Viewpoints

Finding Unexpected Opportunities in Core Bonds

Learn why the current focus on low yields may ignore more exciting opportunities to generate returns in core bonds and how PIMCO’s approach helps build resilient portfolios.

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Text on screen: PIMCO

Text on screen: PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Text on screen: Anmol Sinha, Fixed Income Strategist

Anmol Sinha: Hello, and thank you for joining us. My name is Anmol Sinha, and I’m a product strategist here at PIMCO. I’m joined today by two of our core portfolio managers, Scott Mather, CIO of US Core and Sustainable Investments, and David Braun, head of US Financial Institutions Portfolio Management.

Dave maybe we can turn to you. If we think about the potential for lower returns going forward as a result of elevated valuations, is your ability to generate excess returns on top of the market returns challenged in this environment?

Text on screen: David L. Braun, Head of US Financial Institutions Portfolio Management

David Braun: That’s a good question. So if yields are low and spreads are low, it’s logical to conclude that generic market beta returns are going to be low. But that does not mean that alpha expectations should be lowered as well.

Images on screen: PIMCO trade floor

There’s potentially a lot of volatility coming our way and dispersion with winners and losers. And that actually creates a fertile environment for an active manager to hopefully generate alpha.

Text on screen: TITLE – Where we’re focusing:, BULLETS - Security selection, Industry selection, Relative value assessment

So we’re focusing very much on differentiation of security selection, industry selection, relative value assessment. And that should create an environment where the alpha should be a bigger and bigger proportion of the total return given just how low and compressed beta returns are expected to be.

Anmol Sinha: So low yields seem to weigh on the conversation around core bonds. But in fact, maybe it’s actually a little bit exciting to be in fixed income if we can generate excess returns via all these opportunities. So on that point, Scott, let’s turn to you. Many managers in core tend to over-emphasize credit in portfolios as a source of yield pickup. Right, it kind of makes sense. They’ll tend to outyield the index over time. So in the context of the fact that PIMCO is now celebrating its 50th anniversary and has run core strategies for the majority of that period, you both manage portfolios in core space across mutual funds, ETFs, separate accounts, as well as retail-managed accounts. What makes PIMCO’s investing style more unique in core bonds?

Text on screen: Scott A. Mather, CIO U.S. Core Strategies

Scott Mather: Well, I think it’s a few things, Anmol. One is the process. The philosophy and the process we have around managing high-quality fixed income.

Images on screen: PIMCO trade floor

Yes, it’s important to have our base case views and our point forecasts and we spend a lot of time doing that. But it’s more important to build portfolios that are resilient when the unexpected happens. And you do that through this process that we have of intentional diversification, looking for different sources of alpha.

Images on screen: PIMCO trade floor

What we’re doing is thinking on a multi-year time horizon, looking for persistent dislocations in the market that we can add value to portfolios over the course of a year or two years or three years.

It’s a focus also on liquidity, particularly in the high-quality strategies. It gives us the flexibility to take advantage of dislocations when they’re most attractive.

Images on screen: PIMCO trade floor

And then stress testing. And by doing that, we have this portfolio resiliency that really serves clients well in times of distress.

Anmol Sinha: Thanks, Scott. Certainly an interesting environment. Typically, if we were talking about a robust growth recovery for the next two years, you would probably have assumed we would say, ‘Let’s go overweight some market risk or risk asset in general.’ But certainly, the valuations are a big part of that story. Dave, how are you thinking about credit exposure today in portfolios?

David Braun: So corporate credit is always going to have a home in a core bond portfolio.

Text on screen: Style Matters: The core plus category’s credit-heavy style reflects meaningful equity beta

Images on screen: PIMCO trade floor

But the key as Scott eluded to is scaling and position sizing. Because if you get that wrong and you have too much credit beta in a portfolio, that credit beta will converge on equity beta in times of market stress.

So in particular a couple things we like, more broadly speaking

Text on screen: TITLE – Areas of credit that we like:, BULLETS - Belly of the credit curve, Financials over non-financials, COVID recovery sectors, Taxable municipal bonds

we like the belly of the credit curves, meaning that intermediate part, 5-10-year part of the curve. On a relative value basis, it looks much more attractive in the very front end of spread curves, and the very long end of spread curves.

The next thing is specifically on a sector basis, we really prefer financials over non-financials.

We also like the bonds of explicit COVID-impacted sectors in that as the economy continues to reopen, these bonds will continue to grind tighter in spread, and they’re offering some pretty attractive relative value now.

Additionally, there’s some taxable municipal bonds that look attractive on a surrogate basis versus over-valued generic corporates.

So at the end of the day, we are investing in credit. We’re just trying to make sure we’re buying the right credit, rather than just buying the generic credit that’s not offering much relative value.

Text on screen: For more insights and information, visit pimco.com

Text on screen: PIMCO 50 1971-2021

Recorded 28 September 2021

Disclosure


All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax. Diversification does not ensure against loss.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Alpha is a measure of performance on a risk-adjusted basis calculated by comparing the volatility (price risk) of a portfolio vs. its risk-adjusted performance to a benchmark index; the excess return relative to the benchmark is alpha.

Beta is a measure of price sensitivity to market movements. Market beta is 1.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission.| PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. 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W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG).  The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and  203  to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2). The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. 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CMR2021-1111-1919240

 

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