In Depth

An Introduction to PIMCO's Model Portfolios

PIMCO model portfolios offer advisors an efficient way to partner with PIMCO to navigate challenging markets.

The role of financial advisors goes far beyond selecting strategies and allocating portfolios. Increasingly, clients are asking for help with financial planning, goal setting, estate planning, tax management, and charitable giving. Yet these new demands come as advisors are grappling with challenging markets, increased regulation, and a proliferation of investment options.

PIMCO model portfolios may be able to help. They offer advisors an efficient way to partner with PIMCO and spend more time on understanding and solving client problems.

Our model portfolios span a range of asset classes and objectives. They embody the insights and expertise of a firm with $1.91 trillion in assets1 – one that has focused solely on asset management and stood the test of time for nearly 50 years. Allocations are guided by PIMCO’s investment process, which centers on forward-looking views of the global economy and markets. PIMCO’s actively managed strategies provide the potential for alpha, while our robust analytics platform ensures a careful balance between opportunities and potential risks (see Figure 1).

Figure 1 shows a Venn diagram that illustrates how PIMCO model portfolios are the convergence of three elements of PIMCO’s intellectual capital, represented as circles. One circle represents “forward looking investment news.” Another is “broad opportunity set,” which includes PIMCO’s flagship funds, where active management seeks to add alpha. A third circle represents “analytics infrastructure,” which includes proprietary methods to optimize and stress-test allocations 

PIMCO’s model portfolios

PIMCO offers four suites of model portfolios to help meet client objectives.

Taxable Fixed Income: The foundation of a client’s portfolio, fixed income allocations provide key benefits including the potential for income, total return, capital preservation, and equity diversification. With these traditional benefits under pressure from low yields and rising interest rate and credit risks, PIMCO’s fixed income models seek to improve client outcomes by following our forward-looking investment process to balance the trade-offs offered by today’s market. The actively managed underlying funds seek to capitalize on the structural inefficiencies in the marketplace that can give active fixed income strategies a potential edge over passive.

Three taxable fixed income models are designed to reflect different investor objectives:

  • Capital Preservation seeks to provide an attractive return above traditional cash investments with modest additional risk, while minimizing drawdown potential from rising interest rates or falling equity markets.
  • Enhanced Core seeks to improve upon the low yields and high interest rate risk of passive core approaches, while preserving equity diversification benefits.
  • Income Focus seeks to generate an attractive level of income in a diversified manner across a range of fixed income sectors and funds.

Tax-Aware Fixed Income: For high-net-worth clients, the impact of taxes on fixed income returns can be meaningful. PIMCO’s tax-aware fixed income model portfolios seek to maintain the overall characteristics of our taxable fixed income models while ensuring a meaningful allocation to federally tax-exempt municipal bonds to help boost after-tax income. We actively manage the underlying funds, leveraging PIMCO’s credit research capabilities and market access.

Similar to our taxable fixed income models, we offer three tax-aware fixed income models with similar after-tax objectives: Capital Preservation, Enhanced Core, and Income.

Retirement Income: Amid historically low yields, generating meaningful income from retirement assets is challenging. PIMCO’s multi-asset retirement income model portfolios endeavor to overcome this challenge by seeking to deliver an attractive level of income and the potential for long-term capital appreciation. They aim to mitigate the key risks faced by retirees, including longevity and inflation risks.

We offer three retirement income models – Conservative, Balanced, and Moderate Growth – that give advisors options as they consider their client’s risk profile.

Accumulation: While investors have generally enjoyed strong returns across a wide range of assets post-crisis, the forward-looking environment is likely to be more challenging. PIMCO’s accumulation models seek to provide diversified exposure to global markets and aim to enhance return potential while managing downside risk in an effort to improve portfolio outcomes. The asset allocation process follows PIMCO’s forward-looking views, allocating across a range of actively managed equity, fixed income, and real asset mutual funds.

PIMCO offers five accumulation models, ranging from 20% equities/80% bonds to 80% equities/20% bonds.

See allocations and related data for PIMCO’s Model Portfolio Solutions at www.pimco.com/models.

PIMCO’s investment process

PIMCO model portfolio allocations reflect the firm’s forward-looking investment process, which we have refined over nearly five decades. By combining our top-down global outlook with extensive bottom-up security analysis and risk management, the investment process has provided valuable insights into economic and market developments, while helping PIMCO to anticipate major inflection points. Additionally, the investment process helps ensure that all PIMCO strategies, however varied in their approaches, express a disciplined and coherent investment view.

