Strategy Overview
Investors need to meet two key investment objectives in the post-financial crisis era:
- Hedge against future inflation risks, recognizing that potential inflationary pressures are mounting
- Generate an adequate level of portfolio income, recognizing that it will likely provide a critical component of total return.
Traditional allocation responses have historically offered contradictory investment benefits. While Treasury Inflation-Protected Securities (TIPS) provide a contractual link to inflation, the yields on these instruments are historically lower than those of other fixed income securities. Credit markets, such as investment grade corporate bonds, have historically offered investors an incremental yield pick-up relative to comparable-maturity government bonds albeit without the typical benefits associated with government bonds. However, given most credit instruments are issued without a contractual inflation link, their ability to help investors meet liabilities in real terms, after adjusting for inflation, may be limited during periods of high or rising inflation.
PIMCO’s CreditRealReturn strategy provides investors with a simple portfolio structure that helps investors meet dual investment objectives. It seeks to offer a higher yielding alternative for hedging against secular inflationary risks by integrating the inflation-protection of TIPS with the high quality yield premium typically associated with investment grade credit. Thus, PIMCO’s CreditRealReturn is designed to allow investors to hedge future inflation risks and get adequate compensation in the meantime.
| Applications for the Inflation-Linked Credit Strategy |
An allocation to the PIMCO CreditRealReturn strategy offers several potential benefits: - An inflation-linked bond substitute that seeks to deliver a higher effective real yield
- A corporate bond substitute with a re-flationary bias
- Traditional corporate bonds have a dis-inflationary bias since they are priced off fixed-rate Treasuries
- A liability-driven investment (LDI) solution for investors with:
- Real liabilities that are discounted at a corporate rate (i.e., active defined benefit plans)
- Nominal liabilities given a view of rising rates due to inflation expectations (i.e., frozen or inactive defined benefit plans)
- Real liabilities that grow faster than inflation (i.e., medical inflation)
- Real return diversification objectives in addition to higher total return targets (i.e., public plans)
|
| Sources of Added Value |
The Portfolio Structure
The simplicity and liquidity of PIMCO’s CreditRealReturn strategy is the primary source of value added for investors. By matching every dollar invested in the TIPS market with the yield spread offered by the investment grade corporate bonds, CreditRealReturn helps provide better capital efficiency than making two separate allocations to TIPS and to investment grade credit.
Overlay Management
Through our dedicated resources and our extensive experience in managing both synthetic credit instruments and overlay portfolios, the synthetic credit index overlay component of PIMCO’s CreditRealReturn strategy will benefit from numerous sources of added value, including:
- Index roll
- On-the-run vs. off-the-run
- Curve and tranche relative value
- Single name credit risk hedges
TIPS Collateral Management
We have committed substantial analytical resources to valuing global real return bonds and to assessing relative values between real return bonds and conventional debt. In our efforts to achieve value-added results, we actively apply the following strategies:
- Duration, curve, break-even inflation
- Country rotation
- “Bottom-up” inflation-linked bond relative value
|
| Risk Management/Controls |
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. |