Bill Gross, co-founder and co-chief investment officer of Pacific Investment Management Company (PIMCO), adjusts his sunglasses as he arrives to speak at the Morningstar Investment Conference in Chicago, Illinois, in this file photo taken June 19, 2014. U.S. regulator the Securities and Exchange Commission is investigating whether bond fund manager Pimco inflated the returns of its Total Return Exchange-Traded Fund run by founder Bill Gross, who has come under renewed fire from investors this year over the poor performance of his main fund.Jim Young/Reuters
The revelation that Pacific Investment Management Co. is being probed by the Securities and Exchange Commission is the stuff of media dreams. A bond giant – already under pressure to prove it can withstand the shocking departure of its chief executive, Mohamed El-Arian – is now targeted by the top U.S. regulator.
However, there's a second story here, and it's arguably more important. The Pimco portfolio under investigation by the Securities and Exchange Commission is an actively managed exchange traded fund, and the new probe shines a light on growing problems with these types of products.
Although ETFs were developed as low-cost, passive investment vehicles, their actively managed cousins are growing in stature because they offer investors the chance to beat the market, while paying lower management fees than those charged by traditional mutual funds. (Mutual fund costs remain higher for many reasons, one of which is the marketing expenses associated with convincing investors to buy into them.)
Because actively managed ETFs aren't too expensive, investors have found them attractive. Despite the rise of ETFs, which now hold over $70-billion worth of assets in Canada – which makes it seem like investors are done with hefty management fees – old school mutual funds still hold roughly $1-trillion worth of assets. The numbers arguably show Canadians remain willing to pay up for the potential of good performance.
The problem, though, is that actively managed ETFs are run in a way that is arguably at odds with the core values of traditional exchange traded funds. Transparency is one of the key ETF values – full disclosure of costs, of portfolio holdings, of fund prices – yet active portfolio managers are inherently against full disclosure because it gives their competitors insight into what they are doing.
And there's nothing that says these portfolio managers must disclose more, either. Canadian ETFs are governed by mutual fund regulations, and when it comes to portfolio holdings, the rules state that portfolio managers only have to regularly name their top ten holdings.
This doesn't mean all active ETF managers are doing something wrong. Pimco's probe pertains to the way in which the fund valued its illiquid assets, and that process could be very different from those of rival companies.
But the core issue – the ability to tweak valuations because of limited disclosure – is applicable to all actively managed funds, and that's why the probe matters.
Tim Kiladze