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Strategy OverviewMany investors are searching for sources of additional return without systematic exposure to stock and bond markets and they are looking to investment managers with proven expertise, substantial risk management resources, and a time-tested investment process. Motivations to search for attractive absolute / excess returns include the desire to transport returns to other, more efficient markets as well as desires for superior standalone absolute return investments. PIMCO offers the “PARS” investment approach which we believe will appeal to investors searching for consistent, reliable sources of return / excess return.
PIMCO Absolute Return Strategy (PARS) is a unique and innovative investment approach that captures PIMCO’s investment process in a substantially unconstrained framework. PARS expands the traditional investment toolkit by using short derivatives and prudent amounts of leverage to express PIMCO’s investment ideas and isolate desired exposures from unwanted risks in an effort to exploit anomalies and capture value in global fixed income markets. Investors can select from four different PARS strategy variations that best meet their risk and return preferences.
We believe that using multiple sources of value added in PARS is an outstanding way to seek to produce consistent excess returns. PIMCO implements a large number of diversified strategies and does not rely on only one type of strategy or one sector of the market to help add value. PIMCO utilizes its expertise in a wide range of areas in an attempt to add value.
PIMCO Absolute Return Strategies seek to produce absolute returns by expressing PIMCO’s investment ideas in portfolios that are not tied to traditional investment benchmarks. These strategies, subject to a suitable set of investment guidelines, permit shorting of individual securities, and the prudent use of leverage and derivatives. Portfolio positions are driven both by the firm’s top-down, macroeconomic investment research process and by bottom-up relative value thinking by portfolio managers who specialize in particular sectors of the global fixed income markets. Portfolio Managers diversify investment portfolios across a broad array of risk factors and they employ a significant number of security specific strategies.
PARS portfolios express the firm’s top-down investment process by magnifying the principal risk factor exposures of PIMCO Total Return and Global bond portfolios. Positioning the PARS portfolios in this way allows the strategy portfolios to express PIMCO’s investment ideas but without undesired benchmark risks. Benchmark risks, in the context of a broad bond market index, include continuous long exposure to interest rates, credit, mortgages and other issues that may or may not be attractive at any moment in time.
PIMCO’s cyclical and secular economic forums drive the top-down element of the firm’s investment process which begins with an annual Secular Forum in which investment professionals from all of our global offices convene for three days. During this time, leading industry experts are invited to give presentations on various global economic and financial topics. These presentations are followed by discussions among PIMCO’s Investment Professionals regarding the outlook for the global economy and interest rates over the next three to five years. At the completion of the discussions, the Investment Professionals collectively determine a bullish, neutral or bearish outlook. In addition to the secular three to five year horizon, PIMCO’s Investment Professionals hold quarterly Economic Forums to discuss near term trends and to establish a cyclical outlook. These outlooks are considered by the Portfolio Management group in a separate quarterly meeting to translate global economic themes and specific views on market conditions and relative value into interest rate, sector, quality, and volatility strategies.
Magnifying the risk factor exposures as expressed in the firm’s Total Return and Global portfolios generate approximately 60% to 70% of a PARS portfolio’s potential excess returns over a floating rate base of reference (such as LIBOR).
Our investment process can be thought of as an alpha transport exercise in which the firm’s core fixed- income portfolio’s alpha with respect to the Barclays Capital U.S. Aggregate Market Index is transported to LIBOR space. The remainder of Absolute Return Strategy portfolios’ excess returns should derive from their ability to take advantage of comparatively unrestrictive guidelines and to express those risk factors using the ideal securities or instruments. Other sources of the remaining excess returns will sometimes include quasi-relative value strategies that rely on overlay-style related positions to mitigate certain macro risks. These positions are often generated by interaction of the Absolute Return Strategy portfolio managers and the individual specialist portfolio managers.
Because PARS portfolios are designed to leverage the Firm’s ability to generate alpha in core fixed income portfolios, investors benefit from PIMCO’s over 35 years of experience. The PARS investment process is specifically tailored to incorporate these sources of incremental return.
