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The StocksPLUS PARS strategy uses equity index futures and/or total return swaps to achieve non-leveraged passive stock market exposure, thereby eliminating the stock selection risk typically associated with active equity strategies. As equity index ownership using futures or total return swaps typically requires only a small initial cash outlay, the majority of the client’s cash investment is retained. With StocksPLUS PARS PIMCO invests the cash in one of the PIMCO Absolute Return Strategies (“PARS” - defined in more detail below) with the goal of outperforming the money market interest rate cost typically associated with futures or swaps. If the underlying PARS portfolio outperforms money market rates, in most cases the StocksPLUS PARS strategy should deliver excess returns.
Non-LeveragedStock Index Futuresand/or Swaps
Absolute ReturnBond Portfolio
Large Cap, All Cap, Small Cap and Fundamental Index US Equity versions of StocksPLUS PARS are currently available in addition to our International StocksPLUS PARS strategy.
StocksPLUS® PARS Benchmarks
S&P 500(Large Cap)
Russell 3000(All Cap)
Russell 2000(Small Cap)
If the cash retained with the equity index futures purchase is deposited in a short-term money market account that returns a rate equal to the interest rate cost, in theory the investor will receive the total return of the equity index. Of course, for the same reason that an investor with a long time horizon does not typically hold the predominant portion of his or her investment portfolio in money market instruments, the cash backing the futures in a StocksPLUS PARS strategy is not exclusively invested in money market instruments. Rather, it is invested in PIMCO’s PARS strategy. If PIMCO is able to actively manage the PARS portfolio to consistently achieve returns higher than the money market interest rate cost (generally a LIBOR based cost), the StocksPLUS PARS strategy should outperform the equity index.
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).
In StocksPLUS PARS portfolios, we seek to generate attractive excess returns over the money market based cost of equity exposure by employing diversified investment strategies across a broad array of risk factors and security specific strategies. Portfolio positions are driven by both the firm’s top-down, macroeconomic investment research process and by bottom-up relative value analysis generated by portfolio managers who specialize in particular sectors of the global fixed income markets.
Top-Down Sources of ValuePIMCO’s cyclical and secular economic forums drive the top-down element of the firm’s investment process. In the annual Secular Forum, 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 our economic outlook.
In addition to the annual Secular Forum, PIMCO’s Investment Professionals hold quarterly Cyclical 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.
In StocksPLUS PARS, top-down sources of value begin with PIMCO’s Total Return active bond management strategies, and disaggregate the benchmark risk characteristics associated with each strategy. Among the primary risk characteristics which are actively managed in Total Return mandates are overall duration and yield curve positioning, sector overweights or underweights, and trades which are intended to benefit from structural advantages available to long-term investors such as ‘roll-down’ and volatility. For example, if PIMCO’s sector strategy was a credit underweight in Total Return, the analogous strategy in PARS would be outright short credit exposure.
Because StocksPLUS PARS portfolios are designed to leverage the Firm’s ability to generate alpha in core fixed income portfolios, investors may benefit from PIMCO’s 35 years of investment management experience.
For PARS (and StocksPLUS PARS) to be successful, the first necessary ingredient is PIMCO’s ability to generate excess return in our Total Return style relative to the Barclays Capital U.S. Aggregate Index.
Bottom-Up Sources of ValueThe remaining excess return potential is typically derived from Bottom-Up Relative Value Strategies which draw on the expertise of PIMCO’s specialist teams to take advantage of structural inefficiencies, market mispricings and cross-country or cross-sector spread movements. Additional returns may arise as more flexible guidelines allow for cost effective trade implementation through the use of modern fixed income instruments. Further, overlaying certain risk mitigating trades enables portfolio managers to isolate specifically attractive risks, and implement relative value trades that may materialize during the course of interaction between and among the various specialty areas of the firm.
By virtue of 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 to determine which strategies are adding value and which need to be modified. Extensive use of analytical models allows us to effectively monitor trading practices, and provides an objective check of investment decisions. Advanced proprietary analytics allow us to model portfolio reactions to a multitude of scenarios, including stress scenarios in which a portfolio is ‘shocked’ by extreme changes in security prices, correlations or economic factors. PIMCO has dedicated a substantial amount of resources to monitoring both investment and operational risk across the spectrum of all portfolios, including StocksPLUS PARS. Several key components of our risk management philosophy are outlined below.
