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What is PIMCO’s Long Duration Credit Strategy?
PIMCO’s long duration credit portfolios are primarily composed of long-term investment grade credit fixed income securities and seek to maximize total return, consistent with the preservation of capital and prudent investment management. The strategy utilizes a disciplined approach in the credit selection process and focuses on credits demonstrating solid or improving fundamentals, as issuer and industry decisions will contribute meaningfully to the performance of the product. In addition to long-term corporate bonds, the credit universe includes long-term investment grade sovereign bonds, as well as supranational issuers. While macroeconomic strategies that influence duration, sector and industry decisions are important, bottom-up security selection will most likely be the primary driver of long-term performance.
Global fixed income markets provide a rich opportunity set to an experienced manager capable of identifying and implementing both top-down and bottom-up investment strategies. PIMCO is a leader in global credit markets, having used investment grade corporate bonds as a key component of our investment strategy for core fixed income portfolios since 1971. We have an experienced team of investment grade credit portfolio managers and industry-focused credit analysts.
Credit Portfolio Management Research Platform Drives Security Selection – PIMCO’s global organizational structure is uniquely positioned to capture the broad set of investment opportunities within the global credit markets. The portfolio management team structure is organized by region to capture opportunities among issuers domiciled in North America, Europe and Asia. The credit research function is organized by region and industry, rather than credit quality rating. This structure allows PIMCO to focus an analyst’s experience and expertise within a small set of industries.
PIMCO’s Top-Down Investment Process Anchors Relative Value Assessment – PIMCO’s proven investment process takes a disciplined approach to evaluating global macroeconomic developments and prospective trends in interest rates and relative sector performance. This process is anchored by PIMCO’s secular and cyclical forum process, where all of the firm’s investment professionals from around the globe come together to develop a medium- to long-term outlook for the global economy. This process provides the framework for the regional and sector analyses that are integral to the investment decisions within the global investment grade credit strategy.
The primary application for PIMCO’s investors is to use long duration credit portfolios to closely match the interest rate sensitivity of long-dated liabilities. Because pension liabilities valuation is often based on high quality corporate rates, long duration corporate bonds will generally provide the closest match to liabilities. Indeed, unlike long Treasuries or swaps, long credit bonds are sensitive to both Treasury rates and credit spreads, consistent with most pension liability valuation methodologies.
PIMCO’s recommended approach begins by systematically analyzing liability cash flows – usually in consultation with the client and client’s consultant or actuary. The objective is to understand how the present value of the cash flow stream responds to a wide variety of potential changes in the yield curve and spread curve. Within the scope of client guidelines, the asset portfolio is constructed to take advantage of relative value opportunities among assets and other tactical opportunities afforded by the breadth of PIMCO’s market presence and expertise. Active portfolios are generally managed with the acknowledgment that the duration match may drift slightly from its target when the potential rewards make it worthwhile. The focus is on adding value within the appropriate risk constraints to minimize tracking error relative to the benchmark.
Many of PIMCO’s long duration credit clients have chosen duration matching with active management. In general, clients have considered the opportunity costs of the absolute matching required for total immunization to be high given the level and structure of the long end of the yield curve. An active strategy enables clients to take full advantage of PIMCO’s skills in active management.
Investors may also want to increase exposure to long duration credit assets because they historically have had a different return profile than intermediate maturity credit. In addition, investors may also assume more exposure to long duration credit to take maximum advantage of certain economic trends such as wide credit spreads, low inflation and moderate economic growth, which may provide heightened benefits to longer duration bonds.
We strive to produce consistent, above-benchmark returns by adding value through a broad range of investment strategies. The long credit strategy allows investors to make the strategic decision to invest in investment grade credit while placing the tactical sector, industry and issuer decisions with PIMCO, thereby optimizing exposure amid changing economic and market environments. Sophisticated proprietary software assists in the evaluation of sector opportunities and in the valuation of specific securities. Importantly, we limit risk taking by focusing on managing excess return versus tracking error, seeking to minimize the volatility of portfolios’ excess returns in relation to their benchmarks. Determining portfolio price sensitivities to curve twists and rotations, which do not involve simple parallel yield shifts, requires sophisticated management tools that can address how specific curve changes influence relative values across fixed income sectors.
