Bill Gross Goes ETF...Is That Wise?

03/16/2012 7:45 am EST

Focus: ETFs

Benjamin Shepherd

Analyst, Breakthrough Tech Profits, Global Income Edge and Personal Finance

The newest PIMCO exchange traded fund has been highly anticipated, and now it's time to take a closer look, reports Ben Shepherd of Investing Daily.

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 (TRXT) has been one of the most anticipated exchange traded fund 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%, versus 0.90% 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 that 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 in general.

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 will likely contemplate a change, as will financial advisors who don’t have access to the cheaper institutional shares. 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.

Read more from Investing Daily here...

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