Control Risk to Limit VolatilityThe high average credit quality, limited duration and currency exposure all help to control risk in StocksPLUS PARS. In addition, the strategy is managed to a target tracking error.
Due to the intensive technology investment outlined above, we believe PIMCO reporting capabilities are unmatched among absolute return style investment managers. We further believe that investors must understand the risks in their portfolios, particularly when a portfolio is used to collateralize futures or swaps in the volatile equity market. This detailed reporting capability also enables us to appropriately manage liquidity to meet margin calls from equity futures, and efficiently deploy capital inflows which result from an appreciating equity market.
Equity Exposure ManagementThe use of equity index futures and/or swaps provides an important benchmark-relative risk control. This is because index futures and swaps provide the returns of the underlying equity index.
Unlike traditional active equity management strategies that seek to generate excess returns by altering the stock holdings and/or weights relative to the index, StocksPLUS PARS seeks to achieve its excess return without incurring any additional or non-benchmark equity market risk. While stock selections may be fundamentally sound at purchase, subsequent company, industry, or market events certainly may lead to substantial price declines. The use of futures and/or swaps may provide a better matching to the benchmark than passive index strategies because index futures and swaps provide exposure to all of the stocks in the index in their exact index weights whereas this may or may not be the case with stock-based strategies. Index futures and swap-based strategies also do not need to incur transaction costs and/or benchmark relative risk that may be associated with changes in the underlying index.
Diversified, Stable Investor BaseA focus on long-term investors and limitations on redemptions and contributions into the strategy encourage a high quality, stable investor base.
DiversificationIn combining a PARS strategy with equity index futures or swaps, the StocksPLUS PARS approach may provide additional diversification benefits because the source of excess return potential underlying the equity derivatives, a portfolio primarily comprised of long and short positions in fixed-income securities, intends to have low or negative correlation with returns of other major asset classes. As such, this strategy may provide a significant diversification benefit for the investor.
Bundled solution eliminates the need for new infrastructure and coordination facilities.In managing StocksPLUS portfolios for over 20 years, PIMCO has refined our skills in managing what has come to be known as portable alpha. Liquidity management, equity exposure maintenance and rebalancing, attribution, timing and full employment of committed capital are a few of the advantages that may result from a bundled approach implemented by a manager who’s experience includes the stock market crash of 1987 and a wide spectrum of volatile bond and equity markets.
Various Return/Risk Versions AvailableTwo versions of StocksPLUS PARS are available with similar overall exposures but different risk/return targets. This allows investors to best match their risk/return preferences with the version closest to their profile. Both versions take advantage of the same portfolio management expertise, global resources, implementation and execution, and risk control systems in place at PIMCO.
ApplicationsThe StocksPLUS PARS strategy may be suitable for the equity component of an asset allocation. The strategy is designed to complement or provide a viable alternative to both traditional active equity strategies, which have the formidable challenge of having to pick the right stocks year after year, and other portable alpha based strategies.
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. 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 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. 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.
FTSE RAFI™ U.S. 1000 Index is part of the FTSE RAFI™ Index Series, launched in association with Research Affiliates. As part of FTSE Group’s range of nonmarket cap weighted indices, the FTSE RAFI™ Index Series weights index constituents using four fundamental factors, rather than market capitalization. These factors include dividends, cash flow, sales and book value. The FTSE RAFI™ 1000 Index comprises the largest 1000 publicly traded U.S. companies by fundamental value, selected from the constituents of the FTSE U.S. All Cap Index, part of the FTSE Global Equity Index Series (GEIS). The total return index calculations add the income a stock’s dividend provides to the performance of the index. LIBOR (London Interbank Offered Rate) is the rate banks charge each other for short-term Eurodollar loans. The MSCI EAFE (Morgan Stanley Capital International Europe, Australasia, Far East Index) is an unmanaged index of over 900 companies, and is a generally accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas markets included in the index on a U.S. dollar adjusted basis. The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index. The Russell 3000 Index is an unmanaged index generally representative of the U.S. market for large domestic stocks as determined by total market capitalization, which represents approximately 98% of the investable U.S. equity market. The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market. 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, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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