Bill Gross Starts an ETF

Pimco Total Return, the world's largest mutual fund, with $240 billion in assets, is about to get some tough new competition from -- drum roll, please -- Pimco itself. Pimco, a powerhouse in bond funds, is launching an actively managed, exchange-traded version of Total Return.

One reason the Pimco move is noteworthy is that the vast majority of ETFs simply seek to track an index. Another is the splendid record of Bill Gross, Total Return's lead manager and Pimco's co-chief investment officer (Gross also runs Harbor Bond, a clone of Pimco Total Return and a member of the Kiplinger 25). The presence of Pimco's star manager lends instant credibility to the concept of actively managed exchange-traded funds, which has been having trouble gaining traction.

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The larger question is whether an actively managed bond ETF is superior to an actively managed bond mutual fund. My answer: a flat-out yes. You get the same diversification and professional management as you do with a regular fund. You get access, for the minimal cost of an online trade, to a product that's likely to sport lower fees than the mutual fund version. And you get protection from potential mishandling of derivatives because the feds ban their use in bond ETFs but not in bond mutual funds (as we went to press, Pimco had not yet disclosed the expense ratio of the new Total Return ETF).

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Pimco, which already runs four active bond ETFs (none run by Gross), is hardly alone in the race to attract assets. The Securities and Exchange Commission has given some other outstanding bond fund groups, including Eaton Vance and T. Rowe Price, permission to start active ETFs as well, but so far none have said when they will launch their funds.

Vanguard has been a big player in bond ETFs since 2007. But its offerings and most other income ETFs are designed to track indexes. Pimco's ETF will be an eclectic and flexible product that reflects the economic and market views of Gross and other brains at Pimco. At last word, Pimco's managers were pessimistic. They anticipate higher inflation and slower growth in the U.S. than Kiplinger's and many economists expect. Gross is so down on Treasuries that he had a 4% short position in them in Total Return as of April 30 (the short position enables the fund to profit from falling Treasury bond prices).

But don't count on the Pimco ETF to mirror the mutual fund version precisely. The latter limits high-yield, or junk, bonds to 10% of assets, and securities denominated in foreign currencies to 30%. The ETF will have no such constraints, so it could be quite aggressive. But it won't be mysterious. Unless the SEC does a 180, no active bond ETF can traffic in options, futures, credit-default swaps and other oddball stuff that you find in Pimco Total Return and Harbor Bond. In addition to Pimco's reputation as the créme de la créme of bond shops, the red X over derivatives is reassuring.

But my favorite argument for actively managed bond ETFs is their "transparency," which in this case alludes to the requirement that they must disclose their holdings daily. Fund managers dislike constant disclosure of their trades for fear it will tip off others, who will then copy their moves, affecting prices of securities the managers are buying or selling. Ironically, just before Pimco announced the new ETF, Robert Pozen, a former official at Fidelity and MFS and author of an authoritative new book on how people manage funds, told me that active ETFs would never catch on because "nobody who is any good would ever do this" because of their discomfort with daily disclosure.

Well, I reckon that Pozen would say Bill Gross is good, and I believe Gross's imprimatur is likely to prompt a bunch of other top-notch bond managers to launch active ETFs. If that happens and you hold any of their traditional bond funds, you'll want to strongly consider their new ETFs as replacements.

Kosnett is the editor of Kiplinger Investing for Income and writes the "Cash in Hand" column for Kiplinger Personal Finance. He is an income-investing expert who covers bonds, real estate investment trusts, oil and gas income deals, dividend stocks and anything else that pays interest and dividends. He joined Kiplinger in 1981 after six years in newspapers, including the Baltimore Sun. He is a 1976 journalism graduate from the Medill School at Northwestern University and completed an executive program at the Carnegie-Mellon University business school in 1978.