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).
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.
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
- 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.
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
“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.
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.
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.
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.