What's Next for PIMCO Total Return?

S&P Analyst Todd Rosenbluth analyzes upcoming ETF version of popular bond fund

“When you are the biggest mutual fund in your category and continue to generate above-average long-term returns, what's left for you do?” That's an important question proffered by S&P mutual fund analyst Todd Rosenbluth.

“If you are PIMCO, then the answer is to take your taxable bond Total Return offering and launch an ETF version of it later in 2011,” he writes in an S&P Equity Research piece released Tuesday. Rosenbluth then takes a close look at what the ETF's launch, already slated by PIMCO for later this year, means for mutual fund and ETF investors.

He begins by noting fund manager Bill Gross’ performance and tenure.

“The institutional share class of PIMCO Total Return is among the top-ranked taxable bond mutual funds, thanks to its strong track record, outperformance of intermediate investment-grade bond peers in nine of the last 10 calendar years, manager Bill Gross's long tenure with the fund, a below-average duration (interest rate sensitivity), along with an average 30-day SEC yield of 2.6%,” according to Rosenbluth. "Equally important, in our view, is that the fund's 0.47% expense ratio is below average for a mutual fund in its peer group."

However, he writes that as investors have become more cost-conscious, they’ve looked to ETFs, which Rosenbluth notes offer diversification benefits like a mutual fund, but with more transparency, typically low costs and no minimum initial investment.

“ETFs need to disclose their allocations on a daily basis, offering much more transparency than the quarterly information that open-end mutual fund investors receive,” Rosenbluth writes. “For most ETFs that aim to match a widely followed benchmark this is typically not a concern, but PIMCO Total Return's asset allocation moves are disclosed monthly and tend to make headlines.”

According to PIMCO's regulatory filing, the new ETF will have an expense ratio of 0.55%, which as Rosenbluth notes is more expensive than the institutional version of Total Return Fund, but lower than retail versions of the mutual fund.

As a comparison, he found 90 taxable fixed income ETFs on MarketScope Advisor that had an expense ratio lower than what the ETF will charge. He reports the largest of them, based on market capitalization, is iShares Barclays TIPS Bond Fund, which has a gross expense ratio of 0.20%. The lowest fund, Vanguard Total Bond Market Index Fund, as a gross expense ratio of just 0.11%.

“We think these ETFs and a hundred or so others that focus on taxable bonds have relative appeal compared to mutual funds because they are ‘democratic,’” Rosenbluth opines. “Just like individual stocks, but unlike mutual funds, there is no minimum initial investment.”

Given that the ETF will be less expensive and more accessible for fixed income investors than Total Return Fund, Rosenbluth says “it is possible that PIMCO will experience some outflows from their mutual funds. However, we believe the launching of a fixed income ETF could enable PIMCO to take some market share from other fixed income ETF providers, despite the relatively high expense ratio, given Gross's strong track record and the relatively low duration.”

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