Part 2 of 4 on Bond Market ETFs
In the first installment of this series we talked about several new Bond Market ETF’s which have come to market recently. In today’s article we will take a deeper look at the one which is getting the most attention, PIMCO’s Total Return ETF, the BOND.
On March 1st PIMCO launched an ETF version of the world’s biggest mutual fund, The PIMCO Total Return Fund. The ETF trades under the symbol BOND, and can be purchased for around $100 per share. There has been a far amount of negative press surrounding the launch, which is the topic of today’s installment.
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The article, “PIMCO Total Return ETF Launches At a Bad Time”, written by Jeff Reeves of InvestorPlace.com makes the argument that we are at the tail end of a 30 year bull market in bonds. When PIMCO Funds launched the Total Return Fund in 1987, long-term treasuries were yielding around 9%. The decline from 9% to their current rate of 3% was a very profitable one for buyer of longer dated bonds (as yields fall, bond prices rise).
The biggest component of the Total Return Fund’s profitability was not the acumen of Bill Gross, but being in the right place at the right time. In short, the argument goes now is not the right time to be in bonds, wether the invesment vehicle is an ETF, mutual funds or direct holdings. Legendary investors including Warren Buffet and Larry Fink have also made statements supportive of this viewpoint.
He also believes the days of “12%” returns on bond investments are a thing of the past however, just because the bull market is over, does not mean that we are headed into a bear market (where interest rates rise continually and bonds fall in value). We could be headed into a pro-longed period of low rates. In other words, the priority of the PIMCO Total Return Fund and BOND ETF is shifting towards producing low risk income, versus capital gains.
The PIMCO Total Return Fund is already the largest mutual fund in the world at $250 Billion. To put that into perspective, the fund needs to make $2.5 billion to move returns by 1%. This has several important implications:
Managing more money with an ETF that uses THE SAME STRATEGY will make these challenges even more difficult.
The focus of this argument is that the mutual fund has the ability to use derivatives and the ETF does not. Proponents of this position say that because the ETF cannot make use of derivatives its returns will be lower than the Mutual Fund.
There are several reasons why I don’t think this is true. Bill Gross has said that he plans to cut down on the use leverage (derivatives) based on his long-term view of bond market behavior. His strategies are now “defensive” (capital preservation) versus “offensive” (returns focused). A derivative is an offensive tool not a defensive one and therefore not an important part of new playbook. If Gross thought the use derivatives was important, he could have registered the ETF with CFTC, which is not a big deal.
For the answer to that question see the next article in this series, Who are the Winners and Losers of PIMCO’s new Bond Market ETF?