The PIMCO Intermediate Municipal Bond Strategy ETF: Enduring Principals
The fund is managed by a global leader of fixed income assets. The fund diverges from the tracking index, but reduces the ‘duration risk’ by doing so. PIMCO’s bond management experience may prove to be an asset as the Fed prepares to change policy. A unique feature of the once popular game show, Jeopardy , was that the answer was the question and the question was the answer. So for example, you might been confronted with the answer: “Ben Franklin, Mark Twain, Daniel Defoe, Christopher Bullock and Edward Ward” Your answer, in the form of a question of course, would be, “Who have been given credit for first saying, ‘ Nothing is certain except for death and taxes’ ?” Indeed and invariably, that seems to be the case. Each may be unavoidable in the end, but in the meantime, with careful planning an investor can take a breather from taxes without being in jeopardy with the IRS by including a tax exempt municipal bond fund in a portfolio. Oddly, compared to other types of taxable bond funds, there aren’t that many plain vanilla funds to choose from. The choices are further narrowed by the three choices of Long , Intermediate or Short maturity funds. Pacific Investment Management Company , commonly recognized by its acronym, PIMCO , is a global investment management firm, specializing in fixed income assets, with over $1.47 trillion under its care. It should be noted, though, PIMCO manages its assets independently, but it is wholly owned by Allianz (OTC: OTCQX:ALIZF ) PIMCO offers the actively managed PIMCO Intermediate Municipal Bond Strategy (NYSEARCA: MUNI ) . According to PIMCO, the fund is: . .. Designed to be appropriate for investors seeking tax-exempt income, the fund consists of a diversified portfolio of primarily intermediate duration, high credit quality bonds, which carry interest income that is exempt from federal tax and in some cases state tax… PIMCO makes a point of noting that: … Unlike index funds that typically rely solely on a rating agency for credit analysis, PIMCO applies extensive research on each municipal bond we own in the fund… …to avoid what we feel are municipalities of deteriorating credit quality in our efforts to protect investors’ capital… Having that extra level of analysis should provide the investor with an extra measure of risk mitigation. The fund tracks Barclays 1-15 Year Municipal Bond Index (LM17TR) : …which consists of a broad selection of investment grade general obligation and revenue bonds of maturities ranging from one year to 17 years… The fund was incepted on November 30, 2009 and currently holds approximately $235.5 million in net assets. Its daily trading volume is noted to be 37,881 ETF shares; hence there’s sufficient liquidity available to enter a position. Since inception, the fund has traded at par with its NAV and recently has traded at a discount of -0.13% to NAV. It should be noted that being able to purchase a bond fund at a discount gives the investor an extra advantage. That being noted, the fund’s shares have a slight bias to trade at a discount to NAV over its history, hence it may be worth choosing the moment for the best entry point. The funds current estimated ‘yield to maturity’ is 2.28% and a distribution yield of 2.29%, (distributions are monthly). Management fees are below the ETF industry average at 0.35% which, again, is another advantage in the long run. The 30 day SEC yield, i.e., after fees and expenses is 1.67%. Annualized Returns 1 Year 3 Year 5 Year Since Inception 11/30/2009 Fund NAV (after expenses) 1.80% 1.40% 2.73% 3.38% ETF Shares 1.91% 1.43% 2.73% 3.38% Barclay’s Index 2.61% 2.44% 3.49% 3.97% Fund vs Index -0.70% -1.01% -0.76% -0.59% Data from Pimco A word or two needs to be said about a few terms. First, according to Investopedia, Average Effective Maturity is a measure of maturity, taking into account the probability that a bond might be called back to the issuer. At this point it’s worth noting the term embedded option . This is a special condition ‘written into’ a security. For example, a bond might have a ‘ call date ‘: a date on which a bond may be redeemed, or ‘called’, before maturity. For the entire portfolio, which may have a mix of callable and non-callable bonds, the Average Effective Maturity is the weighted average of the maturities taking into account those with a call provision. Another important concept is that of Duration . Without going into a lot of the mathematics of finance, it may be generally understood by an example. Consider a $100,000.00, 3.25%, 15 year fixed rate loan starting today . Looking forward, in a little under 13 years into the loan, the borrower will have paid back $100,000.00 in combined principal and interest. In other words the lending bank breaks even at a little under 13 years. Now start again but fast forward ahead 5 years from the beginning. The borrower has made interest and principal payments amounting to $28093.00; ($5989.00 of that is principal). However, the lender considers those previous five years of payments, amounting to $28093.00, as paid and ‘off the table’. There’s still $94011.00 of principal left to pay. Since the original five years of ‘cash flow’ is off the table, the lender recalculates and figures out that breakeven on the