Providers churning out new bond ETFs

As investors continue to pour money into fixed-income products, exchange-traded-fund providers are flooding the market with new offerings.

Charles Schwab & Co. Inc., Grail Advisors LLC, Invesco PowerShares Capital Management LLC, Northern Trust Corp. and State Street Global Advisors are among the firms that are planning or have already launched products this year.

Despite the pickup in the equity markets this year, flows into fixed-income ETFs have almost kept pace with last year.

For the first six months of 2010, fixed-income ETFs brought in $17.5 billion, compared with $20.2 billion a year earlier, according to Morningstar Inc. Meanwhile, 23 fixed-income ETF products have been launched this year, compared with 11 a year earlier.

As ETF providers continue to try to take market share away from mutual funds, experts expect the number of such launches to rise in coming months.

“ETF providers are trying to gather assets, and this is where the assets are gathering,” said Scott Burns, an analyst at Morningstar. “There is a performance-chasing aspect to this because fixed income is what's hot.”

The firms, however, argue they are just rounding out their product lines.

“We aren't trying to make a call on the market and say that fixed income is poised to take off more,” said Peter Crawford, senior vice president of investment management services at Schwab. The company has filed with the Securities and Exchange Commission to launch its first three fixed-income ETFs and expects to roll them out in the next few months, he said.

With money market fund yields so low, short-term Treasury ETFs are particularly attractive, said Tom Lydon, a registered investment adviser and president of Global Trends Investments.

Some experts argue, however, that the pricing of fixed-income ETFs is more volatile and not as accurate as the pricing of fixed-income mutual funds.

It can be difficult to get real-time pricing in the bond market, making it unclear whether ETF managers are overvaluing or undervaluing bonds in their portfolios, said Dave Nadig, director of research for Index Universe.com.

“You could argue that you don't have to worry about that with mutual funds because you are getting the end-of-the-day net asset value,” he said.

But prices of bonds in mutual fund portfolios are often just educated guesses, Mr. Burns said. Fixed-income mutual funds use matrix pricing, in which the prices of similar bonds for those securities in their portfolios are used. Many are not updated through the day.

“It's a faux NAV price you are getting, whereas with an ETF, you are getting the real price discovery at the time,” Mr. Burns said.

One emerging trend that is contributing to the proliferation of fixed-income ETFs is the success of actively managed ETFs.

Pacific Investment Management Co. LLC in November was one of the first to launch an actively managed fixed-income ETF, the Enhanced Short Maturity Strategy Fund.

The success of that fund, which now has $663 million in assets and which was PIMCO's first actively managed ETF, has prompted more firms to jump in. For instance, in May, Grail Advisors LLC said it had teamed up with Western Asset Management Co. to launch the Grail Western Asset Enhanced Liquidity ETF, an actively managed short-term fixed-income ETF.

“We definitely think there is a marketplace for this given the returns in money funds,” said William M. Thomas, Grail CEO.

T. Rowe Price Group Inc. also has filed with the SEC to launch actively managed fixed-income ETFs. Heather McDonold, a spokeswoman, declined to comment.

So far this year, there have been three actively managed fixed-income-ETF launches, compared with two for all of 2009, according to Morningstar.

Many fund companies think that actively managed fixed-income ETFs are easier to manage than actively managed equity ETFs, Mr. Burns said.

These firms won't launch actively managed equity ETFs, because their portfolio managers are worried that they will lose their competitive advantage by providing complete transparency of their trades.

“The general feeling is that in actively managed fixed-income ETFs, this is less of an issue,” Mr. Burns said.

And many experts think that in the fixed-income ETF universe, active management makes sense.

Although Index Universe.com is a clear proponent of index investing, “fixed income is a space where active management can provide better returns,” Mr. Nadig said.

“The patterns of return are difficult to obtain with the index,” he said.

Regardless, many firms are launching index-based fixed-income funds.

After shelving plans to launch index-based equity ETFs last year, in May, Northern Trust filed to launch fixed-income ETFs. Cathryn A. Schmaltz, a spokeswoman, declined to comment.

Also in May, State Street Global Advisors launched the first international corporate-bond ETF, SPDR Barclays Capital International Corporate Bond ETF. Invesco PowerShares Capital Management filed for a similar product.

“This is a way to access non-dollar fixed-income exposure,” said Benjamin T. Fulton, head of the firm's global ETF business at Invesco PowerShares.

The company has filed with the SEC to launch four more fixed-income ETFs.

Jessica Toonkel Marquez is a reporter with InvestmentNews, a sister publication of Pensions & Investments.