Please ensure Javascript is enabled for purposes of website accessibility

Pimco's New ETF: A Gross Mistake?

By Dan Caplinger - Updated Apr 7, 2017 at 5:35PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Bond guru Bill Gross' new offering is popular, but is it a smart play?

Bonds have paid so little income for so long that you'd think no one would be interested in them anymore. With Treasury bonds and even many high-quality corporate bonds not even paying enough to keep up with inflation and taxes, let alone provide a positive real after-tax return, the only good thing about bonds lately is that they've generated big capital gains for long-term holders -- capital gains that could easily turn into losses during the next upswing for rates.

But the newest bond ETF from Pimco and its bond guru, Bill Gross, has attracted huge amounts of interest. After only five trading sessions, the ETF already had $134 million under management, giving it the ninth most assets of any actively traded ETF. If bonds aren't meeting anyone's needs right now, why are so many people interested?

A longtime leader
In part, the answer lies in Gross' track record. The Pimco Total Return ETF (NYSE: TRXT) is a rare actively managed exchange-traded fund, and it's designed to closely mimic the performance of the well-regarded Pimco Total Return mutual fund. Although the ETF just came out last week, the Total Return fund is the largest mutual fund, with roughly $250 billion in assets under management.

There's no disputing the long-term excellence of Gross' performance with Pimco Total Return. Over the past 15 years, the fund has beaten its benchmark by more than a percentage point and beaten its peers by even more, putting it in the top 2% of all bond funds since 1997.

How did Gross manage to outperform so strongly? A look at the fund reveals a few hints:

  • You'll find bonds of all different types in the fund, and the allocations don't stay constant. Among the fund's holdings are Treasuries, U.S. agency securities, corporate bonds, and even foreign sovereign debt.
  • Pimco Total Return uses various derivatives to create a leveraged portfolio. In this way, the fund follows a similar strategy to what mortgage REITs Annaly Capital (NYSE: NLY) and Chimera Investment (NYSE: CIM) use, although Pimco's return advantage doesn't appear to be nearly as dependent on interest rate spreads as Annaly and Chimera. But the fund isn't always exposed to such risk; Gross merely has it as an option during certain market environments.

In essence, rather than being content with a standard arsenal of different bond investments, Gross can push the envelope to get outsize performance -- and most of the time, he's been successful.

All good things come to an end?
But even with Gross' long-term track record, he's hit a rough patch recently. Over the past three years, Pimco Total Return fell back into the middle of the pack. And last year, an ill-timed bet against Treasury bonds cost the fund, which dropped to the bottom 13% of bond funds according to Morningstar. That led to a mass exodus of investors last year, with $5 billion in redemptions during 2011.

So far in 2012, however, the fund is back to its winning ways. And clearly, ETF investors hope that Gross will regain his magic touch and deliver better returns in a bond market that's very stingy with income right now.

Will active management save you?
ETF investors hoping to avoid bond market volatility should understand that Gross hasn't managed to smooth his returns entirely. Overall, the fund's annual returns have risen and fallen with the overall bond market. If bonds collapse, then you're not likely to avoid losses entirely just by holding the Pimco ETF.

But even though they're less expensive, passive bond index ETFs Vanguard Total Bond (NYSE: BND) and SPDR Barclays High Yield Bond (NYSE: JNK) will simply ride bond prices down when rates rise. By contrast, it's possible that Gross will take steps to at least slow the descent. That won't necessarily mean strong absolute returns, but compared to alternatives, the Pimco ETF may outperform -- even considering an expense ratio that's significantly higher than what you'd pay for an index fund.

An interesting call
The Pimco Total Return ETF is an interesting experiment for which many have high hopes. Some see the ETF as a game changer, ushering in a new era of active ETFs. For now, though, I'd suggest waiting on the sidelines to make sure that the ETF actually tracks its mutual fund counterpart -- and to make sure that Gross has indeed gotten his mojo back after a disastrous 2011.

Even Bill Gross can't earn strong enough returns from bonds alone to let most people retire. The right stocks can make a big difference, though. The Motley Fool's latest special report on retirement highlights three promising stock picks for retirement investors. Don't wait; get your free report today while it's still available.

Fool contributor Dan Caplinger pleads guilty to gross punnishness. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Annaly Capital. Motley Fool newsletter services have recommended buying shares of Annaly Capital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy prefers things that come in packages of 144.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Annaly Capital Management, Inc. Stock Quote
Annaly Capital Management, Inc.
$6.82 (1.04%) $0.07
Chimera Investment Corporation Stock Quote
Chimera Investment Corporation
$9.61 (2.45%) $0.23

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/13/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.