Investors' romance with bonds is burning strongly, and passive bond funds aren't the only winners. PIMCO's Total Return ETF (NYSE: BOND), which launched on March 1, has doubled in size to more than $2 billion in less than two months. Are investors flocking to this product making a wise decision?
The Total Return ETF is based on its big, mutual-fund brother -- PIMCO's Total Return Fund -- the world's largest mutual fund with roughly $260 billion in assets under management (!). Both are managed by the legendary Bill Gross and benchmarked against the Barclays Capital U.S. Aggregate Bond Index, a broad index of U.S. bonds.
Are you passive or active?
The ETF's most popular passive counterparts, i.e., those that track the Barclays Capital U.S. Aggregate Bond Index are, in order of size (and attractiveness, in my view): Vanguard Total Bond Market ETF (NYSE: BND), iShares Barclays Aggregate Bond Fund (NYSE: AGG), and SPDR Barclays Capital Aggregate Bond ETF (NYSE: LAG). Vanguard's ETF is the largest by a wide margin and, more importantly, it's the cheapest, with an expense ratio of 0.10%.
A bet on Bill
Ultimately, selecting an actively managed fund, whether an ETF or a traditional mutual fund, is a bet on the fund manager's ability to deliver an incremental return over his benchmark -- net of fees, mind you, as the expense ratio of the Total Return ETF is 0.55%.
Despite a well-publicized misstep last year during which manager Bill Gross was heavily and vocally underweight Treasuries as yields continued to fall and bond prices rose, his long-term record at the head of the Total Return Fund suggests that he is capable of adding value over a passive vehicle.
Bill's bets
Where is Bill Gross placing his bets today? The following table breaks the value of the ETF's assets down by sector, with the corresponding weights of the benchmark index:
|
Sector |
Fund |
Index |
|---|---|---|
| Government -- Treasury and Agency |
23% |
46% |
| Mortgage |
45% |
33% |
| Invest. Grade Credit |
7% |
20% |
| High Yield Credit |
4% |
0% |
| Non-U.S. -- Developed and Emerging |
14% |
1% |
| Cash and Other |
7% |
0% |
Source: PIMCO
Gross is heavily underweighting U.S. government (including agency bonds such as Fannie Mae's) and investment-grade corporate bonds, and is betting instead on mortgage bonds and non-U.S. bonds. Note that he is leaving himself some flexibility with around 5% of the fund in cash.
The total package
In my opinion, these "tilts" make a lot of sense in order to achieve positive real returns, a standard that Treasuries will be hard-pressed to meet over any reasonable investment horizon. In that context, I view PIMCO's Total Return ETF as a solid choice for investors' bond allocation, providing they have an adequate timeframe (years, not months) and are prepared to tolerate periods of underperformance.
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