(Bloomberg Businessweek) -- In early February, most of the investing world was watching stocks take a tumble. Matt Pasts, the manager of BTS Tactical Fixed Income Fund, which was invested almost entirely in junk bonds, studied a computer model used by his small investment firm in Lexington, Mass. The model gave him a distress signal: Sell. On Friday, Feb. 9, Pasts sold all of his $900 million mutual fund’s high-yield bond investments so that the fund was fully in cash.
BTS Asset Management Inc. employs no credit analysts to study the fundamentals of bonds. Pasts is a market timer, trying to suss out whether the whole high-yield asset class is going to rise or fall in value. He watches trend and momentum measures, such as the moving average of the price of exchange-traded funds that track the junk bond market. When not in junk, BTS is either in Treasuries or cash.
Trading completely in and out of the market is simple for BTS because the fund doesn’t directly hold the bonds. Instead, it has the unusual strategy for a fund of investing almost entirely via ETFs. In late January, before it sold, BTS had about 95 percent of its assets in the two largest junk-bond ETFs.
Because timers can make all-or-nothing bets, some traders think investors such as Pasts can have a big impact relative to the size of their funds. When investors pull out of ETFs, that can trigger sales of the underlying investments. About $6 billion flew out of high-yield ETFs in early February, so BTS wasn’t the only one selling. But the fund’s sales may have exacerbated the outflow during a tumultuous period, if traders were watching for signs that others were selling. “A billion-dollar fund that by mandate says it will sell everything to go to cash will create volatility,” says Mike Terwilliger, a portfolio manager at Resource America Inc.
Pasts says he takes steps to reduce his footprint in the market, such as selling in multiple blocks. But he dismisses the suggestion that BTS wields disproportionate influence. “Trading impact will be there, but there’s a lot of liquidity in the market, so there will be people on the other side coming into high yield,” Pasts says.
ETFs are part of a big shift to passive investing—instead of paying high fees to managers who select specific stocks or bonds, many investors prefer to use ETFs that simply replicate a market index at low cost. But not everyone who buys passive funds is a passive investor. BTS shows how ETFs can also be used by active investors, who trade them to time the market and pursue other strategies. Managers and advisers who do this can then layer on their own fees and expenses. The BTS fund costs an annual 1.66 percent or more of assets, which includes 0.41 percent for the funds it buys.
“Active management pays a higher fee,” Pasts says. “A lot goes into developing our models, and it’s hard to do.” How do the fund’s returns stack up? BTS benchmarks itself against the Bloomberg Barclays Aggregate Bond Index, an index composed of safe government debt, investment-grade bonds, and asset-backed securities. Here, it comes out on top—returning a cumulative 13.5 percent since its 2013 inception, compared with 10 percent gains for the Bloomberg Barclays Aggregate. But its performance falters when compared with high-yield bonds. Since its inception in 2013, BTS Tactical Fixed Income Fund has lagged the main ETFs it invests in. Pasts says his clients want “a genuinely alternative investment option” that “stresses capital preservation.’’
BTS was started in the 1970s by Pasts’s father, Vilis. In the past two years, the BTS mutual fund has grown fivefold to almost $1 billion in assets, a lot of it coming through referrals by brokers and financial planners. BTS also manages some private accounts and sells its buy and sell signals to clients who follow its lead. The fund’s growth has mirrored a surge of investment into high-yield ETFs.
Junk bonds are quirkier than high-quality corporate bonds and not as liquid as many stocks. Some worry that ETFs make investing in the bonds seem too easy. If the market were to come under sustained stress, liquidity could dry up as ETF investors race for the exits, says Jim Bianco, president of Bianco Research LLC. “What we’ve done with high-yield ETFs is we’ve allowed people a vehicle to trade an illiquid market thinking it has liquidity,” he says. But Luke Oliver, head of ETF capital markets at Deutsche Asset Management, says ETFs aren’t creating any risks that weren’t already there. “There’s always been large institutional players in the space,” he says. “ETFs have just led to further democratization.”
Some investors welcome timers and jumpy traders to the party. “When ETFs have to sell bonds, we find some of these bonds will be down multiple points for no fundamental reason,” says Michael Donoghue, president of hedge fund Phoenix Investment Adviser. “For investors with longer time horizons, all of a sudden, we can buy bonds cheaper.”
To contact the author of this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net.
To contact the editor responsible for this story: Larry Reibstein at lreibstein@bloomberg.net, Pat Regnier
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