By Ryan Blute, PIMCO, Head of EMEA Global Wealth Management.
ETFs have grown rapidly in Europe in recent years, albeit from a small base compared to traditional mutual funds. But if the US market can serve as a guide, there should be continued strong growth in the years to come. Amid this growth, it is also likely that there will be innovations in investment products, ranging from new benchmarks to new asset classes for institutional and individual investors. Yet a misconception continues to haunt the ETF investment vehicle that ETFs are equivalent to passive investments.
ETFs should be viewed simply as investment “vehicles” which provide access to investments in a structure with certain characteristics and advantages. When choosing an investment, the most important decision is the investment strategy, such as European corporate bonds, local emerging market bonds, etc. The follow-up decision should then be the investment vehicle, such as an ETF, traditional mutual fund, or separate account. Yet while many investors have historically used ETFs as a means of accessing passive investment strategies, PIMCO believes that these investors may lose out on opportunities to improve their returns through active management while also benefiting from the structure of the ETF vehicle.
Investors choose the ETF vehicle for a variety of reasons, ranging from the liquidity of its intraday transactions, to the transparency provided by the disclosure of holdings, to the possibility of lower fees compared to traditional retail share classes of mutual funds. placement. But while passive investment strategies have historically dominated the ETF market, active management is gaining ground.
PIMCO has been a pioneer in the active management of fixed income securities since the 1970s and has also been a pioneer in the active management of fixed income ETFs for almost ten years. And we expect investors to continue migrating to active fixed income ETFs in a still low interest rate environment.
Active management of fixed income securities can take advantage of a number of inefficiencies in the bond market that introduce opportunities to improve returns without increasing risk. And these can all be applied to the ETF vehicle. First, the bond market continues to be influenced by rating agencies, which set bond ratings that must be tracked by passive index trackers, regulated banks and insurance companies, and many institutional pension plans. These investors can follow rote rules that require adjustments to their portfolios when bonds go down, introducing an opportunity for independent, value-oriented investors to buy these securities at attractive prices. Second, many formal institutions such as central banks buy fixed income securities with a goal other than maximizing total return. It also introduces distortions to the extent that some securities persist in “trading rich”, which means that those who passively follow an index must pay too much for these bonds held by somewhat “non-economic” players. Active ETF managers can take the opposite view and buy similar bonds at more attractive yields. Third – and related – some investors like insurance companies use bonds for their income characteristics and are subject to specific accounting regulations that distort their transactions in certain securities to optimize financial statement results. Active managers can also take advantage of these “customer effects” and avoid these systematically overvalued obligations. And finally, active ETF managers can take advantage of passive ETF managers who are forced to buy securities that track an index. A perfect example is the case of corporate bonds, in which passive ETFs must purchase the largest or most liquid bond from the issuers of the index they are seeking to track. Active managers are fully aware of these obligations and can avoid them and substitute alternatives at more attractive and substantially similar prices. Then, when these passive ETFs suffer from cash outflows, active managers can take advantage of the fact that the prices of these “must own” securities fall beyond fundamentals and buy them at more attractive yields.
While active investing is the most attractive way to invest in many areas of the fixed income market, there are areas that can offer attractive integrated returns. In these cases, we can seek to capture them in the most efficient and intelligent way possible, whether you call it passive “intelligent” or better beta.
For example, high yield bonds with maturities of less than five years may have advantages over those with longer maturities: they have a shorter spread duration and therefore tend to be relatively defensive in the event of a loss. decline in stocks. They have also historically provided returns comparable to stocks, but at around half the volatility. And choosing an index with a maturity range of 0 to 5 years rather than 1 to 5 allows us to hold bonds to maturity, thus avoiding first year selling and costly transaction costs. that accompany it. When we think of ‘smart’ passive indexing, we don’t focus as much on minimizing short-term tracking error as we do on other goals, such as liquidity, transaction costs, and portfolio turnover. .
Whether investors are looking for active or passive strategies in Fixed Income ETFs, our comprehensive portfolio of strategies draws on the resources, investment process and expertise of the entire PIMCO team. Ultimately, we seek to provide a range of ETFs that enable investors to meet their specific risk and return objectives across the range of fixed income opportunities, by combining PIMCO’s expertise in securities. fixed income with the ease and efficiency of the ETF vehicle.
(The opinions expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)