Pacific Investment Management Co. is the latest company to jump into the municipal bond exchange-traded fund business.
The Newport Beach, Calif.-based asset manager earlier this week launched its first muni ETF, the Pimco Intermediate Municipal Bond Strategy Fund (ticker symbol: MUNI).
The Pimco intermediate fund is at least the 20th muni ETF, but this one is a little different from the others.
An ETF is a publicly traded share of a portfolio. Most muni ETF portfolios try to mimic the returns on a target index. The goal is not to beat the benchmark, but rather to replicate it. Success is measured not in the magnitude of returns, but instead in how closely the returns resemble the returns on the index.
Pimco’s latest fund does not hope to achieve correlation. It is the first actively managed muni ETF, meaning its goal is to deliver plumper returns to investors.
The fund does have a benchmark index — the Barclays Capital 1 to 15 Year Municipal Bond Index — but the principal concern is the generation of returns with the appropriate amount of risk, not mimicry of the index.
In this sense, it is sort of like a publicly traded mutual fund that publishes its holdings every day.
“One should not expect that in an actively managed ETF all you’re going to see is an attempt to replicate that index,” said Bob Fields, muni product manager at Pimco. “We made the decision that an actively managed muni ETF is an efficient vehicle for accessing Pimco’s expertise, market depth, and transaction capabilities.”
Pimco will try to deliver returns by ferreting out bad credits and by minimizing tax events, according to Fields.
He said Pimco can do better than picking up lousy credits just because they are included in a target index. Plus, many muni ETFs had trouble tracking their indexes during the worst of the credit crisis last year.
That means this municipal ETF’s challenge is completely different from the challenges facing the other 19.
The people running the other muni ETFs are primarily concerned with representative sampling, which is the process of making a small portfolio similar in aggregate to a big index.
For instance, the biggest muni ETF, the iShares S&P National AMT-Free Municipal Bond Fund, attempts to mirror the performance of the S&P National AMT-Free Municipal Bond Index.
The fund owns 547 bond issues worth $1.56 billion. The portfolio strives to match returns on an index with 8,172 bonds with $507.7 billion in face value.
The managers of the fund try to accomplish this by decomposing the index into categories, such as credit risk, maturity, duration, coupon, and embedded options. It then takes a sample from each strata, hoping to create a relatively small portfolio that faithfully resembles its much-bigger index.
The Pimco fund’s primary concern is credit analysis. It expects to utilize Pimco’s municipal credit team to select the best deals and build a superior portfolio.
Pimco’s new ETF is managed by John Cummings, who manages about 20 other municipal funds at Pimco as head of the company’s muni desk.
The fund will invest mostly in intermediate tax-exempt bonds rated at least triple-B or its equivalent by Standard & Poor’s, Moody’s Investors Service, or Fitch Ratings.
The fund may take on more or less interest rate risk, depending on Pimco’s forecast for rates.
The fund intends to pay a monthly dividend.
“Municipalities and states face a host of challenges in managing their budgets, so the importance of credit analysis is heightened,” Cummings said in a statement. “With MUNI, Pimco aims to provide investors with a carefully selected, diversified portfolio of municipal bonds with the complete transparency and accessibility of an ETF.”
Before joining Pimco in 2002, Cummings was vice president of municipal trading at Goldman, Sachs & Co.
The fund launched Tuesday with $8 million in seed money, mostly provided by Pimco.
Most of the portfolio is still in cash, but the fund has made a few purchases.
The biggest holding based on market value is $715,000 of a Connecticut refunding issue maturing in 2013.
The next-biggest holding is about $560,000 of a New York State Thruway Authority refunding bond maturing in 2012.
The fund also owns $275,000 of a Georgia refunding bond and $334,000 of a bond issued by the Indiana Finance Authority refinancing highway revenue bonds.
Non-existent until late 2007, municipal ETFs have mushroomed to $5.44 billion in assets, according to the Investment Company Institute. The industry’s assets have doubled this year.
Pimco becomes the fifth company to manage a municipal ETF, joining State Street Global Advisors, Invesco Powershares, Barclays Global Investors, and Van Eck Global.
Pimco also plans to launch an actively managed short-term muni ETF with the goal of beating returns on money market funds.
