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As Negative‑Yielding Bonds Set New Records, Flexible Investing May Offer Benefits

With more bonds trading at negative yields globally, benchmark-agnostic strategies look compelling.

Negative yields on bonds are back with a vengeance. The five-year German government bond yield reached an all-time low of ‑0.69% after European Central Bank (ECB) President Mario Draghi delivered a dovish speech on 18 June, indicating that the ECB could provide additional stimulus if economic downside risks increase and the current inflation outlook remains subdued. This triggered a fall in bond yields globally, with a record of more than US$12 trillion of bonds trading at negative interest rates as of 19 June (see chart). Negative yields mean investors have to pay (rather than being paid) for owning these bonds.

While investors might be satisfied with positive returns from falling yields in the rearview mirror, the picture is quite different when looking ahead. Negative yields represent a significant challenge for investors in traditional benchmark-oriented strategies. The yield on five-year German bonds, for instance, would reduce invested capital by 0.69% each year, or approximately 3.45% over five years. With these negative yields embedded in the respective benchmark-oriented strategies, we believe investors should be exploring alternatives.

Lower compensation per unit of risk

In addition to falling rates, benchmark-oriented investors may be exposed to higher market risk, which is reflected in increased interest rate duration for traditional strategies. Duration measures a bond’s price sensitivity to changes in interest rates, and the duration of the Bloomberg Barclays Global Aggregate Index, for example, has increased by 25% since 2010.

A more flexible investment approach may offer value

Allocations to more flexible strategies are one option investors could consider to address the challenges of negative yields. Well-designed flexible bond strategies can help navigate even the most challenging markets by identifying attractive investments from a global opportunity set while seeking to ensure investors receive appropriate compensation for the risk. In the context of negative-yielding assets, this also means steering clear of markets where risks may outweigh future return potential. Compared with traditional benchmark-oriented strategies, which are anchored to an index, the flexibility of a dynamic strategy may allow for a more patient approach and the maintenance of dry powder to deploy during periods of future market volatility and dislocations.

For investors facing the challenges of a low-yield environment, dynamic strategies with attractive risk-adjusted return profiles, flexibility, and low correlations to core bonds and equities may offer a compelling complement to core bond allocations.

As Negative-Yielding Bonds Set New Records, Flexible Investing May Offer Benefits

Learn more about the potential benefits of dynamic bond strategies in “Unconstrained, Not Unpredictable: Best Practices for Flexible Bond Strategies.

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The Author

Marc P. Seidner

CIO Non-traditional Strategies

Andrei Wagner

Portfolio Risk Manager

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Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

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PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
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+353 (0) 1592 2000

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PIMCO Europe GmbH
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80335 Munich, Germany
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PIMCO Europe GmbH - Italy
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20121 Milan, Italy
+39 02 9475 5400

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PIMCO (Schweiz) GmbH
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8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. 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 32 of the German Banking Act (KWG). 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.

Past performance is not a guarantee or a reliable indicator of future results. 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 is 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. 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. Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors.

In a World of Disruptions, Flexibility Matters
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