Analysis - Investors fleeing Pimco find shelter in ETFs amid bond turmoil

By Ashley Lau

NEW YORK (Reuters) - On Friday, after Bill Gross quit Pimco and the Total Return Fund he had run for 27 years, California-based EP Wealth Advisors decided to pull the plug that same day. Ending its investment in Total Return left it with $130 million in uninvested assets and one weekend to decide what to do with it.

"We assumed with that level of assets our due diligence process was not going to get done in three days, so we needed a place to park the money temporarily," said Kevin Ashworth, the firm's investment director. EP had invested in Total Return for more than a decade, and it was the firm's largest fixed income position.

 

On Monday, the firm moved the entire sum into BlackRock Inc's iShares Core U.S. Aggregate Bond ETF . It was a way to keep exposure to the bond market while buying time to search for a new manager and "better than being in cash, which is earning zero," Ashworth said.

The move by Ashworth and other investors who withdrew money from Total Return on Friday helped drive the iShares ETF on Monday to a record trading volume of $791 million, more than five times its daily average. The ETF has $19 billion in assets.

The shift underscores how important easily traded exchange-traded funds have become for active investors, especially during market tumult.

Money managers use ETFs as short-term shelters during broad market disruptions and for transitional moves between asset classes or investment companies, said Matt Tucker, head of the iShares fixed-income strategy team at BlackRock , the largest U.S. ETF provider.

Tucker said his firm saw a surge in temporary money piling into iShares ETFs over the last week as investors contemplated their next move. The ETF is up 0.53 percent since Friday, according to Lipper.

ETFs trade on stock exchanges throughout the day and offer fast-trading investors the time and space to be reflective, but they also raise questions about whether their use as parking lots adds risk and volatility to markets or instead makes them run more smoothly. As ETF trading volume accelerates, amid a decline in the trading of the underlying corporate bond market, it gives investors improved liquidity and a better read on fixed-income prices during periods of market volatility, Fitch Ratings said in a May report.

"You are basically moving from one pool of bonds to another pool of bonds, and the market absorbs those kinds of moves intra-day pretty quickly," said Dave Nadig, chief investment officer of research and analytics firm ETF.com.

ETFs also help to prevent an influx of hot money going into long-term funds, where it could disrupt and drive up transaction costs for long-term shareholders.

"They act as pretty good safety valves, especially for these less-liquid asset classes" such as the high-yield bonds held in the Total Return fund, said Michael Temple, director of credit research at Boston-based Pioneer Investments. Rather than money coming out of open-ended bond mutual funds, "the 'hot money' tends to be in ETFs."

To be sure, ETFs can spark volatility in corners of the bond market, too, as they foster frequent trading, putting them at odds with long-term investors, according to analysts. Hedge funds, for example, have made big, quick moves in and out of junk-bond ETFs, creating a ripple of volatility for the market to absorb.

OPPORTUNITY KNOCKS

BlackRock's iShares ETF may have been the biggest beneficiary of last week's Pimco selloff - it had $404 million in new money entering the fund on Monday in its biggest single-day gain this year. On Tuesday, the fund added another $349 million.

Vanguard's Total Bond Market ETF also spiked on Monday and Tuesday, albeit in smaller amounts, as investors looked for places to invest their money amid the fallout at Pimco. The fund is up 0.56 percent since Friday.

The iShares iBoxx $ Investment Grade Corporate Bond ETF for corporate exposure and the iShares 1-3 Year Treasury Bond ETF for short duration exposure are also liquid funds that are good spots for temporary money, Nadig said. LQD is up 0.70 percent and SHY has risen 0.13 percent since Friday.

Without the availability of ETFs, fast-trading investors might not have such broad portfolios to jump into and out of. Vanguard, for example, blocks short-term investors from using traditional bond mutual funds aimed at long-term investors. It is common for traditional mutual funds to charge investors who sell quickly after they buy.

"Clearly there's some reallocation going on in the market place," as some money moves out of long-term funds into ETFs, said Greg Davis, global bond chief at Vanguard Group.

Meanwhile, those temporary moves may not be lightning fast. Those holding periods can be anywhere from a couple of days to several months, said BlackRock's Tucker. Even if the money ultimately leaves BlackRock, every $1 billion left in the ETF with a 0.08 percent annual expense ratio can leave the asset management company about $26.7 million richer in just four months. And some money may turn out to be far less temporary than expected, if investors like EP Wealth's Ashworth decide to stop chasing active management and instead embrace ETF's index-following, low-cost approach.

Ashworth said he told his firm's advisers that they should tell clients to expect to be in the ETF for at least a month, potentially longer.

"I don't see us making a decision in two weeks and switching out," he said.

(Reporting by Ashley Lau in New York; Additional reporting by Ross Kerber and Tim McLaughlin in Boston; editing by Linda Stern and John Pickering)