Bill Gross is losing to a smaller, more nimble version of himself.
The Pacific Investment Management Co. chief’s $263 billion Pimco Total Return Fund is getting trounced by the firm’s four- month-old exchange-traded fund that’s more than 100 times smaller as the biggest money managers struggle to navigate debt markets without moving prices. While the world’s largest mutual fund has returned 3.2 percent since March 1, the Pimco Total Return ETF (BOND:US) that started Feb. 29 with a similar mandate has gained 6.8 percent, data compiled by Bloomberg show.
The $1.8 billion ETF, part of an industry that has more than doubled its assets under management to more than $1 trillion since 2008, is seizing on investor demand to own bonds without having to barter them off exchanges. While that has allowed the ETF to snap up notes with the biggest-potential returns, the company’s 25-year-old Total Return Fund is stuck managing thousands of securities as debt-trading volumes become less predictable and as dealers cut credit holdings by 82 percent.
“It’s very difficult to beat the market when you are the market,” said Bonnie Baha, head of global developed credit at Los Angeles-based DoubleLine Capital LP, which oversees $38 billion. “Any choices you make will have an outsized impact when you’re smaller and more nimble. It stands to reason that there will be more opportunities that you can take and fly below the radar.”
Trading in ETFs is rising as investors seek easier and more flexible access to the bond market, even as trading volumes in the underlying securities drop. ETFs typically hold baskets of securities while their shares trade throughout the day like stocks, unlike mutual funds that are priced once daily.
Gross created the exchange-traded fund because he “wanted to bring the Pimco Total Return concept to the ETF space,” he said in a March 1 Bloomberg Television interview with Tom Keene.
A 16-fold increase in shares outstanding since March has enabled the ETF’s managers to “continually adjust the portfolio to align with our current outlook, and to invest in the best opportunities presented each day,” Mark Porterfield, a spokesman for the Newport Beach, California-based firm, said in an e-mailed statement.
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose for a second day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, adding 3.7 basis points to a mid-price of 112.6 basis points as of 11:29 a.m. in New York, according to prices compiled by Bloomberg.
The index typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, increased 0.18 basis point to 24.8 basis points as of 11:29 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Bonds of Citigroup Inc. are the most actively traded dollar-denominated corporate securities by dealers today, with 28 trades of $1 million or more as of 11:28 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
ETFs typically allow individual investors to speculate on securities without directly owning them. The funds have grown to include $1.5 trillion of assets from $724 billion in 2008, according to ETF Global Insight, a London-based research company. Fixed-income ETFs have attracted $39.1 billion of investments this year, compared with $15.6 billion during the same period in 2011, the data show.
The funds generally don’t buy securities directly when they receive inflows or sell them to meet withdrawal requests. Instead, an authorized participant receives cash from investors and uses it to buy securities in exchange for fund shares.
“The way money comes in and out of the two funds is different,” said Gary Gastineau, managing director at ETF Consultants. “I would probably hold, purchase or sell things in a different way and on a different schedule for the two funds.”
Pimco opened its Total Return exchange-traded fund as tighter capital rules and the Dodd-Frank financial-regulation overhaul in the U.S. spur the biggest banks to pare their corporate-bond inventories.
Company-debt securities held by the 21 primary dealers that trade directly with the Fed fell to $43.3 billion as of June 27 from a peak of $235 billion in October 2007.
Investment-grade trading volumes dropped to a daily average of $11.38 billion in June, the lowest this year, while the number of shares in the biggest bond ETF exchanging hands rose 4 percent, Trace and Bloomberg data show.
Activity in BlackRock Inc.’s iShares iBoxx Investment Grade Corporate Bond Fund (LQD:US), the largest bond ETF, increased to a daily average of 1.99 million shares in the past 30 days, equal to about $235.1 million, compared with a daily average 1.9 million shares for the past six months, Bloomberg data show.
The second-biggest fixed-income ETF, the iShares Barclays U.S. Treasury Inflation Protected Securities Fund, recorded a 17 percent increase in trading volumes in the past 30 days compared with the six-month average, according to the data (TIP:US).
Gross’s Total Return Fund attracted $1.4 billion in June and $5.9 billion in new cash during the first six months of the year, reversing last year’s withdrawals of about $5 billion, according to Morningstar Inc. The ETF brought in $498.4 million last month, Bloomberg data show.
“Once you get to a certain size, your ability to add value is constrained almost by definition,” Baha said. “If you believe in the efficient-market theory, the bigger you get the more difficult it is to add value because your choices are more limited.”
About 10.6 percent of the assets (BOND:US) in Pimco’s Total Return ETF are corporate debt, compared with 19.9 percent for the firm’s eponymous mutual fund (PTTRX:US), Bloomberg data show. The ETF has 29.5 percent of its funds in government debt, versus 20.9 percent for its older counterpart. Almost 23 percent of the ETF’s assets are in cash and other investments, compared with 14.4 percent for the Total Return Fund.
Unlike Pimco’s Total Return mutual fund, which uses a combination of options, futures and swap agreements, Gross’s ETF can’t invest in derivatives since the U.S. Securities and Exchange Commission has frozen approval of new ETFs that make significant use of the instruments. Should the SEC lift the temporary ban, the Total Return ETF would invest in derivatives, Pimco said in its filing last year.
While the Pimco Total Return Fund (PTTRX:US) has returned 1.24 percentage points more than its benchmark index in the past four months, the ETF, which trades under the ticker BOND, has outperformed by 4.7 percentage points, Bloomberg data show.
Investors may evaluate a fund’s performance after a relatively short time if the company, team, investment process and philosophy are the same as an existing fund with a live track record, said Cleo Chang, a managing director at Wilshire Associates, a Santa Monica, California-based consulting firm.
“It is not necessarily a critical factor to wait until a new fund has a year or two of track record as long as there’s a preexisting static investment strategy,” she said in a telephone interview. She declined to comment specifically about Pimco.
The institutional share class of the Total Return mutual fund, which requires a minimum investment of $1 million outside of retirement accounts that make it available, has an expense ratio of 0.46 percent, or $46 a year for each $10,000 invested. The Total Return ETF will charge fees of 0.55 percent, Pimco said in a filing with the SEC.
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