PIMCO believes in continuous innovation and conservative execution. Our drive for innovation has resulted in the development of advanced proprietary analytics that have enhanced our understanding of security values and portfolio structure under a variety of interest rate and credit scenarios.
We have many tools specific to long duration credit and liability-driven accounts, including a proprietary tool, PIMCO Optimizer™, that improves our understanding of the risk characteristics of our clients’ liability profiles. PIMCO Optimizer™ enables us to develop and tailor customized benchmarks that reflect specific liability cash flow profiles and client objectives. This allows PIMCO to manage a portfolio more closely to a specific liability profile, instead of a market-based index, where necessitated by client requirements.
PIMCO’s global team of credit analysts addresses issuer selection utilizing four primary areas of analysis.
Country Analysis – Credit decisions begin with an analysis of the country’s underlying credit fundamentals and capacity for long-term economic growth. Those results are augmented with an analysis of the potential impact of external economic conditions and technical conditions of each country.
Corporate credits are then analyzed within the framework of the country analysis to identify and capture differences in the business cycles across countries.
Industry Analysis – Industry analysis represents another important aspect of the issuer selection process. The credit analysts and portfolio managers work together to identify industries that are undergoing structural or competitive changes that will affect profits and cash flow.
Company Analysis – Fundamental, company-specific credit analysis forms the most critical stage of our corporate credit research process. Our team of credit analysts is organized by industry in order to facilitate company evaluation across the ratings spectrum, providing for the identification of relative value opportunities within industries. For each company, the analysts assign a rating to identify the level of intrinsic credit risk, based on the company’s financial condition, the feasibility of its strategic plan and the quality of management, as well as other quantitative and qualitative factors.
Issue Analysis – PIMCO portfolio managers and credit analysts further compare all of the available issues for a given issuer to select the security that offers the best value. This analysis focuses on the valuation of each issue relative to its specific features, such as currency of issue, call risk, seniority within the capital structure and covenants.
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 long duration 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 efforts of our investment professionals and provides a dispassionate check on our investment decisions. These systems also augment our understanding of which strategies are consistently adding value to our clients’ portfolios.
PIMCO also limits interest rate risk by maintaining a portfolio’s duration within a moderate range around the benchmark’s duration. Operating within a moderate duration range may provide opportunities to add value relative to the benchmark.
We combine various measures in assessing the interest rate and credit risk to which a long credit portfolio may be subjected. Simple dollar duration does not fully encompass the various price sensitivities emanating from changing credit spreads, prepayment speeds and yield curve shifts. PIMCO has developed extensive internal modeling that addresses duration in its many forms: bull and bear durations (rate shifts of given amounts), total curve durations (changing yield curve shapes), credit spread durations, and mortgage spread and prepayment durations.
PIMCO systematically analyzes each security’s cash flows, using several valuation techniques and subjecting each valuation methodology to a series of stress tests to understand how a security will react under a broad range of interest rate scenarios. Combining this analytic process for multiple securities, PIMCO gains a full understanding of the risks inherent in a portfolio’s cash flow stream and how these risks affect value.
PIMCO also has extensive policies and procedures for managing derivatives and counterparty risk exposures. As derivatives can be useful tools for long duration portfolios when allowed by client guidelines, a solid platform for derivatives portfolio and risk management is essential. PIMCO has dedicated legal, operational, trading and risk management personnel with decades of combined experience on both the buy and sell side to oversee these important areas.
A portfolio of assets can be constructed to track expected liability values under a variety of interest rate scenarios. In concert with client guidance, assets are actively monitored versus liabilities to ensure that an intended hedge or fully immunized portfolio remains effective through time and that our active approach adds value while maintaining appropriate risk constraints.
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. 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. Sovereign securities are generally backed by the issuing government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. 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 There is no guarantee that this investment strategy 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.
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. ©2013, PIMCO.
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