MINT: A Rock Solid Short Duration ETF Suffering From Low Rates

Summary

• The PIMCO Enhanced Short Maturity Active Exchange-Traded Fund is a diversified fixed income ETF offering exposure to U.S. short term bonds from the government and domestic U.S. issuers.
• The fund is high quality and managed by the most capable fixed income asset manager.
• MINT provides exposure to over 700 individual bonds, passing through monthly dividends to shareholders.
• The fund currently yields just 0.44% on a TTM basis.
• Today, we explore MINT’s portfolio and outlook.

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Source: PIMCO

Introduction

The PIMCO Enhanced Short Maturity Active Exchange-Traded Fund (NYSEARCA:MINT) is an exchange traded fund presenting investors access to a diverse portfolio of the short term fixed income investments. The fund has been a steady performer as a result of high quality holdings and a short term bias. However, a sustained rate of inflation poses a substantial challenge to the capabilities of a fund like MINT. Generally, investors utilize short term fixed income as a cash alternative, earning a modest return while exposing themselves to little risk.

Data by YCharts

The short term focus has been successful in muting volatility, especially as compared to longer duration competitors such as the PIMCO Active Bond Exchange-Traded Fund (BOND).

Data by YCharts

Falling interest rates have a battered the distribution diminishing the value offered by the fund. Additionally, the Fed's tapering has impacted MINT's share price over the course of the past several months. Despite these evolving changes, MINT offers investors an opportunity to access a portion of the investment grade fixed income market. The fund is large with around $14 billion in assets under management.

MINT is a simple fund by PIMCO standards. The fund's goal is an enhanced cash alternative meaning management seeks to outperform traditional money market options with limited additional risk. In contrast to many PIMCO investments, MINT does not utilize options, futures, or swaps.

We want to additionally underscore that PIMCO is arguably the best fixed income asset manager around. The manager has produced reliable, strong returns across fund offerings through capable management. Their results speak for themselves with over 90% of PIMCO assets under management outperforming their respective benchmark, net of fees. Today, the firm manages over $2 trillion in assets with a concerted focus on income strategies.

Source: PIMCO

Let's dive into the portfolio and see what MINT has to offer.

Portfolio

MINT is well diversified by issuers and credit rating. MINT has been able to spread risk effectively. The fund invests primarily in traditional government and investment grade bonds but also includes other categories such as securitized credit. To maintain the short maturity bias, MINT invests exclusively in bonds maturing inside of five years. With the majority of holdings maturing within one year, the fund has a weighted average maturity of just 0.81 years. It's worth noting that the effective maturity is shorter than other short duration funds including the Vanguard Short Term Bond ETF (BSV).

Source: MINT

More than 50% of the portfolio is allocated to investment grade credit. The second largest allocation lies in securitized credit, consistent with PIMCO's general strategies. Finally, government debt accounts for roughly 10% of the total allocation. The diversity of the issuers underscores the active approach of the fund especially as compared to more traditional fixed income ETF's. From a credit perspective, the fund is also well spread with credit ratings ranging from BBB- to AAA.

Source: MINT

Geographically, the fund is more diverse than comparable fixed income ETF's. While most funds are limited purely to domestic issuers, MINT ventures outside of the United States with roughly 35% of the portfolio allocated to international investments.

Source: MINT

The fund has a mandated goal of providing exposure to short term fixed income, meaning bonds maturing outside of the next five years are excluded almost entirely. As a result, the fund's duration is limited protecting investors from rising interest rates. The fund has an effective duration of just 0.64, providing investors protection from coming increases in rates. In the simplest terms, a short duration means that the portfolio's net asset value should be impacted by less than 1% for every rate increase of 100 basis points.

Source: MINT

Performance

MINT is simple and effective in what it delivers. Investors may access a portfolio of investment grade and government issued securities in a scalable, tax efficient, and transparent format. With impressive price stability and monthly distributions, the fund has been able to outperform its treasury benchmark consistently since inception.

Source: MINT

The fund has delivered dependable income to shareholders without falter along the way. Over the past decade, the fund has delivered 1.50% annual returns, primarily through monthly distribution of interest income. While certainly not an exciting or supercharged return (especially by PIMCO standards), MINT may be an alternative cash management opportunity.

