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What is StocksPLUS®?StocksPLUS, a unique and innovative equity management strategy introduced by PIMCO in 1986, is designed to outperform a given benchmark equity index and, at the same time, provide a very similar risk level to that of the benchmark. Typically referred to as an “enhanced index” strategy, StocksPLUS seeks to provide the best of what passive indexing and active management each attempt to deliver.
Similar to most passive index strategies, the equity market exposure in a StocksPLUS portfolio is designed to be identical to that of the benchmark index. However, unlike passive index strategies, StocksPLUS endeavors to provide investors with excess returns.
What makes StocksPLUS unique? The strategy combines PIMCO’s expertise in global fixed-income management with the merits of its “best-of-both worlds” construction, which entails obtaining the equity exposure via derivatives that are collateralized by a fixed income portfolio. Because the fixed income portfolio tends to have both a low correlation to equities and a focus on capital preservation, the combination gives StocksPLUS the potential to mitigate the volatility of the equity exposure amid changing market conditions.
In some cases, total return swaps may provide a largely equivalent way to obtain equity exposure. Both total return index swaps and index futures contracts generally require very little or no cash required at the time the equity exposure is obtained and the investor subsequently receives the total return of the equity index in exchange for the payment of a money market based interest rate (generally LIBOR +/- a spread).
We believe that there are at least four structurally based yield premiums that are available in the vast majority of market environments:
In our view, the most efficient duration management strategy involves at least a modest extension of duration beyond the average time to expiration of the most liquid equity index futures contracts in order to capture the term premium offered by the positively sloped shape of the yield curve under normal market conditions. Except in extreme cases, the higher yield obtained through duration extension and active management may offset any potential decline in the prices of our fixed income holdings due to rising interest rates over periods of reasonable length. Additionally, as we limit our portfolio duration to one year, we seek to avoid excessive sensitivity of StocksPLUS returns to changes in interest rates.
In addition, rather than invest the entire portfolio backing the equity futures in money market instruments, we believe that a portion of a StocksPLUS portfolio should be invested in higher-yielding, slightly less liquid (than money markets) securities, given a long-term investment horizon. These issues tend to earn a higher yield due to their lower trading liquidity. However, because our holdings are generally short-term issues, they are mostly self-liquidating. Thus, market participants who actively trade these bonds, in effect, subsidize PIMCO’s clients who act as long-term holders via StocksPLUS. Importantly, we generally maintain a significant portion of the portfolio in securities we feel can be liquidated quickly at a moderate cost, in an effort to ensure sufficient liquidity to meet margin flows even in a dramatic stock market decline.
Another potential source of value added in StocksPLUS portfolios is obtained by investing a portion of the portfolio in corporate fixed income, asset-backed, and other securities to capture both yield and diversification benefits. Effective use of these securities adds return potential to the portfolio with relatively modest incremental credit risk, given the short-term nature of the majority of these holdings. While PIMCO primarily focuses on the investment grade segment of the corporate bond market and intends to maintain a minimum portfolio credit quality of B to Aaa, we may invest up to 10% of assets in below Baa securities in Full Authority StocksPLUS portfolios.
An additional source of extra potential return in StocksPLUS portfolios is provided by the market in the form of a volatility premium. Investors typically overpay for price stability as demonstrated by the fact that implied market volatility is generally higher than actual realized volatility. Therefore, by effectively selling a volatility hedge PIMCO seeks to exploit this market inefficiency and capture the underlying premium for StocksPLUS portfolios. An example of a strategy that is consistently employed in StocksPLUS portfolios to capture this volatility premium includes buying and holding mortgage-backed securities.
In addition to the structural sources of potential excess returns in StocksPLUS portfolios, we believe that our active fixed income skill set is key to success in the StocksPLUS strategy – a skill set which we have carefully honed over our nearly four decade history as a fixed income manager.
PIMCO’s active fixed income management skill set and broad market coverage together with the aforementioned yield premiums made possible by long-term holding periods of our investors add up to a wide variety of opportunities for PIMCO to add value.
Past performance is not a guarantee or 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 non-U.S. securities involves heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally backed 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. 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. 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.
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, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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