Pacific Investment Management Co.’s widely watched experiment with the industry’s first sizable actively managed exchange traded fund, the Total Return ETF , has significantly outperformed the flagship mutual fund on which it is based.
While both are managed by Bill Gross, Pimco’s Total Return Fund ETF is up 4.8 per cent since it launched on March 1, with reinvested dividends, while the Total Return Mutual Fund has returned just 1.9 per cent, according to Morningstar, a research group.
Mr. Gross, who has managed the $260-billion (U.S.) Total Return Fund, the world’s largest, since its inception in 1987, is seen as a guru in fixed income markets for his colourful commentary and consistent top-tier performance.
But returns for the $870-million ETF in less than three months are better than those delivered by Mr. Gross’s flagship mutual fund in the whole of 2011, his worst year for investing in more than a decade. Pimco declined to comment.
The divergence reflects differences between the two investment vehicles due to the disparity in size, and variations in underlying structure. The ETF, which launched with $100-million sold to market makers, is comprised of about 300 securities, while the mutual fund has more than 19,000.
“You are getting the best ideas of Pimco,” said Timothy Strauts, ETF analyst for Morningstar. “They had time to say: We are starting fresh with a new portfolio, what bonds are we going to put into it?”
The mutual fund by comparison is so large that Mr. Gross has to use derivatives such as swap contracts to express an investment view. This gives broad exposure to an index, but does not allow an investor to add value by cherry-picking individual bonds.
Yet the ETF’s outperformance could reverse if markets deteriorate. The mutual fund holds credit default swaps that provide a level of portfolio insurance, while the ETF cannot hold these derivative contracts. Such insurance acts as a drag on performance, but may mitigate losses if the European credit crisis intensifies, for instance. Such a scenario was part of the “Secular Outlook” published by Pimco this week, a medium-term framework that the asset manager says underlies its day-to-day investment decisions.
“The status quo is no longer an option for Europe,” said Mohamed El-Erian, chief executive, who elaborated Pimco’s view that the most likely outcome is now “a smaller and less imperfect euro zone.”
He laid out two central scenarios: Policy makers could prompt an optimistic outlook by striking “grand bargains” in the U.S., Europe and China, or “fall victim to a more rapid and disorderly de-levering”.
The industry is closely watching the active ETF, as it contemplates the effect of such low-fee investment vehicles. Passive ETFs account for more than $1.2-trillion in assets, but active variants have so far attracted little investor cash.