Viewpoints

The Importance of Active ETFs in Fixed Income

PIMCO offers UCITS ETFs for investors seeking active fixed income exposure via ETFs.

Ryan Blute, who leads PIMCO’s Global Wealth Management team in EMEA, answers questions about the global integration of PIMCO’s ETF business, the benefits of ETFs broadly, and the important differences between passive equity and active bond management.

Q. Why is PIMCO now taking on the full promotion and distribution of your EMEA-domiciled UCITS ETFs?

A. The time is right. We have a 10-year history successfully managing ETFs in EMEA and a suite of solutions that make a compelling complement to our more well-known mutual fund offering. But now we see an opportunity to integrate and globalize our ETF business, putting the whole effort on an equal strategic footing. We see a burgeoning opportunity across the world in ETFs, especially in fixed income, and particularly in EMEA, the second largest region for ETFs after the U.S.

We are a global firm with a global vision for our ETFs that we are eager to execute across regions and channels, with an integrated strategy across products, capital markets, marketing and sales. Just to give you some context on the size of our ETF business, we manage $30 billion in ETFs across several geographies and we’re among the largest active fixed income ETF managers in the world.1 If we look only at our UCITS ETFs, today we are the 6th largest manager of fixed income ETFs in Europe and manage the largest two actively managed ETFs.2

Q. How should investors and advisors think about your ETF initiative in the context of PIMCO more broadly?

A. They should understand that we are a high performance active fixed income manager, and that we are vehicle-agnostic. We are a leader in global active fixed income and have a long track record of almost 50 years in the space. We manage client assets across the fixed income universe and in virtually every structure available ­– from private funds, separate accounts, closed end funds, model portfolios, mutual funds and ETFs. Each structure has different and distinct benefits for investors, some allow for greater illiquidity, others offer more investment flexibility, and some are just more familiar to clients. The ETF vehicle itself has a number of obvious attractions: It trades efficiently on an open exchange, offers greater levels of transparency in its holdings, is priced continuously throughout the day, offers a single “clean” share class, no minimum or additional costs, and provides an intuitive way for investors to gain instant, diversified allocations. Ultimately, we want to deliver our fixed income expertise in whatever form makes the most sense for our clients.

Q. What about those who say that ETFs are synonymous with passive? How does that align with your active management focus?

A. ETFs are a vehicle, not a strategy. It’s easy to forget that. Many assume that ETFs are by nature or by definition passive. And while it’s undeniable that the vast majority of ETF flows go into passively-managed products, and specifically passive equities, it’s factually wrong to claim that ETFs = passive. Also, with equities, it’s easier to understand why investors have begun to default to passive ETFs. In a study that we conducted in the U.S., we found that over the past 10 years, the median active equity manager underperformed its passive peer by approximately 90 basis points annualized – and their stated benchmarks by 110 bps. Given that level of underperformance, the inclination to allocate to passive equities may be the only rational move for most.

Why active for bonds? Passive may make sense for equities but bonds are different

But it’s different with fixed income. Our research shows that in bonds the active versus passive argument is almost diametrically opposite that of equities: Active managers outperformed their passive peers over the last decade in aggregate by 47 basis points. That’s why our advice to investors is don’t be mechanically passive in fixed income. In other words, we suggest that investors take thought before allocating to passive fixed income ETFs on the same premise, or with the same conviction, that they have historically allocated to passive equities. Simply put, bonds are different, and investors should consider the costs of inadvertent or kneejerk allocations to passive fixed income.

Q. What is it that makes fixed income so different from equities, when it comes to active management?

A. Take one obvious example: While stock indices are weighted by market capitalization, bond indices give greater weight to entities with the most debt outstanding. That means passive fixed income investors are lending more money to the most indebted issuers.

But a proper response requires the use of three distinct lenses: whether you look at the buyer base, the benchmarks, or the bond markets themselves – fixed income tends to provide richer ground for active managers to outperform compared to equities.

First of all, over half of investors in fixed income, including sovereign central banks and insurers, are not typically investing to maximize total return; their focus may be on liability matching or supporting currency valuations. Then there’s the nature of bond indices themselves, which are fundamentally different from equities. Replicating them efficiently is a totally different undertaking. They’re generally far larger than most equity benchmarks – the Barclays Global Aggregate Index has over 10,000 underlying securities, the S&P 500 just that many. Also, those fixed income securities are usually less liquid, and the index has turnover that’s almost 40 times that of the S&P 500. The idea of passively “replicating” that many issues with their rate of change, and doing so with very low tracking error, is exceptionally difficult. That’s why passive fixed income ETFs almost always require some form of compromise with the index, via sampling or optimization, to try and reasonably capture the index characteristics. And even then these passive bond funds also tend to operate with higher rebalancing and trading costs than equities. And finally, the limitations of any established bond index can radically limit the opportunity set. Active managers have far more freedom to tap a wider array of sectors and geographies in their search for alpha.

Three Lenses on the Opportunity for Active Bond Management

Three Lenses on the Opportunity for Active Bond Management

In general, the marketplace for bonds is far less efficient than stocks. Equities are traded in milliseconds on public exchanges, while bonds are still traded largely over the counter, slowly and in large blocks. Where equities are highly standardized and perpetual, bonds are far more idiosyncratic in their terms, and with finite, often short, lives. For example, new issues of bonds (the equivalent of IPOs) are frequent, constituting about 20% of the U.S. corporate bond market each year versus 1% for US equities.

All of these factors may give active managers a greater opportunity to outperform in fixed income than in equities. And in bonds, where overall returns may be modest relative to equities, that outperformance could have outsize relevance for investors.

