Article Main Body
PIMCO’s Short-Term Strategy is designed to improve on the return provided by a typical money market vehicle. The Short-Term Strategy seeks to maximize current income while preserving capital and providing daily liquidity by investing in money market and short maturity fixed income securities. It differs from traditional money market strategies because it invests in longer maturities and a broader opportunity set of securities which may generate excess relative returns with only a modest increase in risk compared to traditional money market instruments.
The PIMCO Short-Term strategy seeks to generate a high level of current income, liquidity, and preservation of principal by investing in high quality, short-term securities. The Short-Term strategy benefits from our unique capabilities in economic forecasting, Federal Reserve Bank knowledge, and fixed income trading.
| PIMCO’s Short-Term Experience |
Short-Term investments have formed the foundation of PIMCO’s total return performance record.
- PIMCO began managing dedicated short-term accounts in 1986
- A dedicated team of portfolio managers with over 20 years of investment experience forms the firm’s overall short term strategy
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| Applications for Short-Term Strategy |
PIMCO’s Short-Term strategy has a wide variety of practical applications. The strategy is designed for investors looking to outperform traditional money market vehicles while limiting risk. It is an ideal investment for liquid asset pools such as:
- Defined contribution plans
- Pension and operating cash
- Insurance reserves
- Securities Lending Cash Collateral
Practical applications are:
- Strategic alternative to “cash” investments with minimal price variation focus
- Supplement the less liquid portion of a “cash” allocation with enhanced return potential over cash
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| Investment Philosophy and Sources of Added Value |
By combining a longer term investment horizon with our expertise in managing fixed income portfolios, we are not limited to holding only very short-term assets such as Treasury bills or other money market instruments. In addition, the Short-Term strategy might invest a very modest portion of the portfolio in global securities issued outside of the U.S. and can have non-U.S. dollar currency exposure.
As a result, we are able to expand our opportunity set to include a variety of high quality securities that may provide attractive yields and the benefit of diversification.
Relative to a money market fund index, which includes strategies that have maturities restricted to an average of 60 days, provide daily liquidity, are almost always rated at the highest credit level, and have very stable prices, the potential excess return of PIMCO’s Short-Term strategy derives from four main sources:
1. The term premium (upward slope in the shape of the yield curve)
2. The transactional liquidity premium (yield which compensates an investor for holding bonds with wider bid/ask spreads)
3. The credit premium
4. The volatility premium
We believe that the most efficient duration management strategy involves a modest extension of duration beyond the average maturity of money market strategies in an effort to capture the term premium offered by the positively sloped yield curve under normal market conditions. Except in extreme cases, the higher yield obtained through duration extension and active management should offset any potential decline in price of the fixed income portfolio due to rising interest rates. Additionally, we limit our portfolio duration to a small range around the index, which should avoid excessive sensitivity to changes in interest rates.
The transactional liquidity premium is another structural source of excess return potential. A portion of the fixed income portfolio can be invested in higher-yielding, slightly less liquid securities such as Collateralized Mortgage Obligations (CMO), corporate notes, and other securities. These issues earn a higher yield due to their lower trading liquidity. However, because the securities in this category are short in duration, they are mostly self-liquidating. Thus, market participants who actively trade these bonds in effect subsidize PIMCO’s clients who act as long-term investors.
Another tool for adding potential value is the credit premium obtained by investing a portion of the portfolio in securities rated below AAA in an attempt to capture both yield and diversification benefits. Effective use of securities such as those offered in the corporate sector may add return with little incremental risk from spread widening (basis risk), given the modest duration of these holdings. While we primarily focus on the investment grade segment of the corporate bond market, we do invest a small portion of the portfolio in below-investment-grade securities.
Importantly, while PIMCO attempts to mitigate basis risk by focusing on short duration, high quality assets, the modest credit risk in a short-term portfolio acts to diversify the interest rate or duration risk. This is because an environment of rising short-term rates, where duration exposure would impose a cost on the portfolio, would most likely occur in a strong economic environment when credit risk was diminishing and corporate yield spreads would likely be narrowing. As a result, the use of short duration corporate credits generally offsets the exposure to rising interest rates and further diversifies overall portfolio risk.
An additional source of potential value-added is the market’s volatility premium. Investors typically overpay for price stability as demonstrated by the fact that implied short-term market volatility is generally higher than actual realized volatility. Therefore, by effectively selling price volatility PIMCO may be able to exploit this market inefficiency and capture the yield premium for short-term portfolios. One of the ways in which we attempt to capture the volatility premium is by purchasing mortgage-backed securities.
An expanded investment opportunity set, and more specifically these four risk premiums, add up to a wide variety of opportunities to add value given our broad fixed-income market expertise and the longer term holding periods of our investors.
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| Risk Management /Controls |
Risk management has been a major concern at PIMCO since our inception in 1971. As new technologies and financial instruments develop, we strive to ensure that our risk management procedures remain effective and that we stay ahead of our competition. We dedicate significant financial and intellectual resources to address risk management.
We feel risk manifests itself in two main forms – investment and operational. Effective investment risk management begins with the identification of a client’s objectives and risk tolerance. From there, a set of appropriate investment guidelines and effective risk measures are developed. Advanced proprietary analytics allow us to model securities under a multitude of scenarios including best and worst cases. We believe the decision to hold a security is just as important as the decision to buy. As a result, portfolio holdings are priced and re-evaluated on a regular basis. Operational risk is equally as important as investment risk.
Operational risk deals with problems or errors that may arise during day-to-day operations of the firm. Our organizational structure is designed to cope with this organizational risk. This is accomplished by segregating responsibilities for portfolio management, account management, and investment support monitored by an independent compliance group. At PIMCO, we have embraced this methodology from our inception and it has benefited both our clients and the organization as a whole. Our system has clearly defined checks and balances to provide reasonable assurance that all risk exposures are handled in an appropriate manner. |
Article Disclaimer
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. A Collateralized Mortgage Obligation (CMO) is a multi-class debt instrument backed by a pool of mortgage pass-through securities or mortgage loans. Investments in CMOs may involve a high degree of risk. 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. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. 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 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. Diversification does not ensure against loss.
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.
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