PIMCO recently introduced the PIMCO Credit Absolute Return Strategy, a global approach to credit with a focus on generating attractive absolute returns in a variety of market environments. It also seeks to provide the flexibility to adjust portfolio risk exposure to reflect the company’s macro outlook as well as intelligence gathered by the credit team. In the following interview, portfolio manager Mark Kiesel discusses the strategy’s investment process, the outlook for credit markets and how the strategy seeks a concentrated expression of PIMCO’s top credit ideas without the constraint of a credit benchmark index.
Q. What is the PIMCO Credit Absolute Return Strategy?
Kiesel: The strategy offers long and short exposure across multiple global credit sectors in order to target absolute returns. It’s designed for investors who want exposure to credit with greater flexibility than a traditional benchmark-constrained approach.
I view this as a highly focused, “top-picks” global strategy, with strong conviction backing each and every position. As a result, where another strategy might contain 100 to 150 issuers, we may hold half that total, but they would represent what we believe are the most attractive global credit opportunities available at a given time.
Q. Why introduce this strategy now?
Kiesel: Since the strategy is focused on positive returns irrespective of the market environment, it may appeal to many types of investors over the long term. That said, amid current macro trends, we see heightened opportunities for investors to potentially benefit from a global, flexible approach to credit across the quality spectrum. PIMCO’s New Normal world view includes headwinds to growth in advanced economies, but we also see pockets of strength. So while we are seeing general deterioration in sovereign debt quality, we believe many corporate balance sheets are quite healthy.
In the U.S., for example, the private sector of the economy continues to deleverage and interest rates are low and have recently declined. While earnings growth has been slowing amid subpar economic growth in the developed world, we believe many multinational companies have the potential to do well due to strong balance sheets and significant exposure to emerging markets. Many companies in the energy, metals, oil field services and certain resource sectors and even some global auto companies have generally seen a significant turnaround since the recession. A variety of businesses have cut costs and enjoyed improved pricing power. For example, airlines have experienced double-digit increases in revenue per passenger mile (over the year ended in July 2011), and apartment real estate investment trusts have been raising rents. Luxury and strong brands have been outperforming vs. lower-end ones with help from healthy balance sheets and rising wealth in emerging markets.
We see potential for significant volatility in financial markets, particularly with what is occurring in Europe and the U.S. as global imbalances and high private and public sector debt levels have been restraining growth. Yet, volatility can lead to opportunities, and we believe PIMCO’s veteran global credit team is well positioned to potentially capitalize when markets dislocate. This strategy gives us exceptionally wide discretion to identify, and take advantage of, relative value opportunities that we may find in bonds and other instruments denominated in various currencies.
And our ability to go short gives us additional tools designed to adjust portfolio risk, depending on our macro views. For example, if we are bearish on a sector, we could utilize credit default swaps with the goal of hedging or potentially profiting from underperformance in a specific industry or sectors we see at risk due to top-down macro-economic risk or bottom-up credit concerns. We also have a wide duration range, down to zero – which can help reduce the portfolio’s sensitivity to interest rate moves.
Q. How does the PIMCO Credit Absolute Return Strategy differ from long-only strategies or those that track a credit benchmark?
Kiesel: We are using our rigorous security selection process and macro outlook without the gravitational pull of a credit benchmark index. The strategy’s benchmark is the three-month London Interbank Offered Rate (LIBOR).
Indeed, this strategy follows the same general investment process – and is managed by the same team – that has been running PIMCO credit portfolios over the past decade. That forward-looking process has helped PIMCO identify opportunities across global credit markets and be agile in adjusting its risk profile in anticipation of shifting market risks and opportunities. With this strategy, we believe the alpha potential may be amplified by the flexible guidelines.
An example of anticipating risk: It is well documented that PIMCO was cautious on housing well before the downturn and either exited some related assets or took defensive positioning in others such as on home builders. At the time, the hedge positions on home builders were relatively cheap, and the spreads later widened significantly. So not only did PIMCO seek to become more defensive when we identified risk, but we also sought to utilize strategies designed to help clients benefit from wider spreads, leveraging our firm’s top-down and bottom-up research process.
While the strategy will focus on relative value and may take short positions, I want to emphasize that this it is not like a hedge fund; it is not a levered market neutral strategy. This strategy is designed to provide liquidity, transparency and an absolute-return oriented approach to investing in bonds and other credit instruments. However, some clients may view the strategy as a “light” version of a hedge fund strategy given its objective of delivering positive returns across various market environments and its unconstrained approach to investing in global credit markets.
Q. How does PIMCO’s macro investment process inform this strategy?
Kiesel: A key differentiator for PIMCO is the consistency of our long-term approach to investing in credit for our clients. We have a disciplined process in which investment professionals from across the company’s 11 global offices meet annually at our Secular Forum to chart out likely economic scenarios over the next three to five years, and we update our outlook with quarterly meetings to evaluate and refine our findings.
The global macro view from these forums helps identify in which countries we see conditions favorable to companies, as well as which industries may outperform or underperform. For example, we continue to forecast healthy economic growth in emerging markets, and we expect that companies with exposure to those markets may be poised to outperform over a secular horizon.
Further, our macro views inform our risk management by identifying regions and sectors facing economic, political or other headwinds.
Q. Could you elaborate on how you typically allocate between bonds and other financial instruments? How are you approaching security selection?
Kiesel: The best way to explain this is to walk readers through our global credit investment process.
Each month our global team of 43 credit analysts and 30 credit portfolio managers (as of June 30, 2011) produce their top picks. I manage the process, meeting with the team about 10 days before month end.
Our top credit picks must pass three tests:
- Our top-down macro screen, in which we set parameters for choosing countries and industries we think are most attractive
- Our bottom-up screen, in which we select what we deem to be the strongest companies in those favorable countries and industries
- A valuation test, in which we choose what we believe are the most attractively priced vehicles for exposure to the companies we favor. These vehicles may include bonds, floating-rate loans and credit default swaps.
That third and final screen seeks to accomplish two things. It seeks to answer the question of where we want to be in the capital structure, and it is an overall guide to allocation. When we arrive at that third test we are essentially comparing securities across the globe, deciding which have the highest relative value, whether it is a floating-rate loan issued by Company A or a fixed-rate bond issued by Company B. Our allocations of loans vs. bonds vs. other instruments will result from the sum of these relative value comparisons. In terms of scaling our overall risk, our largest allocations will be our highest conviction ideas that pass these screens.
Q. Could you elaborate on how you select specific companies? How do you build conviction?
Kiesel: Sure. In addition to the extensive numbers crunching PIMCO performs on companies, we engage in face-to-face meetings with corporate executives all over the globe. PIMCO has extensive resources throughout the investment management industry, with 73 bottom-up credit investment professionals who travel around the world in teams of three, four or five to meet with management, do on-site tours, physically inspect the assets, understand the business models and put all the pieces together.
We also meet with government officials, including regulators and monetary policy authorities. These are people in charge of monitoring and sometimes shaping industries over the next three to 10 years – for example, ministers of energy and resources in countries such as Russia and Brazil.
Ultimately, our strong conviction stems from how all these inputs are vetted by the highly experienced global corporate bond portfolio management and credit team. We have analysts that have been covering companies for 20 to 30 years. Many of our corporate bond portfolio managers and credit traders remain credit specialists their entire careers. I, for example, have been at the company for 15 years, all but two of which have been focused on credit, as an analyst, trader and portfolio manager. I firmly believe that this depth of collective experience and knowledge helps PIMCO deliver on our commitment to our clients.
Thank you, Mark.