PIMCO Launches Active Short Term Muni Bond ETF (SMMU)

by on February 2, 2010 | ETFs Mentioned:

Tuesday marks the first day of trading for the PIMCO Short Term Municipal Bond Strategy Fund (SMMU), the third actively-managed ETF from the Newport Beach, California-based bond fund giant. The fund is designed for investors seeking tax-exempt income, and consists of a diversified portfolio of short duration, high credit quality bonds that carry interest income exempt from federal tax.

SMMU is benchmarked against the Barclays Capital 1-3 Year Municipal Bond Index, and will compete most directly against the iShares S&P Short-Term National Muni Bond Index Fund (SUB), the SPDR Barclays Short Term Municipal Bond ETF (SHM), and Market Vectors Short Municipal Index ETF (SMB).

PIMCO’s current active bond ETF offering include the Enhanced Short Maturity Strategy Fund (MINT) and Intermediate Municipal Bond Strategy Fund (MUNI), which were launched in November and December of last year, respectively. The market’s reaction to actively-managed ETFs has been largely disappointing, as most funds have failed to gather more than $10 million in assets. But PIMCO’s bond funds have been an exception – at the end of 2009 MINT and MUNI had assets under management of $45 million and $36 million, respectively. By comparison, the five actively-managed ETFs from PowerShares had accumulated just under $30 million at the end of the year, while Grail Advisors, which launched GVT amidst great pomp and circumstance last year, has only $15 million in five funds (Grail launched two more active bond ETFs last month, bringing the total number of funds to seven).

Behind PIMCO’s Actively-Managed Success

PIMCO ETFs Have Been A Hit On Wall StreetThe reasons for PIMCO’s success in the actively-managed ETF arena are threefold. The first relates to the efficiency of bond markets. Countless studies have proven that efficient market theory holds in equity markets, and that active management adds no value to stock portfolios (and may actually destroy value). But bond markets are another matter. Because many fixed income investments are thinly-traded, many investors believe that active management offers greater potential for excess returns.

Moreover, many fixed income ETFs are effectively active because the fixed income indexes on which they are based simply aren’t built for the replication strategy utilized by ETFs. The Barclays Capital U.S. Aggregate Bond Index, which underlies AGG, has more than 8,000 components. But AGG has fewer than 300 holdings, using a sampling technique to construct a portfolio with similar credit quality, yield, and duration as the benchmark. Sounds like active management to me.

The second reason is an issue of costs. The expense ratios charged by PIMCO’s three bond funds (0.35%)  more closely resemble those of traditional actively-managed bond ETFs than most active products that have hit the market. The Dent Tactical ETF (DENT) holds the honor for the highest ETF expense ratio at a whopping 1.57%, higher than many mutual funds and almost 20 times the costs of Schwab’s low-cost funds at the other end of the spectrum. GVT charges 0.79%, while PowerShares active equity funds charge as much as 0.75%. PIMCO’s bond ETFs are more expensive than their passively-indexed competitors (BND, for example, charges just 14 basis points), but the gap is significantly smaller than in equity markets.

But the cost efficiencies are just one of the attractions. While cheap, PIMCO’s ETFs aren’t any more attractive from a cost perspective than other actively-managed bond ETFs. The new funds from Grail both charge 0.35% as well, and PowerShares’ PLK charges just 0.30%. The third and perhaps most important reason for PIMCO’s success in the bond ETF arena is the company’s long and impressive track record in bond management. PIMCO is the largest bond fund manager in the world, and has a reputation for consistently delivering solid returns to investors. Co-founder Bill Gross is widely regarded as the world’s most prominent bond investor, and his market commentaries are devoured by investors.

The PIMCO brand carries some weight with investors, as evidenced by the mostly successful entrance into the ETF arena.

More In The Pipeline

PIMCO has filed for two more active bond ETFs that should make it to market in coming months, including the Government Limited Maturity Strategy (GOVY) and Prime Limited Maturity Strategy (PPRM). Both of these funds, along with SMMU, were among the Seven Most Anticipated New ETFs of 2010. PIMCO also offers five passively-indexed bond funds, all of which invest primarily in U.S. Treasuries.

The ETF industry expanded at a near record pace in January, with almost two dozen new funds launching in the first month of 2010 (see the complete list). More than 120 new products hit the market in 2009, and expansion this year is expected to exceed that total.

Disclosure: No positions at time of writing.