Our economic forums are the starting point for developing our top-down investment views. These forums, of course, are only as valuable as their quality – and PIMCO devotes considerable time and resources to this end. Four times a year, our investment professionals from around the world gather in Newport Beach, California, to debate the outlook for global markets and economies and identify trends that we believe will have important investment implications.

PIMCO’s Investment Committee, composed of the firm’s senior portfolio managers, then translates these views into guardrails, or risk parameters, for PIMCO strategies. We augment these top-down views with bottom-up insights from portfolio managers, analysts, and traders focused on specific markets and asset classes (see Figure 2).

Importantly, PIMCO model portfolios benefit from the firm’s cohesive view across asset classes – a distinct differentiator for clients, in our view. Rather than setting static allocations or aggregating views from siloed specialist teams, we identify opportunities and risks across asset classes using a consistent framework. For example, our views on the potential path of interest rates will inform not only our outlook on bonds, but also on equities and currencies.

Figure 2 shows a circle representing PIMCO portfolios, surrounded by a segmented ring. The lower half of the ring represents a bottom-up approach as used by portfolio managers, who also consider top-down macroeconomic inputs into their investment decisions, which is represented on the upper half of the ring. The upper half is divided into two parts: labeled “economic forums” and “investment committee”

Identifying the opportunity set

Given today’s low yields and rich valuations, future returns from index-based strategies will likely be muted. Generating income from passive investments will therefore be similarly challenged. These conditions underscore the potential of actively managed funds to help meet client objectives – whether by adding the potential for alpha to increase returns or by seeking an attractive distribution to help achieve income goals.

PIMCO has been recognized for its active management:

  • Morningstar named PIMCO its Fixed-Income Fund Manager of the Year (U.S.) in 2015, 2013, and 2012.
  • PIMCO has won the Lipper Fund Awards’ Large Company Equity Asset Class category five times, including in 2019, 2013, 2012, 2011, and 2010.

The PIMCO model portfolio team also benefits from full look-through into the holdings of underlying funds. This gives the model team a clear, comprehensive and contemporaneous understanding of a model’s aggregate risk and return drivers.

When considering the opportunity set for each model, the model team looks to ensure that underlying strategies address several criteria:

  • They include the asset classes and sectors relevant to
    model objectives.
  • They have a consistent performance track record.
  • They have a sizeable asset base across a range of investors.
  • They are broadly available across platforms.

A CLOSER LOOK AT THE RESOURCES UNDERLYING PIMCO MODEL PORTFOLIOS

The PIMCO model portfolio team

The PIMCO model portfolio team oversees portfolio construction, including strategy selection, the specification of model parameters, and the development of forward-looking return and risk assumptions. Composed of members of PIMCO’s asset allocation portfolio management and client analytics and solutions teams, the model portfolio team ensures that model allocations remain consistent with PIMCO’s macroeconomic views (see Figure 3).

The asset allocation team, led by Mihir Worah – PIMCO’s chief investment officer for asset allocation and real return – draws upon the sector expertise of over 250 portfolio managers across 17 global offices. The team formulates the firm’s capital market assumptions and determines how best to combine asset classes to address specific investment goals.

The client solutions and analytics team harnesses PIMCO’s investment capabilities to provide clients with actionable investment insights. In the context of model portfolios, the team partners with our client-facing colleagues to define model objectives and guidelines, helping to ensure alignment with client needs.

Figure 3 depicts how the model portfolio team seeks to rely on PIMCO’s broad resources. The diagram is formatted as two columns, with one representing the asset allocation portfolio management team, and the other showing the client solutions and analytics team. Each of those columns shows key executives and team members, along with key attributes of the teams. More information is within

Establish guardrails to align model portfolios with client objectives

PIMCO model portfolios maintain a strategic orientation. While we remain agile in adjusting our allocations consistent with our forward-looking views, we also track the amount of active risk in the models. We seek to make sure that risk and return profiles remain consistent with the models’ objectives and, in some cases, in line with specific reference benchmarks. These guidelines seek to ensure clarity and consistency in the characteristics of our model portfolios.

From a risk management perspective, we place limits on the allocations to underlying funds and the total amount of tracking error the models may take. Additionally, as our clients are increasingly in search of specific outcomes, we define our model parameters in a way that seeks to meet a range of client objectives.

