PIMCO | Euro Liquidity Strategy

Euro Liquidity Strategy

What Is PIMCO’s Euro Liquidity Strategy?

The investment objective of the PIMCO Euro Liquidity Strategy is to seek maximum current income consistent with the preservation of capital and daily liquidity. The strategy is actively managed to preserve capital, maximize current income and maintain daily liquidity, while minimizing any risk relative to the benchmark. The strategy invests solely in euro-denominated instruments with maturities of fewer than 397 days and maintains a weighted average maturity of 60 days or less.

Why PIMCO for Cash Management?

The Euro Liquidity Strategy has the following distinguishing characteristics:

A highly diversified, multi-strategy approach – Our philosophy is that no single strategy should dominate. By tapping different sectors of the fixed income markets, the strategy seeks to outperform traditional money market vehicles while preserving capital and providing daily liquidity.
A longer-term focus when making investment decisions – We believe that the careful and detailed analysis of longer-term global demographic, political and economic trends is essential to anchor sound investment decisions.
Influential team of investment professionals and specialists – A broad array of leading fixed income specialists generate both local market and individual security insight and help drive the best, appropriate ideas into each portfolio.
Extensive team of credit research professionals – We never rely on the rating agencies alone. PIMCO places a great deal of importance on independent analysis when evaluating commercial paper and our staff of seasoned credit analysts internally rate every credit held in our portfolios.

These elements help to underpin the Euro Liquidity Sand make it an attractive alternative for those seeking return enhancement vs. traditional money market vehicles while preserving capital and providing daily liquidity.

As one of the world’s largest asset managers, we have devoted extensive resources to developing our expertise in euro bond markets. We believe that in order to efficiently manage euro fixed income portfolios a local presence is required in order to gain a better understanding of trade flows, trade less liquid sectors and participate in the government auctions and new issuance taking place during European time. We have therefore established our European portfolio management operations in Munich and London, with the ability to also draw upon our resources located in the U.S. and Asia.

Investment Philosophy

By combining a longer-term investment horizon with our expertise in managing fixed income portfolios, we are not limited to holding only the shortest-term government securities. As a result, we can maintain a focus on capital preservation and daily liquidity while expanding our opportunity set to include a variety of high-quality securities that can provide attractive yields and the benefit of diversification.

We seek to add value through the use of top-down strategies such as our exposure to interest rates, duration, changing volatility, yield curve positioning and sector rotation. We also employ bottom-up strategies involving analysis and selection of specific securities. By combining perspectives from both the portfolio level and the security level, we seek to consistently add value over time while incurring acceptable levels of portfolio risk.

Secular Emphasis – Our focus on longer-term (3 to 5 year) trends recognises that such secular considerations as demographics, political factors, and structural changes in the domestic and international economy exert powerful, sustained influences on interest rates. Thus, a secular outlook updated annually determines a general maturity/duration range for the portfolio in relation to the market. Short-term, cyclical economic considerations determine shifts within this range.
Avoid Extreme Durations – Striving to build consistent results, we avoid extreme duration shifts. Major shifts in portfolio strategy are driven by our secular and cyclical outlooks as opposed to short-term market events or aberrations in interest rates. Operating within a moderate duration range, typically two years above or below that of the index, increases the opportunity of achieving above-market returns while limiting client exposure to drastic swings in interest rates.
Thorough Volatility Analysis – In addition to forecasting the direction of interest rates, a volatility forecast is crucial to the management of a bond portfolio because volatility impacts the relative performance of the various bond market sectors. Increases in volatility benefit non-callable bonds such as gilts, whereas declining volatility will favour callable instruments such as corporates and mortgages. Volatility also impacts proper portfolio structure.

For a given duration target, volatility will effect a portfolio consisting of a mixture of long and short bonds differently than a pure intermediate portfolio. In addition, volatility influences the coupon choice, the credit quality, the use of futures and options, and the analysis of more complex securities.

Rotate Among Sectors – Our universe includes all sectors of the bond market: governments, corporates, mortgages, asset-backed, money markets, emerging markets, inflation-linked and hedged international. We make sector shifts, or rotations, depending upon changes in relative valuations among the different classes of bonds. Sophisticated proprietary analytics assist in the evaluation of sector opportunities and in the pricing of specific securities within sectors.
Quantitative Research – Due to the complexities of the fixed-income markets, PIMCO has developed a proprietary set of quantitative tools designed to more fully understand how securities will react to changes in interest rates and market conditions and to identify relative value opportunities.
Credit Fundamentals – We place a great deal of importance on independent analysis when evaluating corporate credits. PIMCO never relies on the rating agencies alone. Our senior portfolio managers, who each have many years of experience trading corporate bonds and analysing their credit, work with a team of credit analysts who evaluate individual issues.

PIMCO’s size and reputation gains us access to corporations’ top management, which is integral to the evaluation process. We meet with management as necessary to remain current on the financial and operating conditions of a company. We concentrate our efforts on companies who have strong underlying businesses, a strong competitive position within their industries, and financial flexibility. We focus our investments in those issues that show improving credit profiles, the potential for upgrade by the rating agencies and, therefore, greater potential for capital appreciation.

