Pimco ETF Draws Probe by SEC
Regulators Are Probing Whether Returns Were Artificially Inflated for an ETF at Bill Gross's Firm
The Securities and Exchange Commission is investigating whether bond giant Pacific Investment Management Co. artificially boosted the returns of a popular fund aimed at small investors, according to people familiar with the matter, the latest challenge for the firm run by investor Bill Gross.
A probe into pricing issues at Pimco has been under way for some months, the people familiar with the matter said. Mr. Gross has been interviewed by SEC investigators, the people said. Mr. Gross declined to comment for this article.
The issues being scrutinized by the SEC include the way a flagship exchange-traded fund, managed by Mr. Gross, purchased and valued certain bonds. Investigators from the SEC's enforcement division are examining whether the $3.6 billion Pimco Total Return ETF BOND +0.08% bought investments at discounted prices but relied on higher valuations for the investments when the fund calculated the value of its holdings shortly thereafter. Such a maneuver could make it seem as though the ETF had scored quick gains when it was in fact taking advantage of variations in the way some investments are valued in the bond market.
One possible focus of the SEC inquiry, according to people familiar with the matter: whether Pimco's alleged maneuver meant investors were given inaccurate information about the fund's performance. It is a breach of securities law to provide investors with misleading information about values or performance, even if the wrong information was supplied unintentionally.
Pimco "has been cooperating with the SEC in this nonpublic matter, and we take our regulatory obligations and responsibilities to our clients very seriously. We believe our pricing procedures are entirely appropriate and in keeping with industry best practices," said a spokesman for the firm.
A spokesman for the SEC declined to comment.
An ETF is a mutual fund that trades on an exchange like a stock, allowing investors to move in and out of it quickly.
The inquiry comes amid escalating scrutiny by the SEC of whether investment funds are valuing assets accurately and fairly, according to officials there. The agency has brought several recent improper-pricing civil cases against firms, fund managers and others. A number of these cases focused on conduct during the 2008 financial crisis, when cratering values for subprime-mortgage assets caused some funds to fail. Those cases settled without firms or individuals admitting or denying liability.
For Pimco, the probe comes as the Newport Beach, Calif., firm battles a wave of investor withdrawals from its $222 billion Total Return Fund, managed by Mr. Gross. The departing cash has come amid spotty performance at the fund and a management shake-up earlier this year, highlighted by the abrupt departure of Mr. Gross's onetime heir apparent, Mohamed El-Erian. Since May 2013, more than $65 billion has left the fund, which trails its benchmark this year. Investors also have been pulling money across all of Pimco's mutual funds.
Mr. Gross, 70 years old, is one of the most successful bond investors ever. He is considered the driving force behind Pimco's growth into a blue-chip money manager, with almost $2 trillion in assets under management as of June 30. Pimco is a unit of German insurer Allianz SE. ALV.XE -0.76%
It isn't clear any of the actions by Pimco that are being examined are improper. It can be difficult to ascertain proper valuations in the debt markets, especially for bonds that are relatively small in dollar terms or don't trade frequently.
The Pimco investigation has been under way for at least a year but appears to have intensified in recent weeks, according to people familiar with the matter. Regulators recently have been interviewing Pimco executives, according to some of these people. At least six months ago, Mr. Gross spent over a day being interviewed by SEC officials.
The investments believed to be in question, such as small amounts of mortgage securities—or "odd lots" in the terminology of the financial markets—tend to receive lower prices because of their small sizes or because they are backed by smaller institutions, among other factors.
After the launch of the ETF, Wall Street traders were encouraged by Pimco to offer these small securities to the Pimco ETF, according to some of the people familiar with the matter. Mortgage bonds with a relatively small $500,000 face amount, for example, might have sold for only $480,000, because few investors wanted them, due to the small size.
But when Pimco, shortly after purchasing the bonds, placed a value on them, it typically used outside pricing companies that often assigned higher valuations because they used a similar, but much larger, pool of mortgage bonds to compare them with, according to people close to the firm. Placing a $500,000 valuation on a bond purchased for $480,000, for example, would have allowed Pimco to claim a quick 4% gain on the $500,000 bond, or $20,000.
If that maneuver happened with enough bonds, early results of the ETF could have been aided, these people say.
Traders say buying discounted bonds, then using an outside ratings company to place a higher valuation on those bonds, is akin to buying a used car on the cheap because it is in poor shape but having a lender rely on the list price when making a loan.
It isn't clear how widespread this maneuver is in the bond market. It also isn't clear how much the alleged activity by Pimco might have helped the results of the ETF, if at all.
The fund scored huge early gains, potentially helping it attract interest from investors. The ETF was launched Feb. 29, 2012, with $103 million as a companion to Mr. Gross's much-larger Pimco Total Return fund and designed to follow a similar strategy.
The Pimco Total Return ETF returned 8.7% between March and August of 2012, its first six months in existence, compared with 5.2% for the Pimco Total Return fund and 2.9% for the Barclays BARC.LN -1.04% Capital U.S. Aggregate bond index, according to researcher Morningstar Inc. Since inception through August, the ETF has gained 5.9%, compared with a 3.4% gain for the Total Return fund and 2% for the Barclays index.
Amid the strong early performance, the fund gathered more than $2.4 billion in its first six months, an astonishing rate for a mutual fund or exchange-traded fund, according to analysts.
The heady performance of the ETF raised questions among some of Pimco's clients about the discrepancy in results between the ETF and the Total Return fund, according to a person close to the firm.
Many bonds don't trade frequently, making it a challenge to determine an accurate price. That is one reason mutual funds and others turn to outside pricing companies to set periodic valuations for their investments and funds. The pricing companies in some cases find it difficult to get a sense of the latest prices and valuations, especially for infrequently traded bonds or those in small sizes, and sometimes rely on valuation models, traders say. The models don't always do a good job taking size and other factors into consideration, however, which is why, in some cases, they place full valuations on unpopular bonds, like those the Pimco ETF is said to have purchased, traders say.