PIMCO’s Short Term Municipal Bond Fund (NYSE:SMMU) was launched in late January, 2010 and has since managed to accumulate approximately $18 million in assets, as of the end of July. SMMU is one of 3 actively-managed ETFs that PIMCO has brought to the market. The fund is managed by John Cummings, who is an Executive Vice President and also the head of the municipal bond desk at PIMCO. He also runs PIMCO’s Intermediate Municipal Bond Fund (NYSE:MUNI) which focuses on longer maturity municipals.
The Short Term Municipal Bond Fund has gradually gained some traction with investors over the months, with its asset based increasing from just $8 million back in March, to about $13 million at the end of May, ramping up to the $18 million mark at the end of July. The fund should attract investors in higher tax brackets who are looking for tax-exempt sources of return. The municipal bond market though is by no means a sure bet, with many issuers and municipalities under severe budgetary pressures which can affect their ability to fulfill their obligations significantly. As such, SMMU provides investors who are looking for exposure to the municipal bond market, with access to PIMCO’s established management expertise in the fixed-income space. Unlike index funds which rely solely on rating agencies for credit analysis, the fund utilizes issuer-specific credit analysis from PIMCO. The fund charges investors an expense ratio of 0.35%, which is much lower than comparable mutual fund offerings.
The Short Term Municipal Bond Fund seeks attractive tax-exempt income while preserving capital by investing at least 80% of its assets into municipal bonds whose interest payments are exempt from federal income tax. The fund invests only in securities that are not subject to the federal alternative minimum tax (ie. AMT-free securities). The duration of the portfolio is expected to be less than 3 years and consist primarily of short duration, high quality bonds. The fund managers also do not utilize any derivatives to implement the investment strategies. The portfolio managers also look to manage capital gains and losses in order to minimize taxes on capital gains and harvesting losses.
SMMU consisted of 69 individual securities as of August 28th, whose average effective maturity was about 2.5 years. 71% of the fund was invested in securities with maturities between 1 and 3 years, with none of the securities exceeding 10 years in maturity. The fund’s composition does not differ much from its benchmark, the Barclays Capital 1-3 Year Municipal Bond Index. In terms of maturity buckets, where the index does not hold any securities exceeding 5 years in maturity, SMMU invested 5% of the funds in the 5-10 year maturity bucket. As a result, the average maturity of the fund is slightly higher that of the index.
Given that the fund has only been in existence for about 7 months, it would be unfair to judge the active manager’s performance on that time period. However, looking at the numbers can shed light on the fund’s track record so far. Since inception, SMMU has returned 1.40% till the end of July while the fund’s benchmark, the Barclays Capital 1-3 Year Municipal Bond Index, has returned 1.60% over the same period. That implies an underperformance of 0.20%. The returns of the fund after taxes would have been even lower, standing at 1.18%. The chart below compares the fund’s price performance to that of two comparable index ETFs – the iShares S&P Short-Term National AMT-Free Municipal Bond (SUB) and the SPDR Nuveen Barclays Capital Short-Term Municipal Bond (SHM):
The fund performed quite well in July, as the municipal bond market gained from an increase in investor’s risk appetite. With many states, such as California and New York, and municipalities failing to balance their budgets, credit selection remained important – as pointed out by PIMCO’s monthly commentaries. However, because supply and new issues in the municipal bond market have been limited, money is continuing to flow into this segment of the fixed-income market.
Looking at the premium/discount history for Q2 2010, SMMU has a relatively clean record and has been able to keep the disparity between the ETF price and the fund’s NAV in a tight band. The fund was able to keep the premium/discount to within +/- 50bps on each of the 63 trading days in the quarter, though more time was spent by the fund trading at a discount than at a premium. That should give investors some confidence that they are not trading very far off the fund’s true value when investing or selling SMMU.
Shishir Nigam is the founder of ActiveETFs | InFocus (http://www.etfshub.com/), which provides extensive coverage and analysis of actively-managed ETFs in US and Canada, including debates on major industry trends, insights on the latest product launches from issuers in the Active ETF space as well as in-depth interviews with industry executives and thought leaders.
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