Strategy OverviewThe Mortgage LIBOR Plus strategy aims to generate consistent excess returns over a LIBOR benchmark with limited volatility through active cash management and relative value strategies in mortgages, governments and derivative instruments. The strategy seeks to capture relative value through long/short strategies by opportunistically extracting value from structural and tactical market mispricings. These pricing anomalies stem from supply/demand imbalances, expectations in the interest rate environment and prepayment expectations.
PIMCO believes that actively managed exposure to Agency pass-throughs offers the lowest-volatility way to seek outperformance in a mortgage portfolio. As a result, PIMCO demands substantial yield premiums for illiquid securities and for securities that have significant modeling risk (we frequently demand more compensation than the market affords). Despite an emphasis on Agency pass-throughs, PIMCO’s mortgage investment process still looks to all segments of the vast mortgage-backed securities (MBS) market to add value. However, given the opportunity to generate alpha with the preferred liquidity and quality of the Agency pass-through market, we will not purchase non-index related securities in a portfolio unless we are confident in their potential for outperformance.
PIMCO’s goal in managing mortgage-backed securities is to generate consistent, long-term outperformance. To achieve that goal, we employ a unique approach to the MBS market that emphasizes actively managed exposure to Agency pass-throughs, which we believe offer the greatest potential for risk-adjusted excess returns in a mortgage portfolio.
While we focus primarily on pass-throughs, we also look for value and attractive risk-adjusted return opportunities in all segments of the larger MBS market. However, we believe the Agency pass-through market offers the greatest potential for alpha due to its outstanding liquidity and credit quality. Therefore, we frequently demand more yield for esoteric mortgage securities – collateralized mortgage obligations, interest-only strips, principal-only strips, etc. – than the market provides because we believe these instruments typically subtract liquidity and add more risk to a portfolio than can be justified by their spreads.
We believe Agency MBS offer the best opportunity for excess return in a mortgage portfolio. Our goal in managing MBS portfolios is consistent, repeatable, high-quality alpha.
PIMCO’s term structure models are tailored for LIBOR and swap rates, which are most consistent with the mechanics of the MBS market and the risk/valuation of securities in the sector. Our prepayment model incorporates historical behavior, stressing recent prepayment speeds, and is also sensitive to home price levels, which are a key driver of housing turnover. In addition, we compare our internally created term structure and prepayment model against publicly available Wall Street models daily. This side-by-side analysis is extremely useful in identifying securities with high model risk and also helps us to understand the possible range of outcomes for a security or a portfolio.
We also employ proprietary analytics to evaluate individual MBS with respect to their underlying characteristics, such as rate, type, servicer, loan balance, origination date, borrower quality, housing prices and spread to traditional loans at origination.
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. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. 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.LIBOR (London Interbank Offered Rate) is the rate banks charge each other for short-term Eurodollar loans. It is not possible to invest directly in an unmanaged index.
LIBOR (London Interbank Offered Rate) is the rate banks charge each other for short-term Eurodollar loans. It is not possible to invest directly in an unmanaged index.
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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