small Cap Index ETF (NYSE: VSS) fell from 0.33 percent to 0.28 percent.

What’s New

In addition to the long anticipated launch of the PIMCO Total Return ETF, State Street Global Advisors launched two new SPDR funds.

SPDR MSCI ACWI IMI ETF (NYSE: ACIM) offers broad global exposure by holding about 730 names from both developed and emerging markets. Still, the fund has a definite tilt toward safety, with US equities accounting for roughly half of its portfolio’s assets, followed by the UK (8 percent), Japan (8 percent) and Canada (5 percent). Emerging markets such as China (2.2 percent), India (0.9 percent) and Russia (0.8 percent) receive only minimal allocations.

From a sector perspective, financials receive a 19.3 percent weighting, while information technology has a 12.5 percent weighting and industrials an 11.6 percent weighting. Those are followed by energy (11.2 percent), consumer discretionary (10.9 percent) and consumer staples (9.3 percent).

With an annual expense ratio of 0.25 percent, the fund is an inexpensive option for investors looking to add some global exposure to their portfolios. But if your portfolio already includes substantial exposure to US and European equities, an investment in this ETF could create an inadvertent overweighting of the developed markets.

SPDR MSCI EM 50 ETF (NYSE: EMFT) holds the 50 largest companies of the MSCI Emerging Markets Index. From a geographical perspective, the fund is well diversified, with South Korea and China receiving allocations of about 18 percent each, followed by Brazil (16 percent), Russia (11 percent) and Taiwan (10 percent). For the most part, sector exposure is spread out, though financials receive a 23 percent allocation and energy has a 21 percent allocation. The fund has a 0.50 annual expense ratio.

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