Fixed income specialist PIMCO has launched a new actively managed ETF in the US targeting opportunities within the preferred and capital securities market.
Philippe Bodereau, Head of Credit Research for Europe at PIMCO.
The PIMCO Preferred and Capital Securities Active ETF (PRFD US) has been listed on NYSE Arca with an expense ratio of 0.69%.
The fund has come to market with $50 million in initial assets.
Preferred securities are instruments that typically have both debt and equity characteristics. They generally pay fixed or adjustable-rate distributions to investors and have preference over common stock in the payment of distributions and the liquidation of a company’s assets; however, they are generally junior to all forms of company debt.
Preferred securities have historically exhibited significantly less volatility – less than half – compared to the traditional stock market. In addition, most preferred dividends are considered to be qualified dividend income rather than regular income which can provide a more favourable tax treatment for certain investors.
Types of preferred securities include convertible preferred securities, corporate hybrid securities, Trust Preferred Securities, cumulative and non-cumulative preferred stock, and depositary shares of preferred stock.
Capital securities, meanwhile, are issued by financial institutions (such as banks and insurance companies) to satisfy their regulatory capital requirements. Major types of capital securities include contingent convertible (CoCo) securities, also known as Additional Tier 1 (AT1) securities in Europe.
The yields on CoCo securities are not driven by the riskiness of the issuer, as with most other bonds, but by a contingency element that triggers a conversion into cash or common equity if the issuer’s capital drops below a pre-set level. CoCos are intended to act as a buffer in extreme conditions and will have a lower credit rating, and in turn higher coupon, than the senior debt issued by the same issuer.
Philippe Bodereau, Head of Credit Research for Europe at PIMCO and portfolio manager of PRFD, commented: “Strong balance sheets and higher interest rates make financial institutions, which account for most of the preferred and capital securities market, an attractive investment for those looking for a diversified allocation in fixed income and the potential to earn equity-like returns.”
Investment approach
The fund invests in preferred and capital securities issued in any currency and from issuers in any country, including emerging markets. Up to 50% of the portfolio’s assets may be allocated to securities with ratings below investment grade.
The fund maintains an effective duration within one year of its benchmark, the ICE BofA US All Capital Securities Index, which, as of the end of September 2022, was 5.05 years.
PIMCO utilizes a bottom-up approach to identify sectors and securities that are appear attractively undervalued. The firm notes that the fund’s investment thesis is based on a longer investment horizon designed to minimize trading volume compared with other similar PIMCO-advised funds.
As of 18 January, nearly two-thirds of the ETF’s exposure was allocated to issuers domiciled in the US with the next-largest country exposures being the UK (8.4%), France (5.3%), Canada (5.2%), and Germany (4.7%).
The most notable credit bucket exposures were to BBB- (34.7%), BB+ (19.8%), BB- (7.6%), BB (7.0%), BBB (6.8%), and BBB+ (6.7%). The ETF was not yet publishing its yield but it had an effective duration of 3.8 years.