The headline last night seems like a big deal: PIMCO is paying a $20 million fine to the SEC because it engaged in some less-than-obvious bond pricing strategies, which had the effect of boosting the headline performance of their flagship PIMCO Total Return Active ETF (BOND), particularly in 2012.
But as usual, when it comes to both ETFs and bond pricing, it’s far less simple than it seems.
No Big Deal?
When news originally broke earlier this year that PIMCO was being looked at for these pricing discrepancies, I brushed it off. The allegation was pretty simple: PIMCO, the best bond trading desk in the world for the past 20 years or so, was buying odd lots (less than $1 million) of nonagency mortgage-backed securities, and then using full-lot prices to calculate net asset value.
On the surface, this should make any bond guy shrug. Bond pricing is notoriously awful. Unless a bond trades RIGHT before you decide to strike your net asset value, every bond in any mutual fund or ETF is at best being valued on a guess.
These guesses have gotten more educated over time, and there are a handful of companies that have healthy businesses doing not much else except providing good guesses as to how much a bond is worth every day, just for this reason.
This particular case highlights another quirk of the bond market—nobody wants stub ends of bonds. You want to move $10 million of a Citibank bond? You’ll find a good bid. You want to move $250,000? Fuhgeddaboudit.
So the fact that a new, small PIMCO ETF was buying up odd lots and using round-lot pricing seems like not the biggest deal. It overstated performance a little bit, because PIMCO was taking cash for creations, and using that cash to buy bonds that were then magically “worth more” than they paid, but as an actual investor, it really doesn’t matter.
If PIMCO’s NAV was, for instance, consistently 1% higher than it should have been, for a year, any investor who bought and sold in that year was just fine–they paid 1% too much, but they got 1% too much when they sold.
In fact, the only place investors got hurt was over the past year, when we can assume PIMCO has revised its practices, and thus lowered the value of odd lots on its books, creating an equally artificial loss to offset the initial artificial gain.