Hello, I’m David Braun, and I’m the head of PIMCO Stable Value Portfolio Management Team. A common stable value client question is: can active management add value in a stable value portfolio? Or, given the tight investment guidelines, is it better to pursue a low fee passive strategy?
Text on screen: Why Active Management?
PIMCO strongly believes active management is the way to go for stable value and here are four reasons why.
First, volatility is on the rise. For several years, investors were lulled into complacency due to low levels of market volatility.
Chart: A line graph charts stepped increases in the federal funds target rate from December 2016 to December 2018.
With the shift in the Federal Reserve’s Monetary Policy from accommodation to tightening, and with the fading impacts of fiscal stimulus, PIMCO believes that the market volatility we are beginning to see in 2018 is likely to continue.
While market volatility may make it harder for investors to sleep at night, it provides an active manager the ideal environment to potentially generate excess returns as the active manager can take advantage of market overshoots and undershoots.
Chart: A line graph charts stepped increases in the federal funds target rate starting in June 2018 followed by a decrease in rates at the start of 2019.
Second, credit risk has risen. Investment Grade Corporates will always be a key asset class for stable value portfolios. However, investors need to be careful, as the fundamentals have begun to deteriorate.
Leverage, especially for non-financial issuers, has risen to levels not seen in decades.
Shots of PIMCO employees working and screens with trading information on them.
At the same time, spreads for generic corporate bonds are not very attractive. Plus, a passive strategy that simply buys generic corporates, may be putting stable value investors in harm’s way.
Instead, at PIMCO, we deploy a much more active approach to credit selection.
Shots of PIMCO employees working.
It involves robust bottom up fundamental credit analysis, combined with the willingness and ability to buy out-of-benchmark credits.
We believe that a much more attractive risk reward profile can be achieved via active credit management.
Third, more constraints argues for even more active management. We all know that stable value guidelines are constrained, meaning there are tight limits on certain types of securities. If you’re passively running your portfolio, how do you know you’re optimizing the usage of such scarce risk budgets?
Active management seeks to ensure you’re getting the most out of our portfolio. This should improve your return potential and reduce the downside risk of your portfolio.
Fourth, active management is not just about trading and rebalance. It’s also about building a diversified portfolio. Stable value guidelines are built around generic benchmarks that are heavily concentrated in three types of bonds: US Treasuries, Agency Mortgage-Backed Securities, and Investment Grade Corporates.
Yet these three types of securities represent only a portion of the bond market and leave you with an overly concentrated risk profile. At PIMCO, we leverage our deep team of PMs and analysts to avoid commoditized, overvalued generic bonds and build you a more diversified portfolio.
Diversification can be a powerful risk management tool as it reduces your risk concentrations, and at the same time position you for a chance at better upside returns.
So, what should investors take away from this discussion? We see a market that is likely defined by higher volatility and higher level of credit risk. We believe the unique nature of stable value guidelines argue for more, not less, active management to both manage your downside risk and to pursue upside reward.
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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 the current low interest rate environment increases this risk. Current 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. Money Markets are not insured or guaranteed by the FDIC or any other government agency and although they seek to preserve the value of your investment at $1.00 per share, it is possible to lose money. Investors should consult their investment professional prior to making an investment decision. 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. Diversification does not ensure against loss.
Like other actively managed investments, stable value investments are subject to investment management risk. PIMCO does not guarantee the investment performance and the stable value investment account or portfolio may not achieve its stated objectives. Returns on stable value investments can also vary from benchmark indices because gains and losses are amortized over time, as well as other portfolio-specific factors.
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.
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