PIMCO’s European wealth management team recently met to discuss the state of markets and our outlook for intermediary clients in Europe. Drawing on a survey of over 80 advisors, fund buyers and researchers, we debated what was changing in financial markets today and how to respond. Below are three themes we identified as shaping the year ahead, together with potential solutions for investors.
1. Be Dynamic
With a general consensus that the global economic cycle is entering its later stages, our survey respondents highlighted evolving monetary policy, concern around valuations, and the end of the bull market as their top investment considerations. But as PIMCO noted in our recent cyclical outlook, the late cycle could continue for some time.
Hence while our survey showed investors planning to increase cash allocations in 2019, we also saw continued interest in flexible strategies and alternatives, suggesting that many are seeking ways to retain market exposure while being able to shift positions if conditions evolve.
We agree that embracing a more dynamic or flexible investment approach makes sense in today’s markets, where buying “the beta” (i.e. the market return) may be less likely to work given a starting point of economic uncertainty and high valuations. A dynamic approach has the potential to take advantage of tactical opportunities without being beholden to rigid benchmarks or guidelines.
PIMCO has a number of dynamic strategies but the ones we think could work best today are the Dynamic Bond Fund and Dynamic Multi-Asset Fund. The former is PIMCO’s broadest and most flexible fixed income product, and can be used as an alternative or a complement to more benchmark-driven core bond strategies. The latter is a multi-asset portfolio that could be used as a standalone solution, or provide a more dynamic component to a static asset allocation.
2. Be Currency Aware
One effect of being in the late stages of the economic cycle, and with the US leading, is that US interest rates have been rising over the last year while those in Europe have stayed relatively flat (and low!). In 2018, this led to European investors experiencing wide divergence between currency hedged returns and US dollar returns in global strategies. Given this backdrop it was little surprise that our survey also identified currency hedging costs as a top investment concern for the year ahead.
In reality, currency hedging “cost” is a misleading term, as the cost is mainly driven by the difference in interest rates between regions (more can be found on this topic here). If, in the future, European rates rise faster than US rates, then currency hedging could become a return contributor rather than a detractor.
However, as many investors still expect to see continued divergence between US and European rates, it may be suitable to shift into domestic approaches, such as sterling or euro credit and income strategies. Those seeking a higher risk return profile could also look to a multi-sector credit strategy that includes emerging markets, such as the Diversified Income Fund.
3. Be Opportunistic
Despite the sense of uncertainty in the air, emerging markets was one area in which we saw a significant jump in investor interest. Whereas six months ago, investors were planning to decrease allocations to EM local and external debt, they are now seeking to increase exposure. After a period of underperformance relative to developed markets, it appears that the relative attractiveness of EM has increased.
A more positive outlook on EM is consistent with PIMCO’s view that there are opportunities in this space, although we still recommend a cautious and selective approach, such as the Emerging Markets Bond Fund, which is an active strategy focused on US-dollar denominated debt.
Outside of EM, we think investors looking for pockets of opportunity should consider financial credit, which we see as one of the few sectors within corporate credit that offers value. The sector saw significant spread widening in 2018 and a strategy such as the Capital Securities Fund offers yields over 7% with an average investment grade credit quality. The financial sector could also benefit from any improvement in the Brexit situation and the ECB beginning its hiking cycle this year.