PIMCO’s New (TRXT) ETF: PIMCO Wins, Investors Win, Financial Advisers Lose

Part 3 of 4 on Bond ETFs

(March 2012) In the first two articles in this series we talked about several new Bond Market ETF’s which have come to market recently and 3 arguments against investing in PIMCO’s new ETF the TRXT.

In today’s installment we will look at who the winners and losers will be now that PIMCO has launched an ETF version (TRTX) of its flagship bond mutual fund?

  • Investors Win: You will be able to invest in the Total Return Fund with lower fees and expenses.
  • PIMCO Wins: By providing investors a low-cost way of investing in the Total Return Fund, it gains a new distribution channel that does not rely on financial advisers.
  • Financial Advisers Lose: Why would an investor pay a 2 or 3% load fee for the privilege of investing in the PIMCO Total Return Fund, when they can buy the ETF without incurring this charge? The PIMCO ETF  will force financial advisers to give up this extremely lucrative fee.

Why Investors Win

The PIMCO ETF saves investors money.  Here is table comparing the typical fees associated with a $100K investment in the Total Return Fund vs. The TRXT ETF.

Cost comparison ($100K Account Size) Mutual Fund ETF
Brokerage Fee $75 $10
Load Fee For $100K 3.75%/  $3,750 $0
Management & Marketing Fees For The First Year 0.85% / $850 0.55% / $550

Investing $100k in PIMCO Mutual Fund A Shares will cost the investor around $4,675 in the first year. Investing that same $100K in the ETF will cost around $560.  This means investing $100K in the ETF will save an investor $4,100 in the first year alone on a new investment. Please note, this savings does not apply to those who have already invested in the mutual fund.   After the first year, the difference is reduced to $300, however the ETF still saves investors money.

Why does PIMCO win?

Bill Gross is a smart man. He cautioned investors in the Total Return Fund not to expect the high-returns going forward that the fund has produced in the past. While Bill Gross has stayed away from stating the level of returns he expects going forward, I think most would agree that an estimate of 5% per year is probably not going to be on the low end of the range of possible returns that he may achieve.

If we assume that the fund is going to return 5% per year on average going forward, the upfront load fee and first year expenses come to about 4.7%.  This gives the investor a paltry 0.3% return after fees in the first year.  Not exactly attractive. I think (and more importantly PIMCO appears to think) that PIMCO needs to get expenses more in line with the expected returns.  If they asked financial advisers to give up their fees directly however, they would face enormous resistance. Instead they are using their new ETF to go around the financial adviser, and directly to the retail client.

Why do financial advisers and brokers lose?

Financial Advisers and brokerage firms have traditionally been paid kickbacks (loads) for selling mutual funds. I say the word “kickbacks” because while the fees are fully disclosed to the client, where the money is actually going is not so clear. Many clients assume the majority of the money goes to the mutual fund manager, and there is no flexibility in fees if you want access to a particular fund. In reality however, most of the upfront fee is going to the broker.  The fact that PIMCO’s new ETF will not have this load fee will open many investors eyes that the upfront load fee on the mutual fund is actually going to the adviser.

With the above in mind financial advisors will lose out on a significant revenue source as a result of PIMCO’s new ETF and may also now have to explain why their fee for investing in the PIMCO Total Return Fund is much higher than the ETF.

In our next article, we will discuss how financial advisers are adjusting to this new reality.

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