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Douglas M. Hodge
It’s been a remarkable turnabout. Just over a year ago, then-Fed Chairman Ben Bernanke introduced a five-letter word into our financial lexicon – “taper.” In the weeks that ensued, interest rates on 10-year Treasuries spiked 70 basis points. And whether it was the “Great Rotation” into stocks or the simple aversion to any form of interest rate risk, the seemingly insatiable appetite for bonds, most notably among individual investors, turned into apprehension as they rushed for the exits.Times have changed. Bill Gross, Founder and Chief Investment Officer of PIMCO, and Richard Clarida, who leads PIMCO’s Secular Forum, last month published our latest Secular Outlook, “The New Neutral.” Its core thesis: A convergence of global growth rates to modest trajectories, combined with an overhang of global leverage, will likely lead to a New Neutral policy rate for the Federal Reserve and other global central banks, below the levels of old normal rate hike cycles. Certainly, the recent rate cuts by the European Central Bank and the International Monetary Fund’s reduced forecast for U.S. growth support our New Neutral view, and global investors seem to agree as well, as they are once again recognizing the strategic role that bonds play in a well-diversified portfolio.
Indeed, at PIMCO we are experiencing positive trends in our investment performance and client asset flows across the $1.9 trillion in assets we manage.
Inclusion and collaborationThe New Neutral, and the broad investment implications it conveys, underscores the value of inclusion and collaboration in our investment process and, indeed, our culture. We believe that investment ideas must be able to withstand scrutiny from a diverse range of perspectives. Our forums – in which PIMCO investment professionals from around the world gather in Newport Beach four times per year for open and rigorous debate – are the embodiment of this philosophy.The forums frame the daily work of the Investment Committee – whose membership has recently expanded to include our six Deputy Chief Investment Officers and our Chief Economist, Paul McCulley – and three regional portfolio committees (Asia, Europe and the Americas). It is through this process and the collective energies of our near 250-person portfolio management team that we maintain our focus on managing risk and delivering returns across multiple markets, geographies and asset classes.
The Secular Forum process, which was Bill’s creation, has been central to PIMCO’s performance for clients over the decades: It allowed us to anticipate by months – and even years – the Asian contagion of the late 1990s, the credit crunch and the European debt crisis; and it gave birth to concepts such as the New Normal in 2009 and The New Neutral this past month.
These insights have helped to power PIMCO’s Total Return strategies, including the Total Return Fund, which over its 27-year history has been entrusted with more investor fixed income assets than any other mutual fund. The objective of this fund, which Bill leads, is to outperform its benchmark, the Barclays U.S. Aggregate Index (BAGG), which is composed of investment-grade corporate, mortgage and government bonds, with comparable risk.
As of 30 June 2014, the Total Return Fund has outperformed the BAGG over the past 12 months after fees, as well as the past 24, 60 and 120 months, by an average of 118 basis points, with substantially less volatility.
Institutional Share Class, inception date 11 May 1987. Total expense ratio 0.46.Performance quoted represents past performance. Past performance is not a guarantee or a reliable indicator of future results. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when redeemed. Current performance may be lower or higher than performance shown. For performance current to the most recent month-end, visit www.PIMCO.com/investments or call 888.87.PIMCO.
Apples-to-apples?Given PIMCO’s focus on risk-adjusted returns, it is important to note that when the Total Return Fund is compared with peers, the comparison is often with funds whose investment guidelines permit greater exposure to high-yield bonds, which are not part of the BAGG. The Total Return Fund’s guidelines permit up to 10% exposure to high-yield bonds, which is among the lowest in the category.
To be sure, high-yield bonds have outperformed investment grade bonds for the past 1-, 3- and 5-year periods – by as much as 6% a year in the case of the 5-year period.
Yet we believe the lower reaches of the credit markets have become somewhat frothy. Credit spreads are back nearly to 2007 levels, and there are a variety of worrying trends. Among them: The return of 100% loan-to-value loans that were a feature of the zero-down subprime and the Alt-A lending sprees that ended abruptly in 2008; loan covenants that have weakened dramatically as managers reach for yield; a tightening of secondary liquidity; and often questionable calculations of net debt on corporate balance sheets.
We see opportunities to generate potentially attractive returns in many quarters of the global marketplace of bonds. However, we believe a disciplined, long-term approach that emphasizes risk-adjusted returns is indispensable.
Anchored portfoliosCertainly, recent trends in the bond markets have underscored the merits of this focus.
It was on 22 May 2013 that “taper” became the buzzword – and virtually overnight, higher interest rates the zeitgeist. The intensity and magnitude of the change in investor sentiment, as measured in mutual fund flows, were truly unprecedented. After a strong quarter of inflows into bond funds in the first quarter of 2013, outflows through the rest of the year offset earlier inflows, in what would become the largest wave of outflows from bond funds on record.
To a degree, flows into and out of fixed income funds are a natural part of the market cycle. However, over the last decade an increasing share of our collective retirement savings has been directed by individuals, rather than institutional investors as was the case historically. At the same time, we have seen the volatility of flows into and out of various asset classes and markets rise dramatically. Are institutional investors more patient? Are individual investors more prone to herding behavior? Perhaps. Regardless, we must all adapt to operate in a marketplace characterized by higher volatility.
Recently, flows have been returning to bonds and PIMCO’s broad set of offerings. Investors have perhaps come to realize that their fears of higher interest rates were largely unfounded. Beyond recent performance, investors remind us that they appreciate that the Total Return strategies were an anchor-to-windward during the 2008 financial crisis when many bond funds materially underperformed. They also understand that core bond strategies remain an integral component of many portfolios, providing the opportunity for return, diversification and stability across a variety of market environments.
PIMCO’s Total Return strategies manifest what we believe are our best core fixed income investment ideas executed with due care to risk and long-term performance. Their history has helped them garner the assets of millions of investors. Indeed, we are unaware of any person who has created more wealth for more people in the history of fixed income investing than Bill Gross. In our opinion, no other manager has invested as much money, over as long a period, with the same track record.
It is a record we intend to extend in the years ahead by maintaining our focus on delivering returns and continuing to earn your trust.
Investors should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. This and other information are contained in the fund’s prospectus and summary prospectus, if available, which may be obtained by contacting your PIMCO representative. Please read them carefully before you invest or send money.
The performance figures presented reflect the total return performance for the Institutional Class shares (after fees) and reflect changes in share price and reinvestment of dividend and capital gain distributions. All periods longer than one year are annualized.
Funds typically offer different share classes, which are subject to different fees and expenses (which may affect performance), having different minimum investment requirements and are entitled to different services.
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 the current low interest rate environment increases this risk. Current 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. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss.
Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar- denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. It is not possible to invest directly in an unmanaged index.
This material contains the current opinions of the author and not necessarily PIMCO 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. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2014, PIMCO
PIMCO Investments LLC , distributor, 1633 Broadway, New York, NY 10019, is a company of PIMCO.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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