From a timing perspective, we rebalance our allocations following our quarterly forums in line with updates to PIMCO’s forward-looking outlook. While we may adjust our allocations more frequently when market conditions warrant, quarterly rebalancing ensures that allocations are consistent with our long-term views.

Once the components and guardrails of model portfolios are set, the allocation process is largely quantitative, with qualitative oversight. The two key quantitative inputs into the optimization process are our capital market assumptions (estimates of future returns across various asset classes) and the covariance matrix, which includes the volatilities and correlations of each underlying strategy. The optimization process then seeks to generate the most efficient allocation to meet the model’s objectives within its given constraints.

ADDITIONAL INFORMATION ON PIMCO’S APPROACH TO ACTIVE MANAGEMENT

Fixed income:

Bonds Are Different: Active Versus Passive Management in 12 Points explains why the structural tilts in fixed income favor active over passive.

The Secret of Active Portfolio Management describes the structural risk premia in fixed income markets that offer a sustainable and consistent source of alpha for PIMCO portfolios in addition to the firm’s bottom-up security selection.

Equities:

Traditionally, equity investors have had to choose between two types of investment approaches: passive and active. The dilemma today is that the traditional approach to active equity investing, stock picking, has failed to deliver for many years.

The good news for investors is there’s a broader toolkit for seeking higher return potential. Systematic and index-plus strategies used in our model portfolios, for instance, seek reliable and repeatable excess returns.

PIMCO Research Affiliates (RAE) Strategies explains how the PIMCO RAE systematic equity strategies seek to capture some of the key benefits of passive investing versus traditional active management. These include broad diversification, economic representation, and lower fees, with the potential for excess return.

PIMCO StocksPLUS: Casting a Wider Net for Alpha explains the StocksPLUS approach of using equity index futures and total return swaps to efficiently replicate the performance of a target equity benchmark, augmented with a high quality bond alpha strategy that seeks to deliver excess returns above the financing rate of the equity exposure.

Capital market assumptions

PIMCO’s methodology for estimating returns across asset classes and strategies combines the benefits of two long-horizon return forecasting approaches: 1) quantitative empirical and analytical modeling and 2) judgment and insight from market experts (see Figures 4 and 5).

At the core of our process are forecasts from senior PIMCO portfolio managers for key variables that drive asset class returns. These include economic metrics, such as inflation and growth for a range of countries, as well as market variables, including real and nominal yields, credit spreads, and default rates. To guide and anchor their forecasts, portfolio managers view a collection of quantitative model results. Through this process, we obtain estimates for the key drivers of asset class returns that incorporate expert judgment and benefit from internally consistent quantitative models.

To transform our risk factor premia estimates into total return forecasts for different assets, we do the following:

  • Estimate excess return as the product of each asset class’s risk factor exposures and our risk factor premia forecasts.
  • Add the estimated average return on cash.

Beginning with risk premia, as opposed to specifying asset class returns directly, ensures scalability and consistency. Directly specified asset class return estimates tend to be inconsistent at the risk factor level. However, our approach estimates returns for each asset class by applying risk factor premia to the risk factor exposures of each asset class. This ensures that risk factor premia estimates are consistent across asset classes. For example, the estimated return per year of duration will be the same for a Treasury bond as for a corporate bond.

Underlying strategy volatilities and correlations

When constructing portfolios, PIMCO uses a risk factor approach. Risk factors reflect the underlying exposures within asset classes that justify a return premium and drive variations in returns (asset classes are simply carriers of various risk factors). Therefore, each investment in our portfolios is measured by its exposures to key factors such as broad equity, interest rate duration, credit spread, and currency risks.

Since PIMCO manages all of the underlying strategies in our model portfolios, we can build a risk factor profile of each underlying strategy based on individual securities. This provides the model portfolio team with a detailed understanding of the forward-looking volatilities and correlations of the underlying strategies, which, alongside the capital market assumptions, drive the optimization process. From a portfolio perspective, a risk factor approach also helps with risk management and provides a uniform lens to help ensure final model allocations align with the firm’s forward-looking views.