Q. It sounds like you have no tolerance for passive fixed income in your ETF line-up. Is that right?

A. That’s not entirely true. There are some areas of fixed income that can offer attractive embedded returns. In those instances we may look to capture those in the most efficient and intelligent way we can – whether you call it “smart” passive or better beta.

For example high yield bonds with maturities shorter than five years may have advantages over those with longer maturities – they have less spread duration and so tend to be relatively defensive in an equity downturn. They have also historically provided returns on par with equities but at about half the volatility. And choosing an index with a 0-5 year maturity range rather than 1-5 allows us to hold bonds to maturity, avoiding selling at year one and the accompanying costly transaction costs. When we think about “smart” passive indexing, we are not as focused on minimizing short-term tracking error as we are other objectives, such as liquidity, transaction costs and portfolio turnover.

Short-term high yield investers have historically benefited from a lower volatility profile without sacrificing total return.

There’s a similar argument in emerging markets, and in particular EM local debt. For a variety of reasons, including illiquidity and high transaction costs, generic passive EM debt exposure provides returns that are often meaningfully less than index returns. But we believe we can improve on that. One case in point: the JP Morgan GBI-EM benchmark (the most common benchmark for EM local accounts) assumes zero taxes. Yet, as an example, the government of Indonesia (10% of the benchmark) actually extracts 10% withholding taxes from investors. In that instance we can utilize various strategies, including offshore issuance, to minimize or eliminate the tax impact of investing in emerging markets with minimal tracking error. So in general, with respect to the active versus passive debate in fixed income ETFs, our motto may be: “active where it matters, passive where it saves.”

Q. How would you characterize your offering to the market? What has driven the design of your suite of ETFs?

A. Our suite of ETFs runs from the ultrashort bond or “enhanced cash” category out to the highest yielding segment of emerging market local debt. Along that continuum we offer investment grade covered bonds (with its “dual recourse” character a compelling, higher returning alternative to ultra-safe European government debt) out to investment grade U.S. and European corporate debt. In certain of these areas, like investment grade bonds, we think active management can offer the best solution. In a handful of categories where “smart” passive investing may potentially deliver “better beta,” including U.S. HY, European HY, and emerging market debt, we use that approach.

The PIMCO UCITS ETF Franchise: Offering Strategies Across the Spectrum of Fixed Income

But across that full spectrum of strategies we are leveraging the resources, investment process and expertise of the entire PIMCO team. At the end of the day, we are seeking to deliver a suite of ETFs that enable investors to meet their specific risk and return goals across the fixed income opportunity set, marrying PIMCO’s fixed income expertise to the ease and efficiency of the ETF vehicle.


1 Bloomberg. As of March 31, 2020.
2 Bloomberg. As of March 31, 2020. The two funds are PIMCO US Dollar Short Maturity UCITS ETF and PIMCO Euro Short Maturity UCITS ETF
The Author

Ryan P. Blute

Head of Global Wealth Management, Europe

View Profile

Latest Insights

Europe: Moment of Truth

A committed and decisive fiscal/monetary partnership to tackle the economic crisis is urgently needed, but Europe continues to lag behind. European policymakers face a moment of truth.

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Milan
PIMCO Europe Ltd - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Munich
PIMCO Deutschland GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10


PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Italy branch is additionally regulated by the CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) and PIMCO Deutschland GmbH Swedish Branch (SCRO Reg. No. 516410-9190) are  authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Swedish Branch is additionally supervised by the Swedish Financial Supervisory Authority (Finansinspektionen) in accordance with Chapter 25 Sections 12-14 of the Swedish Securities Markets Act. he services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser.

Important information

Your capital is at risk. You may not get back the amount you invested. Past performance is not a guarantee or reliable indicator of future results and no guarantee is being made that similar returns will be achieved in the future.

This page is not intended as investment advice or as a recommendation to invest in any particular asset class, security or strategy. The information provided is for illustrative purposes only, and it should not be relied upon as investment advice or as a recommendation to buy or sell securities. Investors should seek independent professional advice prior to investing. Any investment in an ETF should be made on the basis of the relevant Prospectus and Key Investor Information Documents, including consideration of the investment objective, risks, charges and expenses. Further information on the ETFs, their Prospectus, Key Investor Information Documents and Supplements are available at pimco.com or from your financial adviser or broker. For actively managed ETFs, further information on the use of benchmarks or indices is set out in the Prospectus and relevant Supplement.

The distribution and the offering of ETFs in certain jurisdictions may be restricted by law. This page does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation. This document is not for distribution to, or for the attention of, US or Canadian persons.

UCITS ETF’s units / shares purchased on the secondary market cannot usually be sold directly back to UCITS ETF. Investors must buy and sell units / shares on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units / shares and may receive less than the current net asset value when selling them.

The representative and paying agent for the sub-funds of PIMCO ETFs plc in Switzerland is BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich, Switzerland. The offering documents, articles of incorporation and annual and semi-annual reports may be obtained free of charge from the representative in Switzerland. The ETFs are domiciled in Ireland.

PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Deutschland GmbH Italian Branch (Company No. 10005170963), and PIMCO Deutschland GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, and Spanish Branch are additionally supervised by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act, and the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. PIMCO provides services to qualified institutions and investors who fall within the category of professional client as defined in the FCA’s Handbook. PIMCO ETFs PLC is an umbrella type open ended investment company with variable capital and with segregated liability between Funds incorporated with limited liability under the laws of Ireland with registered number 489440. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. Copyright 2020, PIMCO.