PIMCO Treads Into ETFs; Consultants Question Allure

(April 25, 2011) — Investment guru Bill Gross plans to offer an exchange-traded fund (ETF) version of its Pacific Investment Management Co. (PIMCO) Total Return Fund, the world’s largest mutual fund.

In an SEC filing, the bond manager said that the PIMCO Total Return Exchange-Traded Fund will buy a combination of US and non-US public and corporate debt, holding as much as 10% of its assets in high-yield securities.

However, investment consultants voice skepticism about the embrace of ETFs among institutional investors, noting that they have remained on the sidelines during the ETF craze.

“When I first saw news about PIMCO’s new investment vehicle, I was scratching my head trying to figure out why institutional investors would choose this investment structure, which provides intraday liquidity for investors who tend to have a longer-term focus,” David Ritter, senior vice president of LCG Associates, an Atlanta-based investment consulting firm, tells aiCIO. “Hypothesizing, I’d say institutional investors may be better off going with an alternate investment vehicle. I’m sure there’s a need out there, but from my perspective as an institutional investment consultant, I question the need for intraday liquidity.”

According to Ritter, institutional investors — which tend to be long-term and strategic in nature — generally do not need the intraday liquidity that ETFs offer. “Gaining exposure to the S&P 500 through an ETF tends to be more costly,” he says, noting that he would advise most institutional clients to seek exposure through a commingled or mutual fund for daily liquidity and lower costs.

From a consultant’s perspective, ETF’s are helpful tools to provide short-term market exposure during transitional periods, after a fund terminates a manager and is working to find a replacement, for example. “We’ll continue to see ETFs grow market share out there, whether it’s because of the belief active managers can’t add value, or because there’s just more demand for index strategies during volatile markets,” Ritter says.

Furthermore, he believes that while ETFs have been slower to gain traction among institutional investors, the proliferation and rising interest associated with ETFs, especially among retail investors, will force fund companies like BlackRock and Vanguard to continue to bring down the cost of ETFs. “Vanguard has priced their ETFs very competitively in the market. Others will be forced to fall in line to be competitive,” Ritter notes. “But, I think ETFs will always be a little more costly for institutions, so if you don’t need that intraday liquidity, it makes sense not going into ETFs.” From his perspective, despite the rising interest over this investment vehicle, ETFs will remain more widely accepted at the retail as opposed to the institutional level.