Pacific Investment Management Co.’s 13-month-old exchange-traded fund is attracting more cash than the firm’s flagship Total Return mutual fund as investors join Bill Gross in preferring ETFs for bond investing.
About $263 million was funneled into Pimco’s $4.3 billion Total Return ETF in March, compared with $32 million for the $289 billion eponymous mutual fund, the lowest monthly volume for the world’s biggest bond fund since December 2011, according to data compiled by Bloomberg. The ETF returned 1.2 percent in the first quarter versus 0.6 percent for the 25-year-old mutual fund, the world’s largest.
The outperformance underscores the rising influence of ETFs as investors seek faster ways to slip in and out of the bond market for an edge with returns dwindling after average annual gains of 6.3 percent in the past four years. After following BlackRock Inc. and Vanguard Group Inc. into fixed-income exchange-traded products, Newport Beach, California-based Pimco is gaining ground as the industry swells to $321.2 billion.
“People like what ETFs offer in terms of intraday liquidity, cost efficiency and transparency,” said Deborah Fuhr, the former ETF research head at BlackRock who helped found London-based research firm ETFGI last year. “Bill Gross is a portfolio manager who is well-known and respected. The performance of the ETF, which has done better than the mutual fund, is an important part of the story.”
The Total Return ETF, selected by Pimco co-founder Gross in January as his top pick for a bond fund this year, amassed $4.2 billion of deposits in the 12 months ended in February, according to ETFGI. That’s almost 10 percent of the $43.1 billion of flows into the 166 fixed-income exchange-traded funds and products in the U.S.
More than a decade after BlackRock created the first fixed- income ETF, investors from hedge funds to retirees are increasingly turning to the products, which have shares that trade like stocks on exchanges, as bond-trading volumes fail to keep pace with record issuance.
“ETFs are the future of asset management,” said Timothy Strauts, an ETF analyst at Morningstar Inc. in Chicago. “Gross being on board with ETFs, I see that as him seeing the light.”
Elsewhere in credit markets, Telefonica SA’s German unit plans to sell euro-denominated bonds for the first time as the parent seeks to take advantage of the country’s lower borrowing costs. A unit of Dish Network Corp. raised $2.3 billion in a bond sale that was more than double the initial plan. Wendy’s Co., the U.S. hamburger chain, set the rate it will pay on a $1.12 billion loan to refinance debt.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, climbed 1.5 basis points to 89.2 basis points, increasing for the first time in four trading sessions, according to prices compiled by Bloomberg.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 2.6 to 117.3 at 10:45 a.m. in London.
Both indexes typically rise as investor confidence deteriorates and fall as it improves. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, decreased 0.27 basis point to 16.28 basis points, the lowest level since March 18. The measure narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
Bonds of New York-based Morgan Stanley were the most actively traded dollar-denominated corporate securities by dealers Wednesday, accounting for 4.2 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Telefonica Deutschland Holding AG hired UBS AG, Bank of America Corp., BayernLB and Commerzbank AG to help sell senior unsecured notes maturing in five to seven years, terms obtained by Bloomberg News showed. The sale would be of benchmark size, typically at least 500 million euros ($640 million), according to the documents.
Spain’s Telefonica, Europe’s most indebted telecommunications company, is borrowing through the growing German unit as sales in its shrinking home economy drop. Telefonica Deutschland had 842 million euros of net debt at the end of 2012, compared with 51.3 billion euros for its parent.
Dish DBS Corp. sold $1.1 billion of 5.125 percent debt due 2020 that yields 387 basis points more than similar-maturity Treasurys and $1.2 billion of 4.25 percent securities maturing 2018 with a 384 basis-point spread, Bloomberg data show. Proceeds will be used for general corporate purposes, which may include wireless and spectrum-related strategic transactions, Englewood, Colorado-based Dish, the third-largest U.S. pay-TV provider, said in a statement.
The company said April 2 that it planned to issue $1 billion of senior notes.
The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index rose 0.02 cent to 98.33 cents on the dollar, matching a level last week that was the highest since July 2007. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 2.2 percent this year.
