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By Christine Benz and Timothy Strauts | 06-19-2013 03:00 PM

PIMCO Total Return: The Mutual Fund vs. the ETF

The performance differences have narrowed between the two funds recently, and Morningstar's Tim Strauts and Eric Jacobson say PIMCO investors should choose the least expensive option.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Should you buy PIMCO Total Return in exchange-traded fund format or in traditional mutual fund form? Joining me to discuss that question is Tim Strauts and Eric Jacobson. They are both senior fund analysts with Morningstar. Eric is on the phone with us, and Tim Strauts is here in the studio.

Tim and Eric, thank you both for being here.

Tim Strauts: Thanks for having me.

Benz: I think we can agree that the two funds probably have more in common than they have differences. But, Eric, let's discuss one of the key differences, which is that the traditional mutual fund can own derivatives, the ETF version cannot. Let's talk about how big a role derivatives have played in the traditional mutual fund over the years.

Eric Jacobson: Sure. Historically, the traditional mutual fund has held a lot of derivatives, but more in terms of making a statement on whether or not one of the markets is a little richer or cheaper than the other. So, for example, if the derivative looks a little cheaper than the cash bond market, they might go with that or vice versa.

Benz: So, Eric, would you say that the derivatives have picked up in importance over the years as PIMCO Total return has become a giant fund?

Jacobson: I think to some degree it's helped them manage liquidity because the fund is so large. But they've actually been peeling back over the last year or so, trying to take some of the complexity and some of the market risk out of the portfolio by using fewer derivatives.

Benz: Tim, a question for you, another key difference is that as an actively managed exchange-traded fund, PIMCO Total Return has to publish its holdings daily, and I think that anytime you see that, you wonder, well is that going to subject it to front-running by people trying to get ahead of the fund building its positions. Is that a concern? Has it been a concern for the ETF so far?

Strauts: Well, I don't really think it's been a concern, and manager Bill Gross has said as much in some of his comments that he feels that the bond market in general--when PIMCO goes out to the bond market to purchase securities, the market gets a feel what PIMCO is doing. So, I don't feel that the daily disclosure has any way impacted them. I mean, frankly, PIMCO has had separate accounts for many years to run the Total Return strategy that also investors could look through those.

The impact of front-running in the bond market is very difficult to do. I mean front-running is more possible in the equity market. In the bond market, you’re not going to get ahead of PIMCO. If PIMCO is buying a bond, oftentimes they're buying all that's available in that particular issuance. You can't get in front of what PIMCO is doing. And if they started allocating more money to Treasuries, you can't front-run Treasuries; the Treasury market is so much larger than PIMCO. So, front-running is really not a concern in the bond market right now.

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