Issue Selection – PIMCO has developed expertise across a variety of fixed-income sectors via specialists who focus in each major fixed-income arena. By understanding the relative value between individual securities, we can capture incremental value for our clients.

We believe that using multiple sources of value added best produces the opportunity for consistent above-index performance. In contrast to some managers who prefer to take a few large exposures, PIMCO makes a larger number of small departures from the benchmark. This approach may increase the opportunity of achieving above-market returns while limiting exposure to sudden swings in interest rates. Therefore, we feel our sources of value added are well diversified and may lead to the potential for greater long-term consistent returns.

Investment Process

The first and most important step in our process is to get the long run right. We believe that analyzing secular economic and political influences is fundamental to sound portfolio decisions. Holding a firm long-term view helps guard against becoming caught up in periodic bouts of euphoria and depression that often characterize financial markets. We are much more optimistic about our skill in identifying long-run value through fundamental economic and credit analysis than our ability to time short-term market movements.

Secular Outlook – We consider secular analysis so important that we devote one week each year to what we call our secular forum, at which we formulate our outlook for global bond markets over the next three to five years. Selected members of the investment staff are assigned secular topics to monitor, including monetary and fiscal policy, inflation, demographics, technology, productivity trends, global trade, etc. Secular researchers tackle their subjects on a global basis and approach them over a multi-year horizon. At the secular forum, our secular researchers summarize their findings for all the firm’s investment professionals. In addition, we invite analysts and scholars from outside the firm to share their expertise with us on financial and economic issues that are germane to the outlook. These external presentations combined with our internal research serve as background for further discussion and debate by the group.

Cyclical Outlook – The next step in our process is the analysis of cyclical or business cycle trends. PIMCO investment professionals meet quarterly in economic forums to evaluate growth and inflation over the near term business cycle. We evaluate the research and economic data presented by four regional research teams staffed by PIMCO investment professionals. These teams cover North America, Europe, Asia and the emerging markets. These presentations are followed by discussion and debate, the purpose of which is to decide whether GDP growth and inflation in each of the four regions will exceed or fall short of the market’s consensus views. Our conclusions help refine and update our forecasts for shorter-term economic trends.

Investment Committee – Following our secular and cyclical economic forums, the Investment Committee, comprising senior portfolio managers, works on a consensus basis to develop major strategies that serve as a model for all portfolios. The Investment Committee makes use of the top-down outlook provided by the forums as well as bottom-up input from specialists who focus on various fixed income sectors. Portfolio characteristics for which the Investment Committee sets targets include duration, yield curve exposure, convexity, sector concentration and credit quality.

Ongoing Review – While our views and portfolio construction are refreshed at least quarterly, our decision-making process is dynamic in nature. The Investment Committee meets at least four times a week to review various aspects of the current strategy in light of changing market conditions. Specialist groups are also invited to review existing recommendations or to present new ideas on a regular basis.

Portfolio Construction – Relative to a money market index, which includes strategies that have maturities restricted to an average of 60 days, provide daily liquidity, are almost always rated at the highest credit level and have very stable prices, the excess return of PIMCO’s Euro Liquidity strategy derives from four main sources:

The term premium (upward slope in the shape of the yield curve)
The transactional liquidity premium (yield which compensates an investor for holding bonds with wider bid/ask spreads)
The credit premium
The volatility premium

An expanded investment opportunity set, and more specifically these four risk premiums, add up to a wide variety of opportunities to add value given our broad fixed-income market expertise and the longer term holding periods of our investors.

Risk Management

Measurement and control of portfolio risk is a major effort at PIMCO. It involves all portfolio and account managers as well as our financial engineering group, which helps to develop proprietary risk measurement models that are theoretically sound and reflect market realities.

To ensure that all relevant market risk factors are captured, portfolio managers use an array of proprietary risk measures at both the individual security and portfolio levels. While we make use of risk measures such as VaR and tracking error, we do not rely on any single risk measure approach, and monitor risks that include credit, interest rate, interest rate volatility, yield curve and sector. PIMCO’s account managers and portfolio managers independently monitor portfolio risk exposures on a daily basis to ensure consistency with investment strategy guidelines.

How To Invest

Eonia (Euro OverNight Index Average) is the effective overnight reference rate for the euro. It is computed as a weighted average of all overnight unsecured lending transactions undertaken in the interbank market, initiated within the euro area by the contributing banks.

Past performance is not a guarantee or a reliable indicator of future results. The value of shares can go up as well as down. The strategy may invest a portion of its assets in non-Euro securities, which can entail greater risks due to non-Euro economic and political developments. This risk may be enhanced when investing in Emerging Markets. Investment in a strategy that invests in high-yield, lower-rated securities, will generally involve greater volatility and risk to principal than investments in higher-rated securities. This strategy may use derivative instruments for hedging purposes or as part of its investment strategy. Use of these instruments may involve certain costs and risks. Portfolios investing in derivatives could lose more than the principal amount invested.

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