Figure 4 is a flow chart showing PIMCO’s capital market assumptions at a glance, represented as a vertical column of five boxes. Portfolio management and analytics serve as inputs to the first two boxes, labeled “models” and “capital market inputs,” which flow in that order down to three more boxes, labeled “risk factor conversion,” “asset class conversion” and “consistency check.” An arrow redirects from the consistency-check-box back to the second box, capital market inputs. More text is within each box

Figure 5 is a bar chart showing PIMCO’s five-year return estimates for equities, fixed income and real assets, as of May 2019. Among equities, emerging markets is projected to have the highest return, at 8.3%, well above the 5% estimate for U.S. equities. Emerging market external bonds have the highest projected return among fixed income, compared with 2.6% for U.S. core fixed income. REITs have the highest estimate among real assets, at 4.9%

Benefits of risk factors

Our investment approach focuses on risk factors in an effort to achieve superior risk diversification and downside risk mitigation. Risk factors help

  • Provide intuition regarding the underlying source(s) of an asset’s returns and risk
  • Allow for easier cross-asset-class comparisons of risk
  • Quantify a portfolio’s underlying risk exposures, making it easier to understand the implications of portfolio changes

Within fixed income allocations, for instance, risk factors can provide clear guidance on the key drivers of portfolio risk and better measurement of sensitivities to changes in rates and credit spreads. Figure 6 shows the total level and source of risk of three common fixed income indices representing allocations to core U.S. bonds, investment grade corporate bonds, and high yield bonds, respectively. While core bonds, represented by the Bloomberg Barclays U.S. Aggregate Index, include allocations to Treasuries, corporate bonds, and mortgage bonds, nearly all of the risk is driven by duration, or movements in interest rates. In contrast, a pure investment grade corporate bond index has greater balance across credit and interest rate risks. However, as one moves down the capital structure to high yield bonds, we can see the overwhelming majority of the risk is driven by movements in high yield spreads. In fact, duration is a net diversifier!

These results help illustrate why the performance of core bonds is so tightly tied to the movement in interest rate risks, whereas the performance of high yield bonds is so tightly correlated to broader credit and equity market movements. These examples illustrate why cutting through asset class labels to get at the true drivers of risk can help ensure a portfolio is more effectively diversified.

Figure 6 compares risk factor profiles of three common fixed income indices, using a bar chart. With core bonds (proxied by Bloomberg Barclays U.S. Aggregate Index), a bar on the left shows how nearly all of volatility is driven by real duration. In contrast, a bar in the middle shows how a pure investment grade corporate bond index (proxied by Bloomberg Barclays U.S. Credit Index) has greater balance across credit and interest rate risks. A bar on the right shows how with high yield bonds (proxied by Bloomberg Barclays U.S. High Yield Index), the overwhelming majority of the risk is driven by movements in high yield spreads

 

1 As of 31 December 2019. Assets reflect those managed on behalf of third-party clients and affiliated assets. Fund of funds assets have been netted from each strategy. Assets include $14.6 billion in assets of clients contracted with Gurtin Fixed Income Management, LLC, an affiliate and wholly owned subsidiary of PIMCO.
The Author

Justin Blesy

Asset Allocation Strategist

Steve Sapra

Client Solutions & Analytics

Mark Thomas

Account Manager, Global Wealth Management

Related

Disclosures

The PIMCO Models described in this material are available exclusively through investment professionals.

PIMCO Models are based on what Pacific Investment Management Company LLC (together with its affiliates, “PIMCO” believes to be generally accepted investment theory. PIMCO models are for illustrative purposes only and may not be suitable for all investors. PIMCO Models are not based on any particularized financial situation, or need, and are not intended to be, and should not be construed as, a forecast, research, investment advice or a recommendation for any specific PIMCO or other strategy, product or service. Individuals should consult with their own financial advisors to determine the most appropriate allocations for their financial situation, including their investment objectives, time frame, risk tolerance, savings and other investments. Volatility is historical and is likely to change over time. PIMCO has not undertaken, and will not undertake, any analysis to determine any specific models’ suitability for specific investors.

