Strategy Overview
The 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.
| Applications for the Mortgage LIBOR Plus Strategy |
| The Mortgage LIBOR Plus strategy can serve as a vehicle for investors looking to benefit from PIMCO's active Agency MBS coupon relative value strategies without taking the full duration exposure of a dedicated mortgage portfolio. The strategy employs long/short positions in the high-quality and liquid Agency MBS market in an attempt to take advantage of mispricings between coupons. |
| Investment Philosophy and Sources of Added Value |
Agency MBS have been tremendously liquid, frequently mispriced, and have exhibited robust mean reversion to fair value.
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. |
| Risk Management/Controls |
| Active MBS portfolio management requires a significant investment in analytics and risk management infrastructure. PIMCO has always devoted substantial resources to our proprietary mortgage analytics platform and has developed a full set of specialized tools. Our analytic arsenal includes two term structure models (Brace, Gatarek, Musiela and Black, Derman, Toy) as well as our proprietary PIMCO mortgage prepayment model.
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.
Our substantial analytics capabilities provide portfolio managers with the best possible platform for the complexities of MBS risk management. |