PIMCO Total Return ETF (NYSEArca: BOND) skipper Bill Gross has an overweight position in municipal bonds relative to the fund’s benchmark index, which is helping the $3 billion exchange traded fund outperform this year.
At the end of September, BOND had 10% of its assets in municipal debt, compared with zero for the Barclays U.S. Aggregate Bond Index, according to data on PIMCO’s website.
The PIMCO ETF is also underweight U.S. Treasuries with a 4% allocation versus about 36% for the index.
Gross oversees the $278 billion PIMCO Total Return Fund as well as the ETF version, BOND. [PIMCO Total Return ETF Hits $3 Billion in Assets]
In the mutual fund, Gross is keeping his municipal-debt holdings at the highest since at least 2006 with the market on a pace to beat Treasuries for a second straight year, Bloomberg News reports.
The largest muni bond ETFs include iShares S&P National AMT-Free Municipal Bond (NYSEArca: MUB), Market Vectors High-Yield Municipal (NYSEArca: HYD), PowerShares Insured National Municipal Bond (NYSEArca: PZA), PowerShares Build America Bond (NYSEArca: BAB), SPDR Barclays Capital Municipal Bond (NYSEArca: TFI) and SPDR Nuveen Barclays Capital Short Term Municipal Bond (NYSEArca: SHM).
“The risk-adjusted returns that we’ve had this year is one of the key factors as to why we’ve been buying them as a firm,” Joe Deane, head of muni investments at PIMCO, told Bloomberg. “We’ve been buying them pretty much across the board and it’s because we felt it was one of the safer, cheaper spread asset classes.” [Muni Bond ETFs: Yield, Safety and Tax Advantages]
“PIMCO continues to see value in high quality municipal bonds and we retain our preference for essential service revenue bonds such as water and sewer, power, and airports,” according to a Total Return Fund third-quarter outlook.
In the second quarter, issuance continued to be strong as issuers took advantage of historically low rates. “However, this increase in supply was mitigated by strong demand, as investors continued to seek the attractive yields provided by municipal bonds,” the firm said.
“We expect the municipal bond supply to dwindle at the very end of the year and demand to pick up as investors realize the relative value of municipal bonds to Treasuries and corporates. In some cases, municipal bond yields are 10- to 20% higher than investment grade corporates. Also, as high-income investors are impacted by the Medicare tax in 2013, asset allocation shifts should favor tax-exempt muni bonds,” said Dan Heckman, senior fixed income strategist with U.S. Bank’s Wealth Management Group, in a recent commentary.
“We will continue to target maturities between seven and nine years that somewhat limit duration risk. We are also buying kicker bonds that have decent call protection and are maturing between 12 and 15 years with minimum coupons of 4% and above. We can pick up substantial yields over non-callable bonds and produce higher levels of cash flow to clients,” he added. “These type of bonds should also perform better if interest rates would happen to rise. We think they also do well in the interest rate yield range bound market that we have been in and expect to continue.”