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Brett Gorman, Andrew Spottiswoode
The decline in interest rates to historically low levels has created challenges for capital preservation strategies in many defined contribution (DC) plans. Although these conservative investment strategies seek chiefly to avoid the loss of invested capital, money market funds (MMFs) today offer tiny nominal yields and negative real returns, and face the prospect of stricter SEC regulations next year. And, although the outlook for stable value has improved recently, some plan sponsors have chosen to exit such strategies.
As account manager Brett Gorman and product manager Andrew Spottiswoode explain below, the PIMCO Short Asset Investment Strategy – which has the potential to deliver returns higher than MMFs with less volatility than typical short-term bond strategies – offers an attractive capital preservation alternative.
Q: What is the PIMCO Short Asset Investment Strategy? Gorman: The PIMCO Short Asset Investment Strategy offers a more conservative version of PIMCO’s traditional short-term bond strategies. It seeks to manage both return and risk and provide a high quality and liquid capital preservation alternative.
Q: What is the thinking behind the strategy? Why did PIMCO launch it last year? Gorman: The Short Asset strategy was designed for DC plan sponsors and other conservative investors seeking alternatives to stable value and, especially, money market funds. Most sponsors are aware that stable value strategies have faced scarce capacity of investment contracts, or “wraps,” which provide an assurance of principal and interest. Largely unnoticed, however have been the challenges money market funds have experienced when used as capital preservation in DC.
Nominal money market fund yields have been near zero for years and, more importantly for many participants, real returns have been negative. Given that DC plans are long-term retirement savings vehicles, it is critical that capital preservation strategies do a better job at keeping pace with inflation.
Building and preserving long-term purchasing power is key to successful retirement outcomes. That’s why we think the Short Asset strategy is an attractive alternative with a compelling value proposition for sponsors and participants.
Q: How does the PIMCO Short Asset Investment Strategy compare with the flagship PIMCO Short-Term Strategy? Spottiswoode: Jerome Schneider is the lead manager on both strategies, and while they both hold a variety of fixed income securities with risk and return parameters slightly beyond traditional money market portfolios, the Short Asset strategy has more conservative investment guidelines that seek to minimize the number and magnitude of negative returns. We limit or prohibit certain fixed income sectors that tend to exhibit higher volatility in periods of financial stress. Specifically, the strategy eliminates currency and high yield exposure, and limits corporate and asset-backed exposures and derivatives use.
Q: Yet didn’t the financial crisis demonstrate that there are some short-term fixed income strategies, or “enhanced cash” approaches, which were volatile? Spottiswoode: There certainly were several actively managed enhanced cash products, marketed as “cash-like” alternatives that experienced substantial, some might say surprising, volatility. We believe that much of that volatility was driven by risky investments. Of course, plan sponsors should take care that the managers they select command the expertise to seek enhanced returns, but not by simply magnifying market risks.
The Short Asset strategy is different. PIMCO developed it specifically with the low volatility needs of DC participants in mind. The result is an enhanced cash strategy that seeks attractive returns with a focus on limiting the volatility typically associated with other short-term bond strategies.
Q: Unlike money market funds which seek a constant $1NAV, the Short Asset strategy will not have a stable valuation. What concerns should sponsors have in transitioning from a constant $1 to a variable NAV capital preservation option in a DC plan? Gorman: The Department of Labor (DOL) does not require the use of $1NAV products as a capital preservation option in a DC plan. So, generally, we think sponsors should rely on the basic guidance that the DOL has provided for fiduciaries when considering any type of DC investment option: i.e., have a prudent process to select investments appropriate for a plan’s objectives.
Of course, some sponsors may believe a $1NAV money market fund that seeks nominal principal preservation is sufficient. However, we believe it’s important to build a DC plan that provides for the best potential outcomes for participants. These are long-term retirement savings vehicles. Capital preservation strategies that do not generate returns close to or exceeding inflation gradually undermine participants’ ability to maintain the purchasing power of their retirement assets. In short, participants simply do not necessarily need – and it’s expensive to maintain – 100% principal stability, 100% of the time.
Q: What are PIMCO’s expectations for short-term rates? If they rise, would MMFs be relatively more attractive? Spottiswoode: PIMCO expects the fed funds rate will remain unchanged until early 2016, and it is likely that real yields of money funds will remain negative. Moreover, PIMCO believes that even when short-term rates eventually begin to rise, money market funds will simply not sufficiently help participants achieve their retirement savings objectives. Funds also may continue to confront technical factors limiting the supply of short-term securities, and the effects of SEC regulatory reforms, including those in 2010, which improved liquidity but also lowered expected returns. These issues will likewise affect other money-market-like alternatives that plan sponsors have considered, such as FDIC-insured deposit accounts or bank CDs.
Q: Is the PIMCO Short Asset Strategy only for defined contribution plans? Gorman: Not at all. Given the objectives and characteristics of the Short Asset strategy, we think it could be a solution for many conservative investors seeking a low volatility option with attractive return potential. The strategy may appeal to institutional investors, such as corporate or university treasurers, and others with a relatively conservative investment profile or looking for an alternative to cash investments.
*Enhanced cash refers to a short-term investment strategy. Short-term strategies are not federally guaranteed and may lose value
Past performance is not a guarantee or a reliable indicator of future results . Investing in the bond market is subject to certain risks, including market, interest rate, issuer, credit and inflation risk; investments may be worth more or less than the original cost when redeemed. Money Markets are not insured or guaranteed by the FDIC or any other government agency and although they seek to preserve the value of your investment at $1.00 per share, it is possible to lose money. 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. Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market liquidity. 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. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. The value of most bond strategies and fixed income securities are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and more volatile than securities with shorter durations; bond prices generally fall as interest rates rise.
PIMCO does not offer insurance guaranteed products or products that offer investments containing both securities and insurance features. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
This material contains the current opinions of the author but not necessarily those of 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. ©2013, 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, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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