PIMCO’s Eyes Fixed on ETFs

Courtesy of James Armstrong

You know a market has arrived when the big kids start to play, and it became obvious that fixed-income exchange-traded funds were around to stay when the don of bonds—PIMCO—jumped into the game.

With the current volatility of the equities markets, investors know they need to have exposure to bonds, but they often desire the ease and liquidity of equities, which ETFs can provide. For that reason, PIMCO launched an ETF platform in 2009, which has grown to 19 funds.

Six of those funds are actively managed, including the cash-management strategy fund MINT, currently the largest active ETF in the world, and the BOND fund, which launched at the end of February and is managed by PIMCO co-founder Bill Gross. All of PIMCO’s funds trade on NYSE Arca.

Don Suskind, head of global ETF product management at PIMCO, said some clients prefer to use ETFs for fixed-income investments because they offer all the benefits of trading in the equities market—intraday liquidity, efficient price discovery, access through an exchange—plus they provide portfolios that are transparent.

Still, there are challenges in taking a basket of fixed-income products and getting them to trade like a stock. Fixed-income ETFs, unlike most equity exchange-traded funds, aren’t fully replicating. Bond indexes often have thousands of issues in them, so in tracking an index, an ETF might only hold half the number of issues in the index, sometimes as few as 3 percent.

The other problem is ETFs rely on the creation and redemption of fund shares in order to keep the vehicle’s price in line with the price of its underlying assets. When an ETF tracks large-cap equities, there are plenty of arbitrageurs willing to buy and sell the underlying stocks and then trade the fund against someone looking for ETF liquidity.

With fixed-income ETFs, the underlying assets are frequently far less liquid, which is why PIMCO is often willing to take cash creations or redemptions of its funds, rather than ETF holders having to go through an authorized participant to help them cash in shares or get new ones issued.

“In our active ETFs, we may create and redeem in cash, which may improve trading quality for investors,” Suskind said, though he stressed there was no hard and fast rule about when the company would be willing to do cash trades.

When it entered the ETF game, PIMCO’s biggest draw was its long experience in fixed-income investing, but the company also made several hires with specific expertise in exchange-traded funds. For instance, the firm hired senior vice president and ETF strategist Natalie Zahradnik from iShares before the ETF giant was bought by BlackRock.

According to Zahradnik, the buyside might not always be in a position to maintain numerous sets of counterparties and go out and get competitive bids on individual bonds, so there is a real advantage to being able to trade fixed-income instruments in the form of an ETF.

And while some bond ETFs often trade at a premium or a discount, particularly when they are just launched, some of the PIMCO funds began trading at tight margins very quickly.

“We’ve had examples like BOND that came right out of the gate at extremely tight spreads,” Zahradnik said. “It traded at a basis point or two consistently right from the beginning.

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