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Pimco Total Return ETF Shines a Light on Transaction Costs

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The launch of the Pimco Total Return Exchange-Traded Fund will test the mettle of investors with trillions of dollars invested in traditional bond mutual funds. But no investors will be more challenged than those with billions already managed by Bill Gross in the Pimco Total Return Fund.

"Basically they will be the same," Gross told Bloomberg Television on February 23rd.

The new ETF, set to list on NYSE Arca on March 1, will invest with the same goals as its traditional fund cousin, save the use of derivative securities.

The derivatives used by the Pimco Total Return Fund, such as interest rate and credit default swaps, options, swaptions, and currency forwards and swaps, are used to express views on everything from corporate and government bonds to trends in the currency market. (Some of the positions maintained by the Pimco Total Return Fund's use of derivatives are now available through ETFs and exchange-traded notes.)

The extent to which the lack of derivatives significantly influences returns will be borne out by the first few months of trading for the ETF relative to the mutual fund. And while many investment advisers traditionally wait for a 3-year track record to commit new money to an active strategy, the Pimco Total Return ETF will more likely be judged sooner by its variance to the Pimco Total Return Fund, sporting nearly a quarter-century of returns.

The fund's performance helped make it the world's largest mutual fund at $250 billion, according to Morningstar.

While Pimco has already been tremendously successful in active bond ETFs with the $1.4 billion Pimco Enhanced Short Maturity Strategy (MINT), the Pimco Total Return ETF shines a spotlight on the all-in costs of traditional fund investing. Even owners of low cost institutional shares are starting to add up the dollars.

"We'll be weighing the option," says Mitchell Reiner of Capital Investment Advisors in Atlanta. Reiner points out that investors and their advisers need to look at total transactions, transaction costs and holding period as they relate to expense ratios and performance differences.

Even investors who have access to 0.46% institutional shares through an adviser should be counting their basis points against the 0.55% charged by the exchange-traded fund.  For smaller holdings, those 9 basis points of difference get washed away almost immediately by transaction costs. Investors in A, C or D shares, should pay even more attention.

For "institutional" investors who count their holdings in the tens of thousands, as opposed to hundreds of thousands or millions, the ETF may end up being the cheaper option (assuming similar performance), depending on how many times you buy or sell. For example, if you buy $50,000 worth of institutional shares, you'll pay $230 in expenses and as much as $75 for one purchase. That's 61 basis points.

That same investment in the ETF would be $275 in fund expenses, but only $8 for the trade. That's 56.6 basis points.

For mutual fund transactions, Fidelity charges $75 and Charles Schwab $76 for buying shares, but $0 for selling. Vanguard Brokerage tops out at $35, regardless of transaction type. E-Trade costs $19.99 and TD Ameritrade $49.99.

ETFs, on the other hand, trade like stocks and investors pay commissions each time. Fidelity charges $7.95; Schwab charges $8.95. For accounts under $50,000, Vanguard charges $7 for the first 25 trades, then $20. E-Trade tops out at $9.99 and TD Ameritrade costs $9.99.

For smaller purchase sizes, the numbers in favor of the ETF get even more compelling, regardless of share class.

Bear in mind that your adviser may have different rates than those charged to retail investors, but the fees are still worth the once over.

The only compelling argument for sticking with the traditional fund is the added juice to be gained by the use of derivatives. And the Pimco Total Return ETF will put that juice to the test.

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For my first take on this, read "The Other Side of Active ETFs" from April.