PIMCO Plays It Safe With Multi-Factor Equity ETFs

PIMCO has long been known as a fixed-income powerhouse with an abundance of investment management talent and enviable track record. They are also one of the most successful purveyors of actively managed exchange-traded funds focused primarily on the bond market to-date.

That dynamic changed recently with the launch of three new multi-factor equity ETFs that successfully complement the existing PIMCO fund lineup. These new funds are backed by a stringent research and stock selection criteria created by Rob Arnott of Research Affiliates, who has a well-respected background in building smart beta portfolios.

These new funds include a combination of U.S. and international exposure broken out in the following buckets:

  • PIMCO RAFI Dynamic Multi-Factor International Equity ETF (MFDX)
  • PIMCO RAFI Dynamic Multi-Factor Emerging Markets Equity ETF (MFEM)
  • PIMCO RAFI Dynamic Multi-Factor U.S. Equity ETF (MFUS)

The term “multi-factor” may seem ambiguous to some, but simply refers to a co-mingling of various investment factor criteria such as value, quality, volatility, size, and momentum. Each of these funds uses a proprietary interplay of those characteristics to create a highly diversified basket of stocks with varying holdings and weights from traditional market-cap weighted indexes.

The multi-factor approach means that these ETFs won’t rely on a single dynamic to drive their security selection and ultimately return profiles. This creates the opportunity for a broader appeal and the ability for investors to implement them as core holdings rather than severely deviating from conventional benchmarks.

For example, MFUS contains nearly 1,000 underlying U.S. stocks with top holdings in Apple (AAPL) and IBM (IBM). The fund charges a reasonable net expense ratio of 0.29% annually and touts the lofty goal of improving excess return potential.

An examination of the upper quartile of the MFUS holdings shows many familiar stocks and others that are generally not as commonplace. The impression is one of a well-balanced, multi-sector portfolio with enough differentiation potential to set itself apart from the likes of the SPDR S&P 500 ETF (SPY) or the iShares Russell 1000 ETF (IWB). The target market being those investors who want alpha potential without going down the road of an over-priced stock picking team with dubious statistical support.

On the international front, MFDX will likely go head-to-head with a fund such as Schwab International Equity ETF (SCHF). Both ETFs aim to deliver exposure to developed markets outside the United States with well over 1,000 holdings each. It’s notable that SCHF charges a rock-bottom expense ratio of just 0.06% compared to 0.39% in MFDX.

Lastly, the emerging market focused MFEM will find itself in a crowded field of plain vanilla and enhanced index peers. The emerging market equity ETF category contains 171 competitors with the $65 billion Vanguard FTSE Emerging Markets ETF (VWO) leading the group. FMEM charges an expense ratio of 0.49%, which is similar to the popular Goldman Sachs ActiveBeta Emerging Markets Equity ETF (GEM) at 0.50%.

It’s also important to note that the underlying holdings in these smart beta PIMCO ETFs are likely to incrementally change over time as well. The index construction criteria will regularly evaluate the existing holdings compared to the available universe to determine if changes are required. Then at per-determined periods, the fund will update its exposure to include the stocks currently meeting its rigid multi-factor methodology.

The Bottom Line

This initial foray into the stock market is a safe one for PIMCO. They combined the expertise of a well-known portfolio strategist with a low cost, liquid, and sound index methodology. Furthermore, they are blending the lines between true active management and the plain vanilla passive indexes that seem so ubiquitous in today’s marketplace. I think it’s a smart strategy that is likely to win over alpha-seeking investors who are comfortable with the PIMCO and Research Affiliate brands.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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