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SEC’s investigation into Pimco could ripple through ETF, fixed income markets

Question hinges on whether fund company artificially boosted returns by relying on lofty valuations

By Trevor Hunnicutt    September 24, 2014

An SEC investigation into how Pimco, the world’s largest bond fund manager, valued some securities in its Total Return Bond ETF could spill over into the expanding universe of funds that invest in hard-to-value assets, according to industry watchers.

Bill Gross, who manages the largest bond mutual fund and the second largest actively managed exchange-traded fund, faced a new setback this week as the Wall Street Journal his Total Return Bond ETF has been under investigation by the Securities and Exchange Commission.

At issue is whether the fund company artificially boosted returns by relying on lofty valuations of mortgage-related investments it bought at a discount, the Journal said.

Some advisers said the report could signal more similar investigations.

“I’m surprised the SEC hasn’t opened more inquiries like this,” said Paul Schatz, president of Heritage Capital in Woodbridge, Conn. “Most investors don’t know that most bonds do not trade on an exchange, but rather in a dealer market. As such, price discovery can be all over the map.”

Some industry professionals think the underlying market makes it difficult for fund managers to trade bonds even as ETFs have surpassed them in terms of liquidity and proper valuation.

“As these funds have gotten more complex with thinly traded securities, it’s become even a bigger challenge,” said Terrance Gallagher, Milwaukee-based executive vice president at UMB Fund Services, a consultancy.

Questions over the subjective valuations used by fund companies to value small fixed income holdings have long been looked at by the SEC, but they have been increasingly on the agency’s radar this year. Their examinations of alternative mutual fund providers, for instance, have included a focus on the way firms value assets, according to two sources with knowledge of those efforts.

Indeed, Pimco and other fund companies sometimes rely on price quotes on its unsold securities furnished by third-party pricing services such as Interactive Data Corp., Thomson Reuters, Bloomberg L.P. and Markit Group, according to company disclosures and industry experts.

Those price quotes can be based on old market data, information from market-makers or estimates based on other similar securities.

“The scary thing is, I deal with a lot of firms that are a hell of a lot smaller that don’t have the infrastructure of a Pimco,” said Todd Cipperman, a Wayne, Pa.-based compliance lawyer. “When they see this, it chills people.”

Details on the SEC’s reported investigation of Pimco are scant and could not be independently verified. SEC spokeswoman Judith A. Burns declined to comment on Wednesday.

But the attention to Newport Beach, Calif.-based Pimco added a new blot to the reputation of Mr. Gross, the industry’s embattled totem.

Mr. Gross boasts one of the best track records in bond investing history, but his firm has suffered nearly $64 billion in withdrawals over the last year after the fund posted spotty performance and Mohamed A. El-Erian, a former heir apparent, announced his departure.

“Any time somebody at the SEC opens up an investigation, it’s rarely anything but bad news for your brand,” said Jeff Tjornehoj, head of Americas research for Denver-based Lipper.

“Pimco has been cooperating with the SEC in this non-public matter, and we take our regulatory obligations and responsibilities to our clients very seriously,” said Pimco spokesman Mark Porterfield, in a statement late Tuesday. “We believe our pricing procedures are entirely appropriate and in keeping with industry best-practices.”

The firm declined to comment further.

The impact on the bond market is unclear, but Pimco may feel the results sooner. In a note to clients, analysts at Citigroup Global Markets Inc., a New York-based investment bank, said the SEC investigation is likely to further tarnish Pimco’s brand.

“The probe highlights the increased regulatory environment [and] offers an opportunity for asset managers to take share from Pimco,” according to the note by analysts William R. Katz, Neil Stratton and Steven J. Fullerton. It said firms should expect delayed product reviews and rising regulatory costs.

 

 

By Alexandra Scaggs And Ira Iosebashvili    September 17,2014

The five-year bull market in U.S. stocks got a new lease on life, as investors embrace the steady-as-she-goes message the Federal Reserve is delivering on the economy and interest rates.

The Dow Jones Industrial Average rose to a record and the dollar jumped to a six-year high against the yen, after the Fed took tentative steps toward unwinding its historic easy-money policies while reassuring investors that rates will remain low even as the economy expands.

The gains were accompanied by a decline in U.S. government-bond prices that sent Treasury yields higher and a selloff in many emerging-market stocks and currencies. Assets in poorer nations often are hit first when interest rates rise.

Wednesday’s action underscores the investor belief that the Fed will raise interest rates next year, while the European Central Bank and Bank of Japan will continue pushing rates down in a bid to spur struggling economies.

“In the big picture, the Fed is decreasing its balance sheet and looking to tighten policy, while the ECB and Bank of Japan are on the opposite path,” said Kiran Ganesh, a strategist at UBS Wealth Management.

The Dow industrials gained 24.88 points, or 0.1%, to 17156.85. That marked the blue chips’ 16th record of the year and leaves the index up 3.5% in 2014.

Investors said the Fed meeting reinforced demand for the U.S. dollar and riskier investments such as stocks. U.S. government bonds are seen as expensive but also unlikely to post sharp declines, with the Fed taking a measured approach toward pulling back on its easy-money policies.

Ahead of Wednesday’s statement by the Fed, investors had been looking for hints as to how rapidly the central bank would proceed toward reversing its easing efforts. Fed policy has been credited with fueling the five-year-long bull market in stocks and keeping bond yields low.

In its policy statement, the Fed said it expected to keep short-term interest rates near zero for a “considerable time.”

However, the Fed also confirmed that it would end its bond-buying program next month and offered new details on the mechanism it plans to use to raise interest rates when that time comes.

“They’re still working to keep rates low,” said Robert Pavlik, chief market strategist at Banyan Partners, which oversees about $4.5 billion in assets. “They’re not moving on interest rates, so the overall equity market should be pleased with that.

“You wouldn’t see a dramatic uptick in the bond-market yield because they’re giving you a pretty dovish stance,” he said.

Mr. Pavlik has reduced the cash holdings in his portfolio in recent weeks. He has tilted his holdings toward stocks that would particularly benefit from accelerating economic growth because of what he sees as a strengthening U.S. economy.

The S&P 500 index fell just short of a record, rising 2.59 points, or 0.1%, to 2001.57, just 0.3% off its high of 2007.71 hit Sept. 5.

The Nasdaq Composite Index advanced 9.43 points, or 0.2%, to 4562.19.

Currencies saw sharper moves than stocks. Even though the Fed signaled a continued go-slow pace, the gradual shift toward higher rates comes as monetary policy is seen as staying loose in Europe and Japan.

The dollar rose 1.1% against the yen to its strongest level since September 2008, while the euro fell 0.7% versus the greenback, its lowest level in 14 months. Late Wednesday in New York, the dollar bought ¥108.37, from ¥107.13 late Tuesday. The euro bought $1.2865, from $1.2960.

Emerging-market currencies weakened against the dollar as well, with the Turkish lira hitting a six-month low.

As of Friday, the dollar has logged its longest winning streak in more than 17 years, rising against a broad basket of currencies for nine weeks ina row, according to the ICE U.S. Dollar Index. Higher interest rates would make the dollar more attractive to yield-seeking investors.

“The Fed is switching gears and talking about the actual modalities of raising rates,” said Aroop Chatterjee, a strategist at Barclays. “This is a significant change, and it is being reflected in a strengthening dollar.”

Prices of Treasury bonds pulled back after the Fed statement, sending the yield on the 10-year note up to 2.600%. Before the statement, it was trading at 2.564%. Bond yields move inversely to prices.

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