Fearless Predictions for PIMCO’s ETF Launch

by on June 2, 2009 | ETFs Mentioned:

Newport, California-based Pacific Investment Management Company (PIMCO) launched its first ETF today, becoming the latest mutual fund company to venture into the rapidly-expanding ETF industry. Unlike many new ETFs that have tried to attract capital by tracking previously uncovered niche indices (such as emerging markets sectors), PIMCO will compete directly with established funds, relying on an attractive expense ratio and name recognition to drive its new ETF.

PIMCO’s first ETF, the 1-3 Year U.S. Treasury Index Fund, began trading this week under the ticker TUZ. According to PIMCO’s press release, the new ETF is designed for investors “focused on relatively stable principal value and avoiding credit risk.” This new ETF will compete directly with iShares Barclays 1-3 Year Treasury Bond Fund (SHY), one of the largest and most liquid bond ETFs on the market, with a market capitalization of more than $9 billion and an average daily volume of over 1 million shares. According to its fact sheet, PIMCO’s fund is expected to charge an expense ratio of 0.09%, compared to 0.15% for SHY.

About PIMCO

Founded in 1971, PIMCO is one of the premier bond management firms in the country. With more than 400 investment professionals and $750 billion of assets under management, PIMCO manages retirement and investment assets for pension plans, corporations, foundations and endowments, and global central banks. With the launch of TUZ, PIMCO becomes the latest traditional mutual fund powerhouse to dip its toes into the ETF waters. The results for previous forays into the ETF space have been mixed, with Vanguard being the best example of a mutual fund powerhouse successfully crossing over to ETF success.

PIMCO was co-founded by Bill Gross, dubbed “the nation’s most prominent bond investor” by the New York Times. Gross manages PIMCO’s Total Return Fund, the largest bond fund and fifth largest mutual fund in the world, as well as several other PIMCO funds.

Why TUZ Will Be a Success

Many analysts have noted the core competencies and cache of the PIMCO name as reasons why the bond giant may be successful with its first ETF. While these assessments are accurate, they overlook the most simple selling point of TUZ: its ultra-low expense ratio. At 0.09%, the new fund’s expense ratio is among the lowest in the ETF industry, higher than only a few Vanguard funds. Since ETFs are passively-managed investment vehicles tracking an underlying index (in this case, the Merrill Lynch 1-3 Year U.S. Treasury Index), there are relatively few comparative metrics beyond expense ratios for potential investors to evaluate when considering an investment. By undercutting the existing funds in the short-term treasury space, PIMCO will likely attract funds from investors for whom cost is a primary consideration.

The Volume Issue

While TUZ stacks up favorably on costs, there are concerns that it may lack sufficient liquidity and exhibit wide bid-ask spreads, at least in the initial months following its launch. But I’m not too concerned about PIMCO attracting enough funds to establish a liquid trading market for TUZ for several reasons. First, according to PIMCO’s web site, the new ETF launched with more than $25 million in assets, making it larger at its launch than many of the established ETFs on the market. Second, PIMCO has more than $750 billion of assets under (mostly) active management. Despite the firm’s sterling reputation, it’s no secret that investor dollars have steadily been trickling out of mutual funds and into ETFs. With PIMCO looking to jumpstart its ETF line, shifting just a small portion of its actively-managed funds to its new ETF would allow it to both increase customer satisfaction and significantly increase the size and liquidity of TUZ.

Fearless Predictions

  • TUZ will have more than $100 million in assets within 3 months of its launch: This might seem like a stretch, but given the size of its total assets under management, the level of demand for short-term Treasury exposure (as evidenced by the size of SHY), and PIMCO’s reputation, I think the company’s first ETF could very well quadruple in size in the first quarter after its launch.
  • PIMCO will lanuch at least five more indexed bond ETFs before the end of 2009:  PIMCO has indicated that it has filed the regulatory paperwork to list six more ETFs. This doesn’t mean these funds are close to a launch, or that they will ever be launched. While PIMCO indicated these additional funds will likely track longer-dated Treasuries and inflation-protected securities, I wouldn’t be surprised to also see an aggregate bond index (similar to AGG) or a high yield index (similar to HYG)
  • PIMCO will launch an actively-managed bond ETF before the end of the year: We’ve seen a number of actively-managed ETFs launched in the last few months, although most have focused exclusively on equity investments. Given the reputation of co-founder Bill Gross, don’t be surprised if PIMCO pioneers an actively-managed bond ETF. Although there would certainly be concerns over cannibalizing its existing funds, it seems like a logical step for a mutual fund giant trying to break into the ETF industry.

For more information on PIMCO ETFs, visit http://www.pimcoetfs.com