* ETF version of PIMCO Total Return fund launches March 1
* Launch will make it highest profile active ETF
* Inability to use derivatives a question mark
* Active ETFs account for less than 1 pct of ETF assets
By Ryan Vlastelica
NEW YORK, Feb 15 Exchange-traded funds
have exploded in the last few years, but there's one corner of
the market that hasn't seen that kind of growth: actively
That could all change with Bill Gross.
Actively managed ETFs account for less than 1 percent of all
assets in the $1.3 trillion ETF market, barely making a dent in
the rapidly growing sector.
That's why ETF product managers and strategists are hungrily
eyeing the March 1 blast-off of an active ETF run by Gross, the
PIMCO high-profile bond manager, calling it a "watershed moment"
for the industry.
Investors use ETFs, which trade like stocks, to gain
exposure to nearly any region of the world, industry sector or
asset class. ETFs are touted for low fees, transparent
structure, and ability to trade throughout the day.
However, actively managed funds, which like mutual funds are
maintained by a manager who selects the holdings at his or her
discretion, have yet to catch on.
"If this doesn't work, it will be a big black eye for the
actively managed ETF industry," said Kevin DiSano, national
sales manager at Index IQ in Rye Brook, New York, which manages
active ETFs. "PIMCO will call a lot more attention to the space,
and if it goes badly that will cause a lag in acceptance. That's
unfair because there already actively managed funds with
excellent patterns of performance."
DiSano's firm manages a number of active funds, including
the IQ Hedge Multi-Strategy Tracker ETF, which has $183
million in assets.
PIMCO's Total Return Exchange-Traded Fund is
designed to mimic the strategy of its Total Return Fund
, the world's largest bond fund at $250 billion.
There's one key difference: regulators have blocked new ETFs
from using derivatives, and the Total Return Fund's use of
derivatives has grown in recent years.
ETFs have posted massive growth in recent years, with the
industry's assets more than doubling to about $1.3 trillion
since 2008, according to Deutsche Bank. But active ETFs have
been left in the dust. With just $7.6 billion in active funds,
they account for a paltry 0.6 percent of the asset class.
Passively managed funds account for $1.255 trillion in
assets, or 97 percent of all ETF assets. The rest is comprised
of semi-active and "passive plus" funds, which have $36.7
billion between them.
Active ETFs can be traded intraday, with holdings disclosed
daily (many mutual funds disclose their holdings monthly or
quarterly), and while their fees can be lower than mutual
funds', investors have grown accustomed to ETFs with rock-bottom
expense ratios. Higher taxes than passive funds are seen as
roadblocks to greater acceptance.
PIMCO already operates four active ETFs, including the
Enhanced Short Maturity Strategy Fund, which has $1.79
billion in total net assets and is up 0.7 percent so far this
year, but the Total Return Fund is the company's flagship.
Through the end of January, the Total Return Fund had an
average annual return of 8.35 percent since its start in 1987,
outperforming the 7.34 percent return of the Barclays Capital
U.S. Aggregate Bond Index.
The inability of the PIMCO Total Return ETF to use
derivatives will prevent a perfect correlation and affect
performance. The size of that difference will be watched closely
and will play a role in the format's acceptance by investors.
Peter Lewis, executive director of liquid markets at Nomura
Securities International in New York, said while some deviation
will not have a big effect on the acceptance of active ETFs, a
wide gulf would be a point of objection.
"Exactly what the correct pain threshold will be is
uncertain but there will be a level of over- or
under-performance that could either cause the product to wither
and die or flourish and grow," he said.
From that perspective, the use by PIMCO's Total Return Fund
of derivatives is notable. The fund in January held half of its
assets in mortgage-backed securities. The move into
mortgage-backed securities comes as the Total Return fund's cash
equivalents and money-market securities fell to negative 35
percent, from negative 32 percent in December.
Having a so-called negative position in cash equivalents and
money-market securities is an indication of derivative use, said
Eric Jacobson, director of fixed-income research at Morningstar,
who has analyzed PIMCO for more than a decade.
In addition, short-term securities are put up as collateral
as a way to boost leverage and increase holdings in bonds with
longer maturities such as MBS, Treasuries and corporate bonds,
A PIMCO spokesperson declined to comment on what deviation
there could be between the fund and the ETF.
So far this year the Total Return fund is up 2.7 percent,
following two years in which gains were less than half a
percent. In 2011 the fund had $5 billion in redemptions, as
performance suffered from PIMCO's bet against U.S. Treasuries.
At 55 basis points the ETF has lower costs than the Total
Return Fund's class D shares, which go for 75 basis points. Its
institutional class carries a cost of 46 basis points. The costs
are higher than other popular bond ETFs such as the iBoxx
Investment Grade Corporate Bond Fund, which carries an
annual expense ratio of 15 basis points.
In January, there were outflows of $20.41 million from
actively managed ETFs, according to IndexUniverse data, compared
to inflows of $28.81 billion into passive funds.
"This is the big test case. If it's successful, and I think
it will be, it will get other fund managers off the sidelines."
said Scott Burns, director of ETFs at Morningstar in Chicago.
"With the actively managed funds that are already out there,
none of them have had a brand-name fund or manager behind them,
so there's a lot riding on this."