| PARS StocksPLUS Experience |
| PIMCO has managed StocksPLUS enhanced equity index portfolios since 1986. While the StocksPLUS and Stocks-PLUS PARS equity index replication process is identical, the StocksPLUS strategy backs the equity futures with a short-term, zero- to one-year duration “enhanced cash” fixed income portfolio instead of a PARS portfolio. |
| PIMCO’s Absolute Return Management Experience |
| PIMCO’s Absolute Return Strategies capitalize on over 35 years of experience managing U.S. bond portfolios using our Total Return approach and expertise in fixed income markets around the globe. We first began managing absolute return portfolios in November 1999. Our commitment to excellence in the management of fixed income portfolios is exemplified in our efforts to devote resources to every fixed income sector in markets across the globe. While most day-to-day portfolio management activities occur in our Newport Beach, California office, portfolio managers in our London, Munich, Singapore, Tokyo and Sydney offices provide valuable insights on developments in the macroeconomic environment within their region and provide important trade recommendations as experts in their local markets. |
| Investment Philosophy |
| The StocksPLUS PARS investment philosophy is based on our belief that equity index futures offer an efficient, relatively low cost way for a long-term investor to obtain passive equity index exposure. Much like an investor who replicates a given equity index by purchasing all of the stocks in the index, an investor who purchases equity index futures should receive the total return of the index. However, while stock purchases generally require payment of the entire cash investment amount in exchange for the stock index exposure, the cash outlay required to gain exposure to a given equity index using futures contracts is typically quite small (approximately 5-10 percent of the total contract value in the case of S&P 500 futures, for example). This allows the remaining cash to be invested in a diversified portfolio of fixed-income securities. Of course, because the investor is not required to pay for the entire equity exposure upfront, as is the case with most “buy now and pay later” arrangements, there is an interest rate cost associated with equity index ownership using futures. Equity index futures provide the total return of the equity index in exchange for the effective payment of a short-term money market interest rate. This interest rate is key to the StocksPLUS PARS strategy. 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).
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| Investment Approach |
PIMCO Absolute Return Strategies (“PARS”) are innovative fixed-income based investment approaches designed to provide excess returns over LIBOR with no material expected correlation with the bond market. PARS capitalizes on PIMCO’s investment process, and implements the associated active management decisions in a substantially unconstrained framework with broader investment guidelines and tracking error parameters relative to traditional fixed-income mandates.
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 Value
PIMCO’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 Value
The 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.
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| PIMCO’s Risk Managment Platform and Transparent Reporting |
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 Volatility
The 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 Management
The 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 Base
A focus on long-term investors and limitations on redemptions and contributions into the strategy encourage a high quality, stable investor base.
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| Benefits of StocksPLUS PARS |
Diversification
In 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 Available
Two 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.
Applications
The 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. |