PIMCO's Total Return ETF is an exception

Updated

PIMCO's Total Return ETF has seen a healthy percentage gain in assets from inflows since the start of the year, and though it lags the amount flowing into its larger mutual fund sibling, the numbers show the 13-month-old exchange-traded fund is finding its own niche.

In the first quarter, estimated inflows for the Pacific Investment Management Co. Total Return ETF were a combined $700 million, with $174.9 million in January, $273.4 million in February and $251.9 million in March, according to Morningstar Inc., Chicago. For the same period, inflows for the Total Return mutual fund totaled $2.533 billion — $919.2 million in January, $890.6 million in February and $723.4 million in March, according to data provided by Michael Reid, PIMCO spokesman.

However, the ETF's first-quarter inflows accounted for 16.3% of its $4.3 billion in total assets as of March 31, while the Total Return mutual fund's inflows accounted for less than 1% of its $289 billion in assets.

And though no one is suggesting the demise of the world's largest mutual fund, the boom in ETF inflows suggests that some attention among investors could be moved toward them and away from flagship mutual funds.

In PIMCO's case, it's easier to be transparent with a fixed-income fund than with an equity fund, which more often than not eschews transparency because managers don't like to broadcast their strategies. “It's like Coca-Cola,” said Deborah Fuhr, partner and co-founder of research firm ETFGI, London. “They don't want to give away their formula.”

The transparency issue is a major one for large managers with big ETF businesses. Efforts by larger money managers to introduce active equity ETFs are sparse. BlackRock on April 18 introduced two enhanced index ETF strategies — the iShares Enhanced ETFs and the iShares MSCI Factor ETFs — but none that mirror any of BlackRock’s fully active equity strategies. State Street Global Advisors, meanwhile, has filed plans with the SEC for its own active ETFs.

“It's not apples to apples,” Ms. Fuhr said. “What you see is that the majority of ETFs are index-tracking funds. BlackRock doesn't offer both an active mutual fund and a similar active ETF. There aren't a lot of active ETFs out there — less than 1% of all ETF assets are in actively managed ETFs. To be fair, PIMCO is one of the few big firms with success in active ETFs. Others who offer them don't have the global recognition with a long track record in active funds.”

Money managers see ETFs as “a new distribution channel,” Ms. Fuhr said, and “are additive in many cases” to other investment structures, including mutual funds. Comparisons between the PIMCO ETF and Total Return fund are rare because both can be actively managed, and few big firms offer active ETFs with a track record, like PIMCO has.

“Nobody's out there selling mutual funds, but a lot of people are out there selling ETFs,” said Tim Barron, chief investment officer at Segal Rogerscasey, Darien, Conn. “Every day … you read about BlackRock talking about ETFs. Never underestimate the power of sales. The flip side is that the mutual fund industry is huge, with trillions of dollars. It doesn't tip easily. But the growth pattern of ETFs is clear.”

“The answer lies in the fundamental concern, which is well founded, that the trend is that more assets are going to ETFs and away from mutual funds,” added David Bauer, partner at Darien, Conn.-based money manager consultant Casey Quirk & Associates LLC, who focuses on ETFs and mutual funds. “And they are, and the signs say that will continue. That causes a mutual fund of any size to ask the question of should we look into active ETFs.”

For institutional investors, what matters with ETFs is their exposure to asset classes where liquidity is important, such as emerging markets debt, bank loans and cash, Mr. Bauer said. In broader use, hedge funds that run money for institutions as well as insurance companies use ETFs for short positions, also because of liquidity concerns.

There's no turning back on ETF inflows, said Ms. Fuhr. Indeed, in an April 8 report issued by ETFGI, ETFs and other exchange-traded products saw a combined $73.4 billion in net inflows in the first quarter, raising total global assets in investments to $2.09 trillion. Both the inflows and assets are all-time highs, the report said. The asset increase was 7.3% from Dec. 31.

In March alone, inflows were a record-setting $23.9 billion. For the month, equity ETFs and ETPs had net inflows of $17 billion, followed by fixed income with $5.6 billion, and leverage inverse with $1 billion. Commodity ETFs and ETPs experienced net outflows of $2.6 billion.

In contrast, mutual fund inflows in the first quarter were an estimated $164.1 billion, with estimated inflows from March totaling $42.1 billion, according to data from the Investment Company Institute, Washington.

Separately, a recent McKinsey & Co. report estimated that assets in actively managed ETFs could reach $500 billion by 2020, compared with the current $12.5 billion (Pensions & Investments, March 18).

However, the transparency issue remains as a “fundamental impediment” to active ETFs, particularly equity funds, said Stephen Clarke, president of Navigate Fund Solutions LLC, Boston, a subsidiary of Eaton Vance Management that is building a new investment structure called exchange-traded managed funds. “Active ETFs that are currently available must be fully transparent on a daily basis. Most equity portfolio managers don't want to do this for the risk of market participants seeing what you're trading. PIMCO has successful ETF products, but they aren't equity products.”

“Equity folks have more questions to answer than fixed-income folks” concerning transparency, said Bill Golden, managing director and head of U.S. product at Legg Mason Inc., Baltimore. “Cannibalizing your mutual funds is a concern,” he said “But active ETFs are still an important consideration. … For equity strategies, I would have a hard time with transparency. Not to say there aren't other strategies that might work, but to clone an equity mutual fund with significant assets would be a tough decision.”

“If you don't offer it, someone else might,” said James Ross, senior managing director and global head of SPDR exchange-traded funds at State Street Global Advisors, Boston. “Why wouldn't you have multiple options for clients? … It doesn't have to be an either-or.”

Mr. Ross said both mutual funds and ETFs ultimately are being offered by the same firm, so what matters is that a manager such as State Street gains flows from investors into either fund. “It's really about giving investors the choice,” he said. “My view is there's plenty of space for both of them.”

Mr. Golden added that it's ultimately a client-driven call. “What's the client's need?” he said, adding that Legg Mason has a history of offering a variety of strategies. “It's not a zero-sum game. I couldn't envision where cloning a mutual fund (for an active ETF) would be a death knell for the mutual fund. It'd be a tough decision, but there are things you can do that won't cannibalize the mutual funds.”

However, Casey Quirk's Mr. Bauer added that mutual fund managers who are creating active ETFs “are missing the point. To them, it's all about the hot dot — in this case, packaging over a new strategy. People are focusing on active ETFs without looking at why they're in ETFs. … They offer precise exposure to an asset class with liquidity and their passive strategies. They don't want the risk of active management,” whether in a mutual fund or an ETF.

Managers creating active ETFs “have to be clear on their value,” he said. “Active management alone doesn't benefit the precision and liquidity of an ETF.”

Legg Mason's Mr. Golden said it's still “very early days” in determining institutional investor interest in active ETFs. “It's too early to tell,” he said. “It will depend on the strategy and the manager.”

On the transparency issue, Mr. Bauer pointed to Eaton Vance, whose Navigate subsidiary's proposed exchange-traded managed fund structure currently under SEC review would allow for active management of a strategy without the disclosure required for an active ETF. BlackRock has also filed for a similar structure. In the case of Eaton Vance, Mr. Clarke said, such funds if approved will be provided alongside Eaton Vance mutual funds with the same strategies and same portfolio managers in both funds.

What's under review isn't a product but a structure, Mr. Clarke said. ETMF methodology is based on trading based on net asset value, a hybrid between a mutual fund and an ETF, so disclosure is not as stringent as with an ETF.