future interest and principal payments occurs in just over 8.5 years. If the recalculation is done after every payment is made and off the table, the ‘breakeven’ will continue to gradually decrease to 0 years, (maturity). Just one more detail is needed: if the loan had a floating rate and interest rates declined, it will take longer to reach that breakeven point. Conversely, if rates increased, breakeven will be attained more quickly . That’s essentially Duration. It’s a way to measure how long it would take for full repayment of the original price of a bond, at the current interest rate via future cash flow and specified in years. If interest rates go up, it takes longer; if interest rates go down, it’s quicker. These calculations are of great importance to fund managers since they often open and close positions before maturity . So why should a retail investor care? The U.S. Federal Reserve sets the benchmark when it comes to interest rates. Recently, the Fed has indicated that, most likely, it will increase the benchmark ‘Fed Funds’ rate by the end of the year. The Fed usually moves in 25 basis point (1/4 point) increments. So if an investor had to choose from bond funds of equal quality holdings, the smart move would be to choose the one with the shortest duration as it would be least impacted by rising interest rates. Analysts like to look at these metrics in different ways or even ‘fine tune’ existing metrics. Indeed, this is the case with bonds. For example, Effective Duration takes into account both callable and non-callable bonds and determines the ‘probable duration’ of the entire portfolio as interest rates fluctuate. Now, having a reasonably good idea of what Duration is, the fund’s Effective Duration is currently 5.07 years. (click to enlarge) The fund’s home page Performance and Risk tab includes an interesting ‘ Key rate Durations ‘, summarized below. It’s an at-a-glance way to see how sensitive a fixed maturity is to a 1% change in market interest rates. Data from Pimco It should be noted that the greatest sensitivity occurs in the 5 to 10 year maturity range, which is 55% of the funds maturity composition. The pie charts below demonstrate the fund’s ‘Maturity Allocation’ as well as the ‘Quality Allocation’ of the fund. (click to enlarge) Just over 47% of total holdings are top quality AA- to AAA. Just over 28% are medium quality A- to A+ and almost 10% are lower quality but investment grade, BBB- to BBB+. Lastly ‘NR’ or ‘Not Rated’ means that, according to the summary prospectus , PIMCO has determined the holding is ‘of comparable quality’ with other bond rating agency grades. It’s also worth noting the fund’s maturity distribution compared with the tracking index. The chart demonstrates that the fund diverges from the index composition significantly; however this does result in a lower duration by just over 31.8%: 5.42 years vs 7.95 year. It should be noted that that the fund does weight strongly the 5 to 10 year maturity range. Those are the maturities with the highest sensitivity to interest rate variations and it does so much heavier than does the index. (click to enlarge) Data from PIMCO The fund charts its sector allocation in an interesting way, both in terms of percentage of total market value as well as percent of total duration. (click to enlarge) Data from PIMCO The holdings include a couple of ‘arcane’ instruments. First are the ‘ Pre-Refunded ‘ holdings. According to the MSRB’s glossary of Municipal Securities Terms: … a refunding in which the refunded issue remains outstanding for a period of more than 90 days after the issuance of the refunding issue… …such refunded bonds are secured solely by an escrow funded with the proceeds of the refunding bonds… …The proceeds of the refunding issue are generally invested in Treasury Securities…. … to pay principal and interest… …on the refunded issue… To put is simply, Pre-Refunded or Advanced Refunded occurs when there’s an overlap in the refunding of an existing issue. The ‘existing issue’ must still meet its obligation, and this is ‘covered’ by the refunding issue’s proceeds and held in escrow. This may partly explain the 4.08% of total holdings as being short term U.S. Treasury Notes. Another interesting holding are the ‘Tobacco Municipal Bonds’. These are bonds issued by a state and funded by a future payment or cash flow due as a result of a settlement or successful lawsuit against a tobacco company. It’s worth noting that tobacco bonds comprise about 2.5% of the municipal bond market. For more on Tobacco Bonds the reader is referred to PIMCO, ” Municipal Tobacco Settlement Bonds: Seeking Value in the Ashes “. MUNI is comparable in returns to the two other funds filtered by the Seeking Alpha ETF Hub . The Fed has indicated that its policy shift will be slow and gradual. This will, no doubt, have some impact on Duration , but when the tax advantage is considered and at the same time having the fund actively managed by the industry leader, it should all add up to make this intermediate municipal bond fund worth holding. Annualized Returns 1 Year 3 Year 5 Year Since Inception 11/30/2009 Fund NAV (after expenses) 1.80% 1.40% 2.73% 3.38% ETF Shares 1.91% 1.43% 2.73% 3.38% Barclay’s Index 2.61% 2.44% 3.49% 3.97% Fund vs Index -0.70% -1.01% -0.76% -0.59% Data from PIMCO