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New Pimco fund a vote of confidence for actively managed ETFs

Pimco's Bill Gross

© Jason Reed / Reuters/Jason Reed/Reuters

Actively managed exchange-traded funds may soon see a jump in popularity after one of the world's most respected bond managers endorsed the concept.

Bill Gross, founder of Pacific Investment Management Co. LLC, is expected to launch an ETF version of his Pimco Total Return fund by early October. The Newport Beach, Calif.-based investment firm filed with U.S. regulators last Thursday, setting the annual management fee for the ETF at 0.55 per cent.

Over the last decade, the Pimco Total Return Fund, the world's largest mutual fund with more than $243-billion (U.S.) of assets, has beaten benchmark returns for intermediate-term investment grade bonds by a significant margin. It has gained an average of 8.9 per cent annually over the last five years, compared with average gains of 6.5 per cent for the benchmark.

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But increasingly, investors have been moving their money out of mutual funds and into ETFs. ETFs hold baskets of stocks or bonds that trade daily and carry lower fees than related mutual funds. Most ETFs are designed to follow an index and rise or fall with the market they track.

Actively managed ETFs – first developed in Canada by Horizons AlphaPro in early 2009 – try to outperform an index, but have not proved as popular as passive ETFs.

Pimco's decision to make an ETF version of its flagship mutual fund "is definitely going to bring a lot of attention to the active ETF space," says John Gabriel, an ETF strategist with Morningstar Inc. in Chicago. "With a brand name like Pimco and manager like Bill Gross it's almost legitimizing the concept."

Pimco's move could bring the firm even greater influence in the bond market by further extending its reach. Many financial advisers are shifting to ETFs from mutual funds. In addition, the new product will make Mr. Gross's proven investment strategies available to many more retail investors.

"It opens up the universe of potential investors to anyone in the world really," Mr. Gabriel says.

Investors in Canada will be able to buy the ETF on the New York Stock Exchange in the same way they can buy U.S.-listed stocks. But Mr. Gabriel warns that currency conversion costs by Canadian financial institutions can run at about 1.5 per cent at time of purchase and again at time of sale, which is a substantial hit to take on a bond portfolio.

U.S. regulations require actively managed ETFs to disclose their transactions on a daily basis. The requirement is one reason most money managers have shunned the product category, concerned that they would end up showing their trading hand even before they complete taking or exiting a large position.

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Institutional investors prefer to keep that information private so that smaller investors can't benefit by "front-running" their own trades. Pimco's Total Return Fund, however, is so large and focuses on such liquid assets that disclosure is not considered a major issue.

Mr. Gabriel says actively managed ETFs work in liquid markets such as investment grade bonds and large-cap stocks. But ETFs focused on mid-size or small cap stocks would not find the structure efficient, he says.

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