The risks of a PIMCO Model allocation will be based on the risks of the PIMCO mutual funds (each, a “Fund”) included in the PIMCO Model allocation (“Underlying Fund”). The PIMCO Model allocation is subject to the risk that the Underlying Funds and the allocation and reallocation of the PIMCO Model among the various Funds may not produce the desired result. The PIMCO Retirement Income Models may not fully reflect the impact that material economic and market factors might have had on PIMCO’s decision-making if PIMCO had actually managed portfolios with assets pursuant to the PIMCO Models since their inception. The PIMCO Models may not reflect the impact that material economic and market factors might have had on PIMCO’s decision-making if PIMCO were actually managing a portfolio with assets pursuant to the PIMCO Model. The PIMCO Model allocations to Underlying Funds have changed over time and may change in the future. The selection and weighting process across Underlying Funds is informed based on return estimates driven by PIMCO’s forward looking view and risk estimates driven by PIMCO’s analytic infrastructure. Management risk is the risk that the investment techniques and risk analyses applied by PIMCO will not produce the desired results, and that certain policies or developments may affect the investment techniques available to PIMCO in connection with managing the strategy.

PIMCO Model allocations are licensed or otherwise made available to investment professionals. PIMCO Models’ allocations are updated on a defined production cycle. The Underlying Funds are available by prospectus only. Implementing investment professionals may or may not implement the PIMCO Model’s allocation as provided, and actual allocations to Underlying Funds may vary. There are expenses associated with the underlying Funds in addition to any fees charged by implementing investment professionals. Additionally, the implementing investment professional may include cash allocations, which are not reflected herein.

Return assumptions are for illustrative purposes only and are not a prediction or a projection of return. Return assumption is an estimate of what investments may earn on average over the long term. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods.

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

The portfolio analysis is based on the indexes shown. No representation is being made that the structure of the average portfolio or any account will remain the same or that similar returns will be achieved. The analysis may not be attained and should not be construed as the only possibilities that exist. Real results will vary and are subject to change with market conditions. Different weightings in the asset allocation illustration will produce different results. Actual results will vary and are subject to change with market conditions. There is no guarantee that results will be achieved. No fees or expenses were included in the estimated results and distribution. The scenarios assume a set of assumptions that may, individually or collectively, not develop over time. The sample analysis reflected in this information is based upon data at time of analysis. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. PIMCO routinely reviews, modifies, and adds risk factors to its proprietary models. Due to the dynamic nature of factors affecting markets, there is no guarantee that simulations will capture all relevant risk factors or that the implementation of any resulting solutions will protect against loss. All investments contain risk and may lose value. Simulated risk analysis contains inherent limitations and is generally prepared with the benefit of hindsight. Realized losses may be larger than predicted by a given model due to additional factors that cannot be accurately forecasted or incorporated into a model based on historical or assumed data.

VOLATILITY (ESTIMATED): We employed a block bootstrap methodology to calculate volatilities. We start by computing historical factor returns that underlie each asset class proxy from January 1997 through the present date. We then draw a set of 12 monthly returns within the dataset to come up with an annual return number. This process is repeated 25,000 times to have a return series with 25,000 annualized returns. The standard deviation of these annual returns is used to model the volatility for each factor. We then use the same return series for each factor to compute covariance between factors. Finally, volatility of each asset class proxy is calculated as the sum of variances and covariance of factors that underlie that particular proxy. For each asset class, index, or strategy proxy, we will look at either a point in time estimate or historical average of factor exposures in order to determine the total volatility. Please contact your PIMCO representative for more details on how specific proxy factor exposures are estimated.

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. High yield, lower-rated securitie 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. Equities may decline in value due to both real and perceived general market, economic and industry conditions. 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. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. Diversification does not ensure against loss.

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. Investors should consult their investment professional prior to making an investment decision.

PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

The Morningstar Fixed Income Fund Manager of the Year (US) award is based on the strength of the manager, performance, strategy, and firm’s stewardship. The Lipper Fund Best Group over 3 Years Large Equity award (US) recognizes funds that have delivered consistently strong risk-adjusted performance, relative to peers PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation.

This material contains the 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. It is not possible to invest directly in an unmanaged index. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2020, PIMCO.

For financial professionals: The implementation of, or reliance on, a model portfolio allocation is left to your discretion. PIMCO is not responsible for determining the securities to be purchased, held and sold for a client’s account(s), nor is PIMCO responsible for determining the suitability or appropriateness of a model portfolio allocation or any securities included therein for any of your clients. PIMCO does not place trade orders for any of the your clients’ account(s). Information and other marketing materials provided to you by PIMCO concerning a model portfolio allocation — including holdings, performance and other characteristics -may not be indicative of a client’s actual experience from an account managed in accordance with the model portfolio allocation.

CMR2020-0128-436040

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