PIMCO's Active Bond ETFs: Institutional Pricing for All

by: Morningstar

By John Gabriel

These days there's never a dull moment in the ETF industry. Following Schwab's (NYSE:SCHW) long-anticipated foray into ETFs, another industry giant -- PIMCO -- is set to introduce five actively managed ETFs. The new funds, which charge 25 to 35 basis points per annum, provide access to the professional investment advisory services of PIMCO. Remember, as actively managed ETFs, the funds do not seek to replicate the performance of a specified index. PIMCO, which currently manages a shade under $1 trillion in assets, is effectively opening its doors to make it possible for the average Joe to invest alongside its bond-market gurus.

In a Nov. 10 prospectus (.pdf), we got our first look at the fees and tickers for the firm's five forthcoming actively managed fixed-income ETFs. PIMCO debuted with a bang when it launched PIMCO 1-3 Year US Treasury Index (NYSEARCA:TUZ) with the rock-bottom expense ratio of 9 basis points per annum in June. With its brand held in such high regard among investors, many industry participants questioned where the firm would debut, in terms of expenses.

The real anticipation, however, has surrounded the five actively managed funds, which PIMCO filed to launch back in July. Sure, PIMCO has the expertise and a world-class bond desk to potentially offer better tracking or more efficient trades, but at the end of the day, its first batch of ETFs are simply passive indexes. Indeed, some of PIMCO's passive ETFs have provided unique fixed-income exposures (like PIMCO 1-5 Year US TIPS Index (NYSEARCA:STPZ)). But PIMCO's second wave of ETFs takes it to the next level by bringing individual investors a step closer to having unmitigated access to the intellectual capital behind the strategies of the famed bond shop.

PIMCO Enhanced Short Maturity Strategy, which is set to launch on November 17 with the ticker symbol MINT, levies 0.35% in net annual expenses. The other two actively managed short-term bond ETFs set to launch are PIMCO Government Limited Maturity Strategy (ticker: GOVY) and PIMCO Prime Limited Maturity Strategy (ticker: PPRM). Both of these ETFs will charge even lower 0.25% expense ratios.

The three new short-duration ETFs will be managed by EVP Jerome Schneider, who joined PIMCO in 2008 after spending 13 years with Bear Stearns, where he had most recently served as senior managing director, specializing in credit and mortgage-related funding transactions. Schneider now works closely with Paul McCulley, managing director and head of the firm's short-term desk. (Interested investors can check out this recent interview with Schneider to get a glimpse of his investment philosophy.)

The firm's comparable open-end offerings -- PIMCO Short-Term (PSHDX) and PIMCO Low Duration (PLDDX) -- have performed well over the past year. McCulley manages PIMCO Short-Term, while the bond king himself -- Bill Gross -- manages PIMCO Low Duration. While many have been hoping that "celebrity" portfolio managers would eventually embrace the ETF structure, investors can rest assured that Schneider will be working within arm's length of McCulley and Gross.

The retail share classes of the two open-end funds are both currently rated 4 stars and each charges a 0.75% expense ratio with a $1,000 minimum investment. Interestingly, the institutional share classes, which charge 0.45% per annum with a $5 million minimum investment, are both currently rated 5 stars. The 0.30% difference in fees is responsible for the rating discrepancy between the share classes. Now individuals seeking exposure to the short end of the yield curve have cheaper access to these strategies than some institutional investors. This is significant, in our opinion, considering that mere basis points can separate the leaders from the laggards in this corner of the bond market.

The tax-exempt funds set to launch--PIMCO Short Term Municipal Bond Strategy (ticker: SMMU) and PIMCO Intermediate Municipal Bond Strategy (ticker: MUNI)--will both be managed by EVP John Cummings. After a five-year stint at Goldman Sachs (NYSE:GS), where he most recently served as VP of municipal trading, Cummings joined PIMCO in 2002 and currently heads up the firm's municipal desk.

For some perspective on how the 0.35% expense ratios stack up, consider that PIMCO Municipal Bond (PMBDX), which is also managed by Cummings, charges 0.78% per annum with a $1,000 minimum investment. Again, what really jumps out, though, is that the ETFs will be even cheaper than the institutional share class. PIMCO Municipal Bond Institutional (PFMIX) charges 0.47% with a $5 million investment minimum. Each of the five new ETFs will declare and distribute dividends on a monthly basis.

Though poised to make waves, PIMCO's active ETFs aren't the first of their kind. That distinction belongs to PowerShares Active Low Duration (NYSEARCA:PLK), which launched in April 2008. Still, PLK, which levies 30 bps in net annual fees, has failed to generate investor interest and currently has well below $10 million in assets under management. PLK's objective is to deliver alpha above the index tracked by iShares Barclays 1-3 Year Treasury Bond (NYSEARCA:SHY), which levies 15 basis points per annum and currently has about $7.6 billion in assets.

PIMCO's timely launch comes ahead of two other actively managed ETFs to be offered by Grail Advisors, the niche ETF provider that plans to launch up to 30 actively managed ETFs. The firm's first actively managed ETFs covering fixed-income markets are to be Grail McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core Taxable Bond ETF. Fees and ticker symbols have yet to be determined. Needless to say, Grail's forthcoming bond ETFs were much more compelling before one of the best-known names in fixed income threw its hat into the ring. When (or if) the Grail ETFs commence trading, they'll certainly face a tall order in competing head-to-head with PIMCO for assets.

We hope this is just a glimpse of what's to come from PIMCO ETFs. As we've noted before, we'd like to see PIMCO Total Return (PTTDX) eventually find its way into an ETF wrapper. The retail shares of this flagship fund are available at 0.75% per annum ($1,000 investment minimum) and the institutional shares go for 0.50% ($5 million investment minimum). Let's hope that PIMCO is just getting its feet wet. Gross' Total Return as an ETF (hopefully for around 50 basis points or less) would represent yet another instance of ETFs democratizing the investing landscape.