From the January 2010 issue of Research Magazine • Subscribe!

PIMCO Adds Treasury ETFs

Two ETFs linked to U.S. Treasuries have been introduced by PIMCO.

The PIMCO 3-7 Year U.S. Treasury Index Fund (FIVZ) and the PIMCO25+ Year Zero Coupon U.S. Treasury Index Fund (ZROZ) were launched in November by the Newport Beach, Calif.-based money manager.

FIVZ follows the BofA Merrill Lynch 3-7 Year Treasury Index, which contains the bellwether 5-year Treasury note along with other Treasuries of similar duration. The fund pays dividend distributions and is rebalanced monthly. The fund's annual expense ratio with fee waivers that expire on October 31, 2010 is 0.15 percent.

The performance and yield of ZROZ is benchmarked to the BofA Merrill Lynch Long US Treasury Principal STRIPS Index. Dividend payments and index rebalancing are scheduled to occur quarterly. After calculating fee waivers that expire on Oct. 31, 2010, ZROZ charges annual expenses of 0.15 percent.

Zero-coupon bonds come equipped with varying maturities as short as one year up to 40 years. "STRIPS" is an acronym for "Separate Trading of Registered Interest and Principal of Securities." It means a financial institution has taken a regular U.S. Treasury issue and separated the principal and interest payments into two separate securities.

Here are other important characteristics of zero coupon bonds: They're issued at a deep discount and redeemed at full face value. Annual taxes are due on interest payments even though they're not received until maturity. Zero coupons tend to be more volatile than conventional bonds. Zero coupons tend to be more sensitive to interest rate changes.

While the discount to par that zero coupon bonds carry may seem attractive, risks abound. The biggest threat is that your coupon payment at maturity may be less than inflation. This can be a significant hit, especially for long-dated bonds with maturities that reach 20 years and longer. Unlike conventional bonds, zero coupons don't give you the chance to reinvest at higher yields should interest rates rise.

Another negative factor is taxes, which are due even though your interest payments aren't received until the time of their maturity.

Nevertheless, in the context of a diversified portfolio zero coupon bonds may be complementary.

"These newest offerings highlight PIMCO's ongoing commitment to introducing well-engineered ETF solutions that look to meet the needs of investors," says Vineer Bhansali, PIMCO managing director and portfolio manager for the new funds. "Along with our existing ETFs, these new funds offer access to a broad range of Treasury maturities for investors who prefer indexed strategies and the ease of trading ETFs."

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