PIMCO Jumped on the ETF Bandwagon. Should You?

Yesterday, PIMCO launched the Pimco Total Return ETF (TRXT), an exchange traded fund version of the world’s largest mutual fund– the $250 billion Pimco Total Return Fund. Once again, this move will have investors wondering if they should invest in this new ETF, and more broadly, what the differences are between mutual funds and ETF’s.

TRXT will invest with the same goals as its traditional fund cousin, but one of the key differences is that TRXT will not make use of derivative securities in the same that the mutual fund version does. AsForbes recently noted, “the derivatives used by the mutual fund such as interest rate and credit default swaps, options, swaptions, and currency forwards and swaps, are used to express views on everything from corporate and government bonds to trends in the currency market… The extent to which the lack of derivatives significantly influences returns will be borne out by the first few months of trading for the ETF relative to the mutual fund.”

But this begs to question why PIMCO would create an ETF version of its highly successful mutual fund. The answer may lie in the growing trend of investors to generally favor ETFs as an investment vehicle of choice for several reasons. Here are three key differences between mutual funds and ETFsthat investors should be aware of.

Fees

ETFs were originally designed specifically to track a specific market benchmark, like the S&P 500 or the Barclays Aggregate US Bond index. In this sense, ETFs are “passive” investment vehicles-– their purpose is to closely replicate the performance of a market benchmark, not to outperform the benchmark. Because less overhead is required to track an index than to try to outperform it, passively-managed ETFs will generally have lower management fees than actively managed mutual funds.

But many active ETFs– funds that try to beat an index– have also entered the fray recently. TRXT itself will be an active ETF. Investors might be forgiven for thinking that active ETFs have similar fees to active mutual funds, but take note– active ETFs are also generally cheaper than their mutual fund counterparts. This is due mainly to the structural difference between two types of securities. Simply put, “the ETF structure is far simpler” notes Business Insider, making for less overhead and administrative burden. This translates into lower fees for the investor.

And while ETFs generally just charge a management fee, mutual funds complicate their fee structure with multiple types of different charges applicable to different share classes, for example: front-end or back-end load, retirement, institutional and so forth.  Each class reflects different types and levels of fees, including sales load, redemption, 12b-1 and other varieties.

Trading

Mutual funds typically price once at the end of each trading day, and investors buy and sell (“redeem” in mutual fund parlance) based on the Net Asset Value (NAV) reflected in that price. The redemptions are handled by the mutual fund company itself.

ETFs trade like regular shares of common stock between market participants, which is to say on a stock exchange with prices changing continually throughout the trading day in response to buy and sell orders.  As Business Insider notes “ETF trades can be executed throughout the day– a feature that can generally become increasingly valuable in volatile markets.”  As much as investors may prefer to trade intra-day, the flip side of course  is that there is no guarantee that a transaction will be completed at or near the NAV of the fund. ETF investors therefore risk selling at a discount to NAV. However, they can often reduce risk by placing a limit order, whilst having the ability, on the other hand,  to possibly sell at a premium.

Transparency

Another major difference between active ETFs and actively-managed mutual funds relates to transparency. “The necessity to reveal holdings on a daily basis will prove interesting for the ETF version” writes ETF Trends of the new PIMCO fund, alluding to the requirement of  most active ETFs to publish their holdings on a daily basis. This allows investors to see exactly what is in the underlying portfolio.  Mutual funds, on the other hand, are required to reveal their holdings with far less frequency (on a quarterly basis).

As with all things, there are pros and cons to ETFs and they may not be right for all circumstances and all people. But PIMCO’s move is no doubt a major nod towards the huge growth trend in ETFs driven primarily by investor preferences.

Tell us:  Are you looking to invest in TRXT?

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Originally published here.