An Active ETF Managed by Morningstar's Fixed-Income Fund Manager of the Year

The mutual fund industry has long offered and promoted ultrashort portfolios with floating net asset values as alternatives to money market funds, and PIMCO has its own,

With their mandates so close together--both this exchange-traded fund and PIMCO Short-Term keep their interest-rate sensitivity quite muted, and thus their durations typically stay under one year--it would be easy to look at them as interchangeable. They are in fact run by the same team at PIMCO, including lead manager Jerome Schneider, who was recently named as the 2015 Morningstar Fixed-Income Fund Manager of the Year for his work on PIMCO Short-Term. Notably, though, MINT lacks exposure to or has smaller allocations to sectors that have been key drivers behind keeping PIMCO Short-Term as competitive as it has been. As of October 2015, for example, PIMCO Short-Term had a 9.5% allocation to high-yield and a non-U.S. developed-markets stake that stood at roughly 23%; neither sector was present in the MINT portfolio. And while MINT did have a 4.1% allocation to emerging markets, that was less than half the weighting in PIMCO Short-Term.

That's clearly a positive distinction for MINT investors who really want to shy away from risk without going all the way to a money market offering. But it has also made it more challenging for the ETF to really distinguish itself, an already difficult task given the way that the Federal Reserve's so-called ZIRP (zero interest-rate policy) had long been an anchor for yields at the short end of the yield spectrum. And while MINT's 0.36% expense ratio wouldn't warrant much attention during more historically normal periods, it presents the kind of hurdle that any fund plying the same waters would find difficult to overcome. On average, that bite took roughly 30% of MINT's gross returns during the past five years through December 2015.

Fundamental View Normal times may be nigh, or at least over the horizon. The Federal Reserve took a much anticipated first step, reversing its long-standing ZIRP by hiking short-term rates by 0.25% at its December 2015 meeting. However, while many investors expect that hike to be followed by further increases, many also expect that process to be gradual.

In fact, as expected, the Fed did not raise rates at its January 2016 meeting. And, in its statement released on Jan. 27, it pointed to expectations that inflation will remain low in the near term despite ongoing improvements in the labor market. Considering the unprecedented growth of the Fed's balance sheet during the past several years, many investors have speculated about the threat of rising inflation. However, that fear has been stoking for years, and projected inflation continues to run well below the Fed's 2.0% long-term goal. The Fed also noted that it is closely monitoring recent global economic and financial developments. With mounting fears of a significant slowdown in China and the recent sell-off in the equity markets, it's not surprising that the futures market is pricing in a relatively modest 24% chance of a rate hike at the Fed's March 2016 meeting.

The good news for a fund of this type is that it's not likely to feel more than a bump as short rates rise, and its own prospects should improve as higher short-term rates create more opportunity for income generation, and assuming that those normalize at a reasonably higher level, the fund's expenses won't look as onerous. Higher yields really couldn't come too soon for a fund of this type. Its five-year annualized return--after expenses--was 0.91% as of December 2015. That looks light years better than the near-zero return from three-month T-bills during the same period, but it clocked in at just beyond half the level of inflation, as measured by the Consumer Price Index.

Portfolio Construction MINT has a great deal of flexibility when compared with money market funds. Its prospectus language is vague in that the fund primarily holds exposure to investment-grade bonds, but in practice, it doesn't hold any junk bonds. It holds no non-U.S. developed-markets issues, and as of October 2015, it held less than 5% in emerging-markets debt. It will typically keep its duration under one year and its weighted average maturity under three years.

Fees The fund charges 0.36% per year. That has taken a considerable bite from returns in the ultralow interest-rate environment that has persisted since its inception, though it won't look as onerous if short-term rates get closer to historically higher norms. Until that point, though, the expense and trading costs associated with a fund of this kind might continue to make a conventional money market mutual fund a better deal.

Alternatives Especially with market yields as low as they have been in recent years, it pays for investors to keep their eyes on CDs or other higher-yielding options available at FDIC insured banks and weigh whether or not the inherent trade-offs (such as a CD's withdrawal penalties) appear reasonable.

There are nearly a dozen ETFs in the ultrashort-bond category. MINT's closest competitors include Guggenheim Enhanced Short Duration ETF GSY, FlexShares Ready Access Variable Income RAVI, iShares Ultra Short-Term Bond ETF ICSH, iShares Short Maturity Bond ETF NEAR, SPDR SSgA Ultra Short Term Bond ETF ULST, First Trust Enhanced Short Maturity ETF FTSM, and AdvisorShares Sage Core Reserves ETF HOLD. All of those funds employ similar active strategies--and all sport lower fees than MINT. Investors with slightly more appetite for risk might consider a short-term fund (as opposed to ultrashort). Most ETFs in that category are passively managed and have durations between one and three years.

The closest analogue to MINT is mutual fund PIMCO Short-Term. On average, the latter fund has produced about 46 basis points of annualized outperformance versus MINT over the trailing five years through December 2015, despite a higher expense ratio of 0.45%. That fund doesn't typically take on much more interest-rate risk than MINT but has maintained greater exposure to credit-sensitive sectors, including corporate high-yield, non-U.S. developed-markets, and emerging-markets bonds. That higher risk profile has generated and should continue to generate higher returns over the long term, but also at a slightly higher cost.

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