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Strategy OverviewRecognizing that their liabilities often are in real (inflation-adjusted) terms, investors are seeing the need for inflation hedges. These “real return” products can also offer important diversification for a portfolio. PIMCO offers a broad range of real return products to meet investors’ needs:
Our ILB management extends to separate accounts having inflation-indexed benchmarks and to tactical allocations to client accounts with conventional benchmarks. Separate real return accounts include short-maturity, long-maturity, global, and leveraged assignments. Our ILB exposures also include global ILB allocations in many client separate accounts. We are able to apply our relative value framework and institutional research capabilities across the global fixed income markets in an attempt to add value through the use of ILBs. This is for strategic applications in separate real return portfolios and for tactical applications in conventional debt portfolios.
In analyzing non-U.S. real return issues, we use our global real return debt valuation models, incorporating currency-hedging costs, inflation expectations and forecasted monetary policy effectiveness. We have used limited allocations to U.S. corporate and agency ILBs, non-U.S. ILBs, and shorter-duration conventional debt in an attempt to enhance returns and manage duration for client portfolios.
These characteristics have provided opportunities for an improved efficient frontier.
TIPS have had relatively small return correlations across various asset classes. Thus, real return portfolios have the potential to enhance the risk-return trade-off for equity-debt portfolios. TIPS can be used effectively within a portfolio containing equities due to low absolute return volatility, small return correlations with equities, and the possibility of an active manager adding value.
TIPS have exhibited smaller return volatilities than similar maturity Treasuries. The smaller TIPS return volatility is a result of lower real yield volatilities. In turn, lower TIPS return volatilities require the use of effective duration as the standard of comparison between TIPS and similarly rated conventional debt, such as Treasuries. We derive TIPS effective durations by adjusting real yield durations by a “yield beta,” which incorporates the expected relationship between real yield and conventional yield movements. This yield beta will vary depending on where we are in the business cycle, but it is less than 1.0. This means that longer-term TIPS can be substituted for shorter-term Treasuries without changing the effective duration of the portfolio.
Low effective durations and price protection through inflation adjustments make TIPS a valuable asset class within a portfolio context. TIPS can be used more effectively than conventional bonds in customizing portfolio risk-return profiles.
Common portfolio risks and objectives can be actively and effectively managed using TIPS investments:
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. Inflation-linked 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. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. 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. 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. 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 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.
The Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics. There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time. 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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