Broadly speaking, three types of “top-down” approaches include (1) over- and under-weighting macro factors, which include yield level, yield curve slope, country spread and currency; (2) tactical allocations to and away from credit, Treasury Inflation-Protected Securities (TIPS), municipal bonds, interest rate swap spreads and mortgages (3) structural positions, which include sales of interest rate volatility (either through the purchase of mortgage securities or from the outright sale of options), underweight positions in US Treasury securities and overweights to Treasury bond futures, long positions at the short end of the yield curve which may benefit from attractive yield, roll down and volatility characteristics.
No Single Strategy Dominates Risk
The Absolute Return Strategy integrates the full opportunity set of PIMCO’s investment ideas across the globe using multiple sources of value-added. The strategy capitalizes on a diversified set of exposures and investment strategies hinged on our expertise across local markets and depth of sector knowledge. This active, multi-market strategy executed by prudent investment management may help reduce the overall volatility of returns in the strategy.
Low Correlation to Traditional Asset Classes
By owning a highly diversified set of assets, the Absolute Return Strategy demonstrates low correlation to traditional asset classes such as bonds and stocks. The strategy can provide significant diversification benefit for the investor.
Lack of Benchmark Constraints May Help Optimize Return/Risk
The Absolute Return Strategy is detached from a traditional benchmark index, allowing the strategy flexibility in identifying and implementing the most optimum investment strategies.
With this separation of index weights and other constraints, the Absolute Return Strategy is not subject to factor exposures that might underperform on an absolute basis and instead can take advantage of differences in regional economic cycles, growth trajectories, and relative valuations with sectors.
Various Return/Risk Versions Available
Several versions of the Absolute Return Strategy are available with similar overall exposures but different only in risk/return targets. This allows the investors to best match their risk/return preferences with the version closest to their profile. All versions take advantage of the same portfolio management expertise, global resources, implementation and execution, and risk control systems in place at PIMCO.
Control Risk to Limit Volatility
A broad diversification of investment strategies helps limit the reliance on a single strategy to add alpha. Instead, the exposures of the Absolute Return Strategy are consistent with Total Return and Global portfolios, scaled only by leverage, but without any imperative to track a broad market index. The high average credit quality maintained and limited duration and currency exposure all help to control risk in the Absolute Return Strategy. In addition, the strategy is managed to a target tracking error to help reduce volatility.
Transparency and Proactive Reporting
We have clearly defined checks and balances to provide reasonable assurance that all risk exposures are handled in an appropriate manner. Advanced proprietary analytics allow us to model securities under a multitude of scenarios and we have dedicated a substantial amount of resources to monitoring both financial and operational risk.
Commitment to Advanced Risk Management Technology
By virtue of our size, PIMCO is able to commit significant human and financial resources to the development of advanced risk management systems. We use advanced proprietary quantitative tools to both measure and monitor risks such as leverage. The use of leverage, in particular, requires careful risk assessment and sophisticated management tools. These models include our Tracking Error Model, the integrated Position Blotter system, the Global Relative Value report and a variety of customized risk reports also are employed to determine which strategies are adding value and which need to be modified. Extensive use of analytical models allows us to employ investment professionals more effectively and provides a dispassionate check on investment decisions.
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. Inflationlinked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. Government. U.S. Government securities are backed by the full faith of the government; portfolios that invest in them are not guaranteed and will fluctuate in value. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor there is no assurance that the guarantor will meet its 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. Swaps are a type of derivative; while some swaps trade through a clearinghouse there is generally no central exchange or market for swap transactions and therefore they tend to be less liquid than exchange-traded instruments. There is no assurance when investing in short sales that the security necessary to cover a short position will be available. The use of leverage may cause a portfolio to liquidate positions when it may not be advantageous to do so to satisfy its obligations or to meet segregation requirements. Leverage, including borrowing, may cause a portfolio to be more volatile than if the portfolio had not been leveraged. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Diversification does not ensure against loss.
Barclays Capital U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. 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. ©2014, PIMCO.
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