PIMCO manages StocksPLUS Long Duration by combining synthetic equity index instruments, primarily index futures, with a long duration fixed income portfolio based on the Barclays Capital Long-Term Government/Credit Bond Index . Ownership of equity futures typically requires a 5% to 10% margin deposit, such that the remaining capital can be invested in a diversified fixed income portfolio. Because equity index futures contracts are priced such that a combination of futures and money market investments should produce a return equal to that of the equity index, if the fixed income portfolio outperforms money market rates, the portfolio should generate an incremental return over the equity index. Further, the bond portfolio may deliver excess returns which have a high correlation with interest rate sensitive liabilities. The synthetic equity index instruments capture the returns of the equity index, eliminating adverse stock selection risk. Combining these attributes, the StocksPLUS Long Duration strategy is designed to: - Deliver the return of the desired equity market index
- Over longer time frames, deliver attractive excess returns over equities with:
- High correlation of excess returns with interest rate sensitive liabilities
- Reduced tracking error to liabilities
- Strongest opportunity to outperform when liabilities are rising
- Increased excess return potential from active management of the long duration bond collateral
- Low correlation of excess returns with existing equity managers
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PIMCO’s long duration investment philosophy is an extension of the approach we have employed for over 30 years:
Long-Term Focus
Major shifts in portfolio strategy are driven by longer-term trends. Strategies are deployed with a macro view of the portfolio driven by 1) our secular outlook of the forces likely to influence the economy and financial markets over the next three to five years and 2) our cyclical views of one- to four-quarter trends. Through PIMCO’s annual secular forum, we forecast the global financial and economic outlook over the next three to five years, and assess their impact on the fixed income markets. Our investment process utilizes both “top-down” and “bottom-up” strategies. Top-down strategies focus on duration, yield curve positioning, volatility, and sector rotation. Bottom-up strategies drive our security selection process and facilitate the identification and analysis of undervalued securities. Here, we employ advanced proprietary analytics and expertise in all major fixed income sectors. By combining perspectives from both the portfolio and security levels, we attempt to consistently add value over time. Our fundamental objective is to maintain levels of risk that are tailored to the needs of our clients. This objective is to achieve a profile that has both acceptable levels of portfolio risk and risk that is consistent with that of portfolio benchmarks.
Active Management
The Long Duration portfolio construction process is focused on adding value utilizing PIMCO’s core strengths. These include duration, yield curve positioning and sector allocation with a particular focus on spread product. The strategy formulation process also takes advantage of specific security liquidity issues, the firm’s view on volatility, and expertise in issue selection throughout the broad spectrum of fixed income asset classes.
Our basic approach is to actively manage duration and curve positioning strategies in an effort to maximize total return. Yield curve management is crucial to achieving strong relative returns for long duration portfolios as yield curve shape may change markedly and its impact on Long Duration portfolios is magnified. Sophisticated proprietary software assists in the evaluation of sector opportunities and in the valuation of specific securities. Determining portfolio price sensitivities to curve twists and rotations, which do not involve simple parallel yield shifts, requires sophisticated management tools which can address how specific curve changes influence relative values across fixed income sectors.
Sources of Value Added
We approach individual security analyses from a “bottom-up” perspective. Proprietary modeling, internal credit research and cost-effective trading can add value to our client portfolios. Where permitted, PIMCO utilizes all sectors of the fixed income market, including governments, mortgages, corporates, real return, derivative, and hedged international fixed income in an effort to derive above-benchmark performance. Our proprietary modeling assists in dissecting the price and return behavior of securities under various interest rate scenarios. Credit research focuses on factors, such as company fundamentals, capital structures and industry economics, to anticipate potential credit ratings actions. Cost-effective trading is important in brokered markets where bid-ask spreads and other transaction costs can vary widely.
Innovation
PIMCO believes in continuous innovation and conservative execution. Our drive for innovation has resulted in the development of advanced proprietary analytics that have enhanced our understanding of security values and portfolio structure under a variety of interest rate and credit scenarios.
Specific to long duration and liability-driven accounts, we have developed a proprietary tool, the PIMCO Optimizer,™ that improves our understanding of the risk characteristics of our clients’ liability profiles. The PIMCO Optimizer™ enables us to develop and tailor customized benchmarks that reflect specific liability
cash flow profiles and client objectives. This allows PIMCO to manage a portfolio more closely to a specific liability profile instead of a market-based index where necessitated by client requirements. |
The equity exposure in the StocksPLUS Long Duration strategy may provide a better match to the equity index than passive index strategies because index futures and swaps provide exposure to all of the stocks in the index in their exact index weights which may or may not be the case with stock-based strategies. Therefore, non-benchmark equity market risk is generally avoided in StocksPLUS Long Duration as we seek excess return from the bond collateral portfolio. Stock selection strategies rely on individual stock risk to assemble a portfolio that will outperform the index.
Risk management within our bond investment process is regulated both by guidelines and sophisticated analytics. Average credit quality in long duration portfolios may vary within a limited range, depending upon our outlook for the economy, interest rates and credit quality spreads. We believe that there are substantial opportunities for excess returns without exposing long duration portfolios to substantial credit risk as many of these portfolios seek to maximize return while preserving principal.
To measure interest rate exposure, simple dollar duration does not fully encompass the various price sensitivities emanating from changing prepayment speeds, credit spreads and yield curve shifts. PIMCO has developed extensive internal modeling which addresses duration in its many forms: bull and bear durations (rate shifts of given amounts); total curve durations (changing yield curve shapes); credit spread durations; and mortgage spread and prepayment durations.
PIMCO also has extensive policies and procedures for managing derivatives and counterparty risk exposures. As these can be useful tools when allowed by client guidelines for long duration portfolios, a solid platform for derivatives portfolio and risk management is essential. PIMCO has dedicated legal, operational, trading and risk management personnel with decades of combined experience on both the buy and sell side to oversee these important areas. |