Leveraged loans and high-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.
Wendy’s will pay interest on a $300 million term A loan due in 2018 and an $815 million B portion maturing in May 2019 at 2.5 percentage points more than the London interbank offered rate, with a 1 percent floor on the lending benchmark, according to a person with knowledge of the matter, who asked not to be identified because the deal is private. The company may sell the six-year debt at 99.875 cents to 100 cents on the dollar.
In emerging markets, relative yields were little changed at 304 basis points, or 3.04 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. The measure has widened from 265.8 at year-end.
Investors are turning to ETFs to maneuver quickly in a market that’s losing 0.07 percent this year on the Bank of America Merrill Lynch U.S. Broad Market index compared with 0.46 percent gains in the same period of 2012 as the Federal Reserve holds its benchmark interest rate at close to zero percent for a fifth year.
Pimco’s Total Return ETF has returned 13.4 percent since it started trading on March 1, 2012, more than 5 percentage points more than the 8.3 percent gain for its mutual fund. With lower volatility, the ETF’s risk-adjusted returns of 4.6 percent compare with 2.3 percent for the mutual fund, Bloomberg data show.
“It’s a proof point that fixed-income ETFs and ETFs in general are no longer niche investment vehicles,” David Mazza, head of ETF investment strategy in the Americas at State Street Global Advisors in Boston, said in a telephone interview. “They now can be used and embraced by the largest institutional investors in the world.”
Unlike Pimco’s mutual fund, the ETF is prohibited from using certain derivatives, such as futures, options and swap agreements. In all other respects, the firm says, it seeks to follow a similar investment strategy, with at least 65 percent of its assets held as fixed-income securities and the same targeted allocations to different credit markets.
Gross, who helped found Pimco in 1971 and now serves as co- chief investment officer, named the ETF as his “first pick” as he selected three bond exchange-traded funds to be used as “bond substitutes.”
“I manage it on a daily basis,” he said at a Jan. 14 roundtable in New York hosted by Barron’s. “It has been a huge success story.”
Gross, who is often referred to in the media as “the bond king,” also runs the Total Return Fund, which has advanced an annualized 7.9 percent over the past five years to beat 93 percent of peers.
Mark Porterfield, a Pimco spokesman, said executives weren’t available to be interviewed this week on the performance of the firm’s two funds.
The ETF charges 55 basis points in annual expenses, according to fund documents. That compares with 46 basis points for the traditional fund’s institutional shares, which generally are used by advisers.
At the ETF’s inception in February 2012, Gross said in an interview that “if you already own the Total Return Fund with a lower fee, it’s hard to see why you’d want to go into the Total Return ETF with a higher fee other than for more liquidity.”
While the amount of dollar-denominated corporate bonds outstanding has surged 11 percent in the year ended March 31 to $5.2 trillion, the average volume of the notes traded daily rose 2 percent to $19.2 billion, according to Trace and Bloomberg data. Corporate bond sales in the U.S. reached a record $1.475 trillion in 2012.
The market for company debt, which generally trades over the counter, is growing less liquid as the biggest banks reduce the volume of their own money they use to facilitate credit trading. The 21 primary dealers that do business with the Fed have cut their corporate-bond holdings by 76 percent since the peak in 2007.
BlackRock’s iShares iBoxx Investment Grade Corporate Bond Fund, which started trading in July 2002 and was the first of its kind, has grown to include $23.6 billion of debt, while the six-year-old Vanguard Total Bond Market ETF now includes $17.9 billion of assets, Bloomberg data show.
Pimco’s Total Return fund’s holdings are equal to almost half of all actively managed fixed-income ETFs in the U.S., BlackRock’s data show. It has garnered the greatest volume of net inflows among all fixed-income products listed in the U.S. through in the 12 months ended in February, according to ETFGI data.
“People want to be able to use exchange-traded products for fixed-income investing,” Fuhr said. “Most mutual funds that are actively managed haven’t been able to consistently deliver alpha.”
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