another sign of a toppy bond market in the US

running an ice cream stand

One of the most useful tips on company analysis I’ve ever gotten came from a former P&G marketing executive who was working for a hotel company when I heard him speak.

He said that if you run an ice cream stand that sells vanilla ice cream, you don’t start to sell strawberry (my favorite, by the way) until the market for vanilla stops growing.  In other words, once you see a company begin to segment the market for a product (by offering several varieties), you know that sales of the “plain vanilla” version are tapping out.

the new Pimco Total Return ETF

That’s my take on the Pimco announcement that it’s launching an ETF version of its total Return bond fund, the largest actively managed bond mutual fund on the planet, two days from now.  It means investors have stopped buying bond mutual funds from Pimco.  Since Pimco is the biggest bond manager and has the best long-term record, I think this also means investors have stopped buying bond mutual funds, period.

Remember, too, that Pimco–a unit of Deutsche Bank–is a marketing monster.  It’s executives are constantly pounding home their message, often packaged as “economic” commentary, that now is the best time to buy more bonds.  During the two decade+ period of secular long-term interest rate decline that ran from the early 1980s until recently, that stance was 100% correct.  Not anymore, though.

True, Pimco had a year to forget vs. peers in 2011.  But I don’t think that’s the issue.  Pimco’s long-term record is strong.  And the company had begun laying the groundwork for the new ETF before its performance weakness unfolded.  Despite Pimco’s relentless sales efforts, I think investors are finally catching on that bonds may not be the one-way street that they’ve come to expect.  Even if the light bulb hasn’t gone on, investors are at least signalling that they don’t think they need any more bonds.

ETFs aren’t a walk in the park

performance differences

Many bonds are surprisingly illiquid.  Pimco won’t be able to use the much more easy-to-trade derivatives market to change the shape of its ETF holdings in the way it does in its mutual fund portfolio, however.  So it’s possible that the ETF won’t track the mutual fund very closely.

That’s potentially a big concern.  Holders of the vehicle that’s doing less well will always be unhappy.

filling a need nobody has

So far, actively managed ETFs haven’t been very popular with investors, who have preferred low-cost passive products.

cannibalization

Cannibalization of the Total Return mutual fund by the lower-cost ETF might seem to be an issue, but I don’t think it is.  Two reasons:

–taxable investors with unrealized gains on their mutual fund holdings won’t switch to the ETF because they’d trigger capital gains tax

–it’s always better to cannibalize an existing product with a new one of your own rather than have a rival do it to you with one of his.

conclusion

The new ETF will be interesting to watch, if nothing else to see how successful it is in gathering assets.   Still, I think it’s probably as close as we’ll get to a bell ringing to signal the top of the market.

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