David Fisher, Head of Traditional Product Strategies: Hello, I'm David Fisher, and I’m here once again with PIMCO’s group CIO Dan Ivascyn for an inside look at some of the recent discussions taking place inside PIMCO’s investment committee, or IC. Thanks for joining us, Dan.
So, 2019 was a fairly atypical year for most asset classes. We saw strong returns, really, across the board. 2020 has started off with a little bit more volatility, more two-way markets. How is the IC thinking about markets for 2020?
Daniel J. Ivascyn, Group Chief Investment Officer: Well 2019 was certainly a great year for most financial markets.
Somewhat unique in that almost everything went higher in terms of price. So, looking forward into the remainder of 2020, we see valuations as somewhat stretched, looking at valuations across both equity and fixed income markets in historical context, they look fully valued, closer to being expensive rather than cheap. And we see increasing sources of uncertainty. So in looking forward, over the next few years, we see lower expected returns, higher volatility, which of course is a more challenging environment for end investors.
Also, what we’ve noticed, and perhaps not too surprising coming off such a strong year in 2019, is that at least in early January, people were very, very, very optimistic about not only economic fundamentals on a global basis, but also by the prospect for ongoing strong returns across financial assets. The more recent volatility has shaken confidence somewhat, but in general, we see a marketplace where there’s still a decent degree of optimism, a desire to buy dips, and in general, a high level of confidence in terms of the direction of returns.
David: So another interesting aspect of 2019 was on the flow side, where we saw very strong investor flows into fixed income in particular, and these have continued so far in 2020, despite the fact that yield levels remain quite low. So, what are your thoughts on what is driving investors into fixed income?
Dan: I would characterize the demand for fixed income coming from two categories of investors.
The first, a group of investors that are looking for a steady, consistent income stream, which is increasingly more challenging to obtain, given the low rate environment. And then the second category of investors are investors that are looking for capital preservation in strong relative performance when other financial assets are performing poorly. That’s exactly what bonds are for.
During this more recent period of volatility tied to the coronavirus and the resulting uncertainty, we’ve once again seen the defensive qualities of a higher quality fixed income portfolio.
We still believe that these defensive qualities represent a key attractive aspect of an allocation to fixed income. We still see significant amounts of our investors, both on the retail and the institutional side, looking for that type of protection if we were to get into a much more challenging environment, both from the perspective of economic fundamentals or other sources of risk like we’ve seen more recently.
David Fisher: So, where is the investment committee looking right now for opportunities within the fixed income markets?
Dan: Given the very low level of yields, tighter spreads, stretched equity valuations, investors including PIMCO are going to need to be more creative in going out and sourcing return. One thing we’re doing is expanding our opportunity set.
We’ve made considerable investments, and plan on continuing to make considerable investments in expanding our footprint globally, with a focus on newer markets that have grown considerably over the course of the last few years, markets that tend to be a little bit less efficient than more developed markets, but offer interesting opportunities for investors.
Examples of those would be the emerging markets, an increased focus on Asia across the board, both in the higher quality rate-oriented markets, as well as the credit markets, including even expansion of some of our activities across regions of Europe, Latin America, and elsewhere.
Secondly, we’re focusing on more flexible mandates, at the direct request of our clients. Flexible mandates in the context of more of our traditional strategies, as well as an expansion of activities within the private segments of our business. Looking for ways to generate attractive yield, find ways to add incremental yield to portfolios while maintaining downside resiliency. That’s what we try to do thematically. And again, we’re doing that in expanding the suite of offerings to our end client based on their demand for increased flexibility.
When you look at starting valuations here in early 2020, it’s going to be hard to rely on further compression and spreads just providing beta returns.
So the focus on relative value is going to be increasingly more important. Expressing views in more of a market neutral sense, looking for dislocations associated with volatility, overshooting tied to relative illiquidity in certain segments of the market, ongoing frictions relating to regulations, ongoing frictions and opportunities associated with an increasingly uncertain political environment
David: So one of the areas that you've talked a lot about in the past is housing related investments, where in general PIMCO has been quite constructive. Has anything changed there?
Dan: No. Actually, in fact today we are even more confident in the relative merits of portfolios with strong emphasis or strong allocation to the housing related sectors. We, have continued to see almost rabid demand for generic, more traditional corporate credit assets. Because of the significant issuance, it’s not surprising that we’ve seen some deterioration, or further deterioration in underwriting quality.
Shots of neighborhoods and a for sale sign outside of a house.
And in the housing market you see fundamentals across the board that remain stable. It shouldn't be surprising, given the significant post-crisis regulation, rating agency and investor conservatism that’s still being expressed towards that sector.
So, in terms of relative value, we find these housing investments today, in early 2020, even more attractive on a relative basis.
A second area that’s worth noting is what’s occurring over on the agency mortgage segment of the opportunity set, partially related to the rally in interest rates recently, we’ve seen a significant cheapening in good old-fashioned agency mortgage-backed securities.
Those are the securities that are guaranteed directly by the US government or one of its agencies. They're attractive alternatives to high quality credit, treasury assets where you’re exchanging a bit more complexity for higher yields.
David: Great! Well thanks for joining us, Dan. And thanks to you as well. We’ll see you next time.
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The terms “cheap” and “rich” as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager’s future expectations. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.
Bonds tend to pay regular and stable interest absent default. Bonds tend to be less volatile and historically less correlated to equities and other risk assets, making bonds a good diversifier for investment portfolios
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 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. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Securities issued by Ginnie Mae (GNMA) are backed by the full faith and credit of the United States government. Securities issued by Freddie Mac (FHLMC) and Fannie Mae (FNMA) provide an agency guarantee of timely repayment of principal and interest but are not backed by the full faith and credit of the U.S. government.
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