Smaller bond funds have an advantage over bigger ones in illiquid markets: They’re more nimble.
See Pacific Investment Management Co.’s Total Return exchange-traded fund. It purports to follow the same strategy as the firm’s $229 billion flagship Total Return mutual fund, yet the $3.4 billion ETF’s returns are more than 6 percentage points better during the last two years. Both are managed by the firm’s billionaire co-founder, Bill Gross.
The outperformance highlights how subtle differences in fund sizes and strategies may result in big disparities in returns, especially as it’s become more difficult to maneuver in the corporate bond market.
“There are things you can do in a smaller fund that you can’t do in a larger fund,” said Eric Jacobson, an analyst at Morningstar Inc. (MORN)
Enter DoubleLine Capital LP. The Los Angeles-based firm is teaming up with State Street Corp. (STT) to open its first bond ETF. DoubleLine’s ETF will take on Pimco’s, pitting Jeffrey Gundlach’s bond-picking acumen against Gross’s.
While the SPDR DoubleLine Total Return Tactical ETF won’t follow the same investment strategy as the DoubleLine’s Total Return Bond mutual fund, it will draw on the knowledge of a similar team of analysts and money managers.
DoubleLine’s Total Return Bond Fund (DBLTX), which includes $33 billion of assets and focuses on mortgage-related debt, has performed better than 95 percent of its peers during the past three years, according to data compiled by Bloomberg. Its proposed SPDR Total Return ETF has a broader bond-market focus, according to a May 30 filing.
And it will be more agile as it faces a market that’s turning over at about the slowest rate ever. Trading has failed to keep pace with a 22 percent expansion of corporate bonds outstanding in the three years through December, with average daily volumes dropping 12 percent in the period, according to Securities Industry and Financial Markets Association data.
This is partly because banks are committing less capital to facilitate trading in the face of risk-curbing rules. Also, central bank stimulus has suppressed borrowing costs and pushed investors into a crowded bullish wager on bonds.
The smaller Pimco fund has trounced the firm’s biggest one in this environment. Pimco’s Total Return ETF has returned 14.7 percent since its Feb. 29, 2012, inception, compared with an 8.7 percent gain on the $229 billion bond mutual fund overseen by the Newport Beach, California-based asset manager, according to data compiled by Bloomberg.
The two funds generally adhere to the same broad-market philosophies determined in large part by Gross, though there are some different attributes, like the mutual fund’s ability to use derivatives.
Returns may differ, “especially over shorter time periods, primarily driven by differences in flows and guidelines,” Mark Porterfield, a Pimco spokesman, wrote in an e-mailed statement. “Over longer periods, we expect outcomes to be well in line with each other.”
Pimco’s bets last year on non-agency and commercial-mortgage debt show the benefit of being smaller. The ETF boosted such holdings to about 12 percent of assets, compared with an increase to 7 percent of the mutual fund’s, Jacobson said. The securities were hard to come by as they were in high demand, so purchases had a bigger impact on the smaller fund, he said.
“They both were helped by those positions, but the ETF was helped by 80 basis points more than the mutual fund in 2013,” he said.
If the performance of Pimco’s ETF is any indication, it’s good to be spry in today’s bond market. That may bode well for Gundlach’s new ETF.