Economic and Market Commentary

Stable Value 2020: Parallels to 2008?

What’s the same, what’s different this time, are there opportunities ahead? Chit Purani, Portfolio Manager, and Henry Kao, Head of PIMCO's Stable Value Practice, discuss how Stable Value is holding up in the current market conditions.

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Henry Kao, Head of PIMCO's Stable Value Business: Hello. My name is Henry Kao and I head PIMCO’s stable value practice in Newport Beach.

Over the past couple of months, many in the retirement community have told us that the current market environment feels to them a lot like the 2008 financial crisis.

And with so many participants increasing their allocation into Stable Value, many are asking if there are any reasons to be concerned about this very popular DC capital preservation option.

To help answer this question, joining me today is Chit Purani, Portfolio Manager on the PIMCO stable value investment team.

Chit, you may remember that many stable value funds were hit pretty hard back in 2008.

Do you see any parallels between the current market environment and the 2008 financial crisis? And if you could, please talk a little bit about how PIMCO stable value portfolios are positioned. And how have they held up?

Chitrang K. Purani, Portfolio Manager, Financial Institutions: Thanks, Henry. Yes, it certainly feels similar to 2008.

Like then, we experienced a shock to the economic system. And that shock led to pronounced uncertainty for investors, and that uncertainty in turn led to broad deleveraging, which overwhelmed the banking system. And so, the result then, like now, was fiscal and monetary policymakers forcefully stepping in to provide a circuit breaker for the markets.

What's different is that this economic shock requires more than just a financial solution. It requires a medical one. And because of the rapid global spread of COVID-19, this shock seems more pervasive.

Now, as it relates to positioning of PIMCO’s stable value portfolios, it's important to reiterate: we have a centralized investment process that influences portfolio construction across all of our strategies.

Prior to 2008, this process helped us recognize the excesses, in terms of leverage and valuations in the housing market.

And so, PIMCO portfolios, including stable value, largely exited exposure to weaker mortgage and asset backed securities: the types of exposures which drove meaningful declines in market to book value ratios across the stable value industry.

Now, leading up to the current COVID crisis, we saw similar troubling trends, in terms of leverage and valuations within corporate credit markets.

This led us to be relatively defensively positioned in corporate bonds versus higher quality securitized exposures, heading into March.

Now, to be clear, as volatility spiked in recent weeks, correlations across asset classes, both high and low quality, rose, and so the mark to market effects were felt across portfolios.

But, the key is protecting our clients’ capital.

And we believe our defensive stance, heading into March, has increased the resiliency of our stable value portfolios and into what's likely to be a pronounced downgrade cycle.

Henry: Since Congress passed the coronavirus relief package, we've seen spreads come in, in the credit space. Would you say that the crisis is now behind us and are you starting to see pockets of opportunity?

Chitrang: Well, the initial phase of the sell-off was quite extreme, as there was a liquidity-driven collapse in asset prices, driven by wide range of investors looking to harvest cash or cover margin into a broker dealer network that had little capacity to warehouse that risk.

Since then, Central Banks have created an alphabet soup of facilities to enable purchase of everything from treasuries to even high-yield bonds. And this has significantly helped market functioning and valuations, but it doesn't mean markets are now immune to any further weakness.

In the U.S., for example, we may be close to, but not yet past the peak of infections and when we are, the process of returning back to normal will be a long-tailed one.

Also, the speed of demand destruction caused by this crisis potentially leaves parts of the economy structurally impaired.

This is an important consideration, given valuations across most parts of the fixed-income market have already retraced greater than 50 percent of the weakness we experienced since risk-off sentiment took hold in late February.

As a result, while we do have some dry powder across our stable value portfolios, we're taking a gradual approach. Specifically, this means staying up in quality, as there are many industries and issuers that remain vulnerable and it also means focusing on being a liquidity provider in volatile markets like these, instead of chasing assets.

Henry: Yes, you know, many plan sponsors, consultants and retirement advisors are actually right now just looking at their first quarter stable value statements. What would you tell them to be on the lookout for in the coming months?

Chitrang: Well, it's important to take a step back and remember what the role of stable value is within a retirement plan.

It serves to provide safety, liquidity and yield, in that order.

So, the first thing that those who oversee plan assets should do is to ensure that they have a reasonable sense of the level and nature of portfolio exposures that may be more vulnerable to an extended COVID-related shutdown.

We know that it's not easy forecasting fundamentals in the next few months or longer. But having some sense of stress scenarios and their impact on portfolios may help formulate a risk mitigation strategy, if needed, or guide potential conversations with RAP providers.

The other thing for plan sponsors and advisors to focus on is a real time understanding of their manager’s investment strategies in the context of ongoing uncertainty in the market and on the ground.

Fortunately, we continue to see inflows into PIMCO’s stable value platform.

And I'll reiterate that our approach is a gradual one. We're focused on being opportunistic but remaining up in quality, because the markets will continue to differentiate assets that are more vulnerable to an extended period of economic weakness versus those that are just temporarily dislocated.

Henry: Thank you, Chit.  I think that is really, really helpful. And thank you for bringing up wrap providers.

Since the end of February, PIMCO has been in constant contact with all of our wrap providers and we're happy to report that contrary to the 2008 financial crisis, we are not seeing any signs of wrap capacity constraint, or dislocation in the Stable Value market.

In fact, wrap providers continue to accept new deposits, and many have proactively reached out to extend additional accommodations.

Now, because stable value is fixed income, it is going to be impacted by what is happening in the fixed income market.

It's our opinion, however, that this time around, the stable value market is doing exactly what it's intended to do: which is protecting participants’ retirement savings during periods of heightened volatility and large drawdowns.

We are mindful that this situation is fluid and ongoing and we'll be ready to provide additional updates, if and when appropriate.

In the meantime, your team at PIMCO stands ready to answer any questions related to the market in general, or specific to stable value. And we look forward to continuing a dialogue.

Thank you for watching.

For more insights and information visit pimco.com

Disclosure


Past performance is not a guarantee or a reliable indicator of future results.

A word about risk: There is no guarantee that a stable value fund or strategy will achieve its investment objective. Stable value funds or accounts are not FDIC-insured, may lose value and are not guaranteed by a bank, insurance company or other financial institution.  Although stable value investments seek to reduce the risk of principal loss, investing in a stable value fund or strategy involves risk including loss of principal, market risk related to the underlying securities in the portfolio, and management risk. The crediting rate for a stable value fund will be affected by, among other factors, the prevailing general level of interest rates, the performance of the portfolio’s fixed income investments and cash flows into and out of the fund.

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. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations

Statements concerning financial market trends are based on current market conditions, which will fluctuate. 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. Outlook and strategies are subject to change without notice. The information discussed herein does not take into account the investment objectives, financial situation, or needs of any particular investor.

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. 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.

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