PIMCO’s Intermediate Municipal Bond Strategy Fund (MUNI: 52.28 0.00%) was launched by PIMCO ETFs in Nov, 2009 as the first actively-managed ETF to focus on the $2.7 trillion municipal bond market which was then followed up by a launch from Grail Advisors called the Grail McDonnell Intermediate Municipal Bond Fund (GMMB: 51.90 0.00%). MUNI is managed by EVP and municipal bond desk head, John Cummings, who also manages the shorter maturity SMMU provided by PIMCO.
MUNI has gained traction and assets slowly and steadily since March, 2010 when it had $23 million in assets to about $43 million now. The strategy should appeal to investors in higher tax brackets that can take advantage of the tax-exempt income available from municipal bonds. The main value proposition for the actively-managed ETF is ability to avoid owning bonds of issuers that managers feel have poor credit characteristics, especially in an environment where many US municipalities are stretched financially. The ETF has not been as quick to grow as PIMCO’s money-market offering, the Enhanced Short Maturity Fund (MINT: 100.78 0.00%) and many industry watchers are looking to MUNI for confirmation that PIMCO’s success was not one-off with MINT.
Investment Mandate
MUNI invests at least 80% of its assets (under normal conditions) in intermediate duration, high quality municipal bonds which provide interest income that is free from federal and sometimes state tax. Research is done on the credit quality of the issuing municipalities with an effort to avoid weak issuers, while maintaining the average duration of the portfolio between 3-8 years. Importantly, the portfolio invests only in AMT-free bonds and avoids futures, options or swaps. The ETF has net annual expenses of 0.35% and is benchmarked against the Barclays Capital 1-15 Year Municipal Bond Index.
Portfolio Composition
The portfolio composition of MUNI differs quite a bit from its benchmark which, of course, is how the managers try to outperform their index. The big differences lie in the fund’s maturity distribution, which is presumably where the managers are looking get their outperformance from. Where the Barclays Capital 1-15 Municipal Bond Index is quite evenly spread out across maturities between 1-20 years, MUNI currently concentrates 77% of its holdings within the 5-10 year maturity range and hence has much lower proportions in other maturity buckets. The 5-10 year maturity bucket for municipal bonds likely provides better liquidity in securities that the managers can take advantage of. Despite the higher concentration in a lower maturity bucket, MUNI’s overall average maturity is shorter than that for the index because the fund has a much lower concentration in the 10-20 year bucket versus the index.
Performance
Looking at the performance of the fund relative to its index though, MUNI has not performed all that well. In every time period, except the last 1-mth, the fund performance has lagged behind the benchmark. For example, since inception, the fund has underperformed the index by 42 bps, with NAV returns of the fund being 2.18% while the index returned 2.60%.
To provide a visual comparison, the performance of MUNI is compared to the iShares S&P National Municipal Bond Index Fund (MUB) below:
To understand why MUNI may be underperforming, it’s helpful to read the monthly manager commentaries that describe market conditions. The municipal bond market did see overall strong performance in the month of May alongside a flight to quality resulting from the debt crisis in Europe. Another factor has been continued concerns over budget deficits across states and municipalities in the US that have been aggravated due to April tax receipts being lower than expected.
Premium/Discount History
As with any ETF, it’s important to look at how closely the ETF’s share price has been tracking the fund NAV because large deviations from NAV may mean investors may be getting a raw deal when they get in and out of the fund. In that regards, MUNI has done a good job of keeping deviations to a minimum, with no instances in Q1, 2010 where the ETF price deviated from the fund NAV by more than 50 bps.
Disclosure: No positions in above-mentioned names.
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