Market Overview

5 Reasons Why The Total Return ETF Is Overrated


Just as the tech world is abuzz with speculation about the possibility of another iPad coming out next week, the ETF world is equally aflutter about the Pimco Total Return ETF (NYSE: TRXT), which debuts on Thursday March 1, 2012.

Taking an overtly contrarian stance, we still don't think the ETF version of the Pimco Total Return Fund, the world's largest mutual fund, is that big of a deal.

Put another way, the comparisons to the debut of the Total Return ETF and any new Apple (Nasdaq: AAPL) product, and there have been these type of comparisons, are misguided and arguably come solely by virtue of the Bill Gross name being tied to the new ETF.

Here's why it's wise to temper enthusiasm for the Total Return and not treat it as though it's ETF equivalent of the Facebook IPO.

Assumptions, Assumptions Nearly everyone that has something to say about the Total Return ETF is predicting the ETF will be an immediate success in terms of gathering assets. It probably will be, but the question is where exactly are those assets going to come from? It's reasonable to expect that since the ETF is far cheaper than the mutual fund, plenty of retail investors, and maybe some institutions, will shift from the mutual fund to the ETF.

So net-net, Pimco doesn't really benefit in that scenario. In fact, the firm loses because those assets will now be managed with a lower fee.

The other assumption is that investors have just been sitting around, dying for the Total Return ETF to come to market and that they'll be tripping over themselves to get in on the act. However, there's no empirical evidence to suggest that's the case. Bottom line: TRXT will be a big ETF, but is that a big deal? No.

Timing Is Everything Kudos to those that have realized the Total Return Fund debuted in 1987 at the start of a major bull market for bonds. Problem is Treasury yields aren't what they used to be.

Something else to consider: By virtue of what is an overall stellar track record, Gross does garner plenty of attention on those occasions when he is wrong. With ETFs being more liquid than mutual funds, investors that have knee-jerk reactions to any misstep by Gross will be able to sell TRXT immediately, perhaps punishing the share price in the process.

Cheaper, Sort Of TRXT will be 30 basis points cheaper than its mutual fund sibling, but an expense ratio of 0.55% is still pretty high in the world of large fixed income ETFs. Here are some massive bond ETFs with expense ratios far lower than 0.55%: The Vanguard Total Bond Market ETF (NYSE: BND), the iShares Barclays Aggregate Bond ETF (NYSE: AGG), the iShares Barclays TIPS Bond ETF (NYSE: TIP) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSE: LQD).

"While we think it is possible that a successful PIMCO Total Return ETF launch could take some market share away from some of the larger passively managed, index-based ETFs, our expectation is that the fixed income ETF asset pie will continue to grow. As bond mutual fund investors focus more on inexpensive ways to find yield in a low-rate environment, we expect the larger fixed income ETFs are likely to gain appeal, even with increased competition," according to S&P Capital IQ.

Not A Twin Simply put, the Total Return Fund has benefited from the use of derivatives. The Total Return ETF will not use derivatives. Investors will probably quickly discover how important the derivatives issue is here and if the mutual fund is outperforming the ETF by a wide margin, then where will the assets flow? Probably not to the ETF.

Recent Performance As we already stated, there's no denying Total Return's long-term track record, but 2011 was not so kind to the fund. Yes, the fund was up on the year, but it lost $5 billion in assets and lagged over two-thirds of its peers. Striking is that Total Return lost assets as investors poured $121 billion as of November 30 into taxable funds, according to Morningstar.

Posted-In: Long Ideas News Bonds Short Ideas Specialty ETFs New ETFs Previews Intraday Update Best of Benzinga


Related Articles (AGG + AAPL)

View Comments and Join the Discussion!