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PIMCO’s Bank Loan universe includes primarily the upper tiers of the U.S. bank loan market that are mainly secured by first-lien asset obligations. We believe first-liens are better compensated due to their underlying asset quality and liquidity. We do take exposure to second-lien debt, albeit at much more modest levels, when valuations relative to associated risks merit investment.
As with all PIMCO’s fixed income product offerings, we take a moderate approach with respect to risk in our bank loan portfolios. Our philosophy is characterized by three key principles: 1) higher-quality focus; 2) diversification and 3) focus on improving credits.
Quality Focus – One of the most distinctive elements of PIMCO’s style is our focus on the upper-quality tiers of the bank loan market. While the strategy may only invest in securities that are rated at least Caa by Moody’s, or equivalently rated by S&P or Fitch or another NRSRO, or if unrated determined by PIMCO to be of comparable quality, we generally restrict our holdings to issuers rated B−/B3 and above and typically maintain a BB average quality. We feel the best risk-adjusted returns are offered by B+ and BB− bank loans. The strategy will maintain a minimum average credit quality of B. This approach distinguishes us from bank loan managers who venture into CCC and defaulted issuers, and often maintain a lower average quality. Another manifestation of our higher quality orientation is our focus on asset coverage. We favor credits where loans constitute a relatively small percentage of the capital structure relative to the assets owned by the company.
We believe that our higher-quality focus serves to benefit our clients, especially in a market environment characterized by both deteriorating fundamental credit quality and indiscriminate selling in the marketplace.
Diversify Exposure – PIMCO takes a disciplined approach to diversification of bank loan portfolios. We generally limit exposure in individual issuers to less than 3% and industry concentration to 15%. Although we may feel higher exposures could enhance relative performance from time to time.
Focus on Identifying both Weakening and Improving Credits – PIMCO’s first priority is to avoid the downside scenarios in credit. We believe by identifying and avoiding credits with weakening fundamentals, we can best protect our clients’ principal. At the same time, we use our forward-looking investment process to identify credits with improving fundamentals. The end goal of our process is to maximize total return, or the combination of current yield and price change, by focusing on issuers that we believe have good prospects for price appreciation due to improving credit fundamentals. Identifying these issues combines credit research, industry analysis and macroeconomic forecasting. In our global business cycle forecasting process, we formulate strategies for average portfolio quality and cyclical vs. non-cyclical industries. We then launch intensive industry-specific research in an attempt to identify industries whose ability to generate profits and cash flow are improving.
Our loan selection process finishes with thorough, traditional, fundamental credit research on companies within the industries we find attractive. All companies considered for purchase are visited by one of our analysts. In addition to discussing financial matters, longer-term strategic plans, asset valuation and ultimate liquidity of collateral, we also focus on character of management.
Individual issue selection is also enhanced by an analysis of structural features and covenants. It is PIMCO’s experience that a loan’s position within the corporate structure of a company has a substantial effect on the value of that loan. For example, a loan to a holding company can often be less desirable than a loan to a subsidiary with collateral assets such as machinery or property.
High yield securities are subject to greater levels of credit risk and liquidity risk than other securities. High yield bonds are considered predominately speculative with respect to the issuer’s continuing ability to make principal payments. An economic downturn or period of risk aversion could adversely affect the market for high yield debt and reduce an investor’s ability to sell its securities.
In addition to PIMCO’s disciplined approach to fundamental credit research, extensive analytical tools are used to measure and monitor the risk characteristics of the portfolio. PIMCO has invested considerable resources in developing proprietary models and analytical tools that enable a robust approach to risk management. These tools are important in managing credit strategies as their flexibility facilitates analysis at the regional, sector and security level. These models include our Bonds Under Management report, which provides an extensive summary of portfolio holdings and portfolio-level risk characteristics. Additionally, the PIMCO Position Blotter system provides risk and portfolio structure information, allowing for the aggregation of detailed security-level information into a variety of risk matrices including sector and issuer exposure by quality and duration bucket.
Extensive use of analytical tools allows us to maximize the value of our investment professionals and provides a dispassionate check on our investment decisions. These systems also augment our understanding of the strategies that have consistently added value to our clients’ 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 certain risks including market, interest-rate, issuer, credit, and inflation risk. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. Bank loans are often less liquid than other types of debt instruments. Some debt instruments may include senior and subordinated and secured and unsecured debt obligations (including investments in the senior, subordinate, hybrid debt instruments, and Collateralized Debt Obligations or CDOs and Collateralized Loan Obligations or CLOs). General market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. 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. PIMCO strategies utilize derivatives which 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. There is no guarantee that these investment strategies will work under all market conditions and each investor should evaluate their ability to invest for a long-term especially during periods of downturn in the market. Diversification does not ensure against loss.
This material contains the current opinions of the manager 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.
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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