Data by YCharts

As we mentioned, the bulk of MINT's modest return is generated by the fund's distributions. MINT passes through dividend distributions which varied since inception as a result of movement in interest rates. A short focus leaves it more susceptible to variation in income than more flexible funds. That said, the low duration insulates the fund's net asset value in times of rising rates which may soon be crucial. All in all, the fund has had a very stable performance due to broad strength in the credit markets.

Data by YCharts

MINT has offered dependable income and stable share prices with some appreciation to be enjoyed along the way. For over a decade, the fund has delivered solid performance. However, we must always acknowledge that past performance is an unreliable predictor of future returns. To that extent, MINT's outlook remains weak.

Outlook

In the short term, the most significant risks facing funds like MINT is inflation. MINT itself is a stable fund and we believe it will continue to perform in line with its goals. That prediction is obviously subject to changes in market conditions, but the bond market has a durable track record. On a broader level, investors should consider the purpose and efficacy of short term bonds. Facing an elevated rate of inflation, we must consider if MINT is even capable of generating a real return. Keep in mind, the fund has never provided an annual return greater than the current rate of inflation.

Source: U.S. Inflation Data

Inflation has now become a crucial consideration for all investors. While tepid inflation if generally not a concern as outperforming comes almost naturally, times have changed. The disparity between inflation and interest rates has created a problematic situation for fixed income investors. While initially described as transitory, it appears as though inflation is here to stay on account of a variety of markers. If investors cannot earn at least the rate of inflation, they are not earning a real return on their money. Given the portfolio, it seems unlikely that MINT offers the firepower to outperform such a dramatic rate of inflation.

Interest income should continue to remain stable, but modest for the duration of low interest rates. One silver lining worth mentioning is the benefit of rising rates. When issuers refinance at higher rates, the newly issued bonds may fall into the maturity range of MINT. The bonds will likely have higher coupons ultimately translating to a boost in the distribution, offsetting any NAV impact.

The Alternative

Having observed the main issue facing MINT, it feels prudent to explore strategic alternatives. Given the depth of the investment universe, we will stick with relatively close competitors, excluding some other more exotic categories such as business development companies, closed end funds, and other fixed income oriented asset classes exposed to higher leverage.

We certainly don't recommend that investors venture further out in terms of maturity, as longer maturities will be exposed to significant rate risk. At this point, it appears prudent that investors would remain short term in their maturities. Given the continued strength of the economy, investors may be able to benefit from looking slightly down the credit curve. The PIMCO 0-5 Year High Yield Corporate Bond Index ETF (HYS) is a viable alternative for investors comfortable accessing high yield credit.

Data by YCharts

The fund has a similar maturity mandate inside of five years and focuses entirely on non-investment grade issuers. It is crucial to note that many of these issuers still remain on the higher end of the junk credit spectrum. Many of these issuers on the upper end of the high yield credit ratings.

Source: HYS

HYS offers a TTM yield of 3.89% which dramatically outpaces MINT and lands investors closer to the current rate of inflation. With inflation expected to temper over time, HYS may offer shareholders a yield that can match. Better yet, the fund's yield could better protect the fund from rising rates as it will offset the NAV impact. While the fund is inevitably more volatile, it has been able to outperform MINT over time without too much added pain.

Data by YCharts

Investors must still note that high yield fixed income is inherently riskier than investment grade and treasuries. Even though bonds across the board have been stable with remarkably low default rates, investors need to note the risks.

Conclusion

MINT is a simple fund which has delivered value to shareholders for over a decade. PIMCO is one of the world's most capable asset managers and MINT is a sizeable fund with $14 billion in assets. One substantial pain point with regards to the fund is related to the management expense. MINT Charges and management fee of 36 basis points. While this fee is reasonable in the grand scheme, it becomes meaningful when applied to a yield compressed fund such as MINT. Given the current yield is just 44 basis points, expenses and fees account for nearly half of the total return stemming from the distribution. This is highly problematic especially considering the availability of cheaper alternatives from asset managers such as Vanguard.

Bonds deserve a spot in every portfolio. Their consistency provides a moat of stability in volatile times and their interest income can offer yields that are comparably attractive. That said, it's tough to get excited about MINT with a TTM yield of 0.44%. MINT will survive and over longer terms, may even thrive as a result of a capable management team. At this point, we are neutral. If you are a shareholder in desperate need of a short term bond fund, MINT is a viable option for providing excess yield over traditional funds are direct investments.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article is not investment advice. Research provided in this article is supportive of your own thorough and complete due diligence. Please consult your investment advisor on opportunities presented herein.