Fixed Income Returns in 2023
Text on screen: PIMCO
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Text on screen: Tina Adatia, Fixed Income Strategist
Tina: Looking at markets, 2022, certainly very challenging for investors, some of the worst returns for asset prices. So how should investors be interpreting this?
Text on screen: Marc P. Seidner, CIO Non-traditional Strategies
Marc: I'm not sure it's a moment to be bold right now but waking up and recognizing the growing value and the opportunity that's been created, particularly in fixed income would be my advice to investors. The reset has been challenging for many, but the exciting element is that reset is complete, and the return opportunities have become much more compelling and much more interesting.
As investors, what matters to us is coalescing around a base case, but also understanding a wide range of possible outcomes. This is an extraordinarily unusual environment and heading into 2023.
FULL PAGE GRAPHIC: TITLE – Strained Markets, Strong Bonds: Investment implications. SUBTITLE – Our process helps us evaluate a range of scenarios to determine the most likely road ahead. The graphic shows three hexagons with bullets that connect to each other via arrows. The top hexagon reads Scenarios with the accompanying bullets: Soft landing, overheating, hard landing and stagflation. The middle hexagon reads 2023 DM Outlook with the accompanying bullets: Recession likely, Inflation moderating, Policy on hold. The bottom hexagon reads Investment Implications with the accompanying bullets: Bonds are back, Focus on resilience, Opportunities in active.
There’s a wide range of possible outcomes. I mean, there's the soft landing, there is the hard landing, there is the possibility of a continued overheating, and there's the risk of stagflation.
Tiffany gave the base case of moderating inflation, mild recession, mild yet extended recession and central banks on hold. But what's important for us is not investing just for that base case but investing to add value across a wide range of possible outcomes. Building resilient portfolios, utilizing active management, utilizing our investment process, and to be sure recognizing that bonds really are back, the reset higher in yields is creating very compelling opportunities.
Active management will allow for the appropriate deployment of capital to the best risk adjusted returns at any given point and bonds yet again, with higher levels of starting yields, can offer a resilient element to a broad asset allocation and some diversification of broad risk.
Tina: So, looking on that theme a little bit more, can you describe the framework that you and the investment committee and the broader process looking at in terms of when you're thinking about volatility and risk going forward?
Marc: Of course, happy to
FULL PAGE GRAPHIC: TITLE – Proven Framework: Concentric circles SUBTITLE – Expect volatility due to central bank policy to decline, but asset market volatility to remain elevated. The graphic shows a concentric circle framework with the least amount of risk in the innermost circles, and increasing as we move to the outermost circles. The representation of each circle from the inside moving outwards are as follows: Fed funds and overnight repo; Short-term core government bonds and commercial paper; Intermediate core government bonds; Long core government bonds; Agency MBS; AAA securitized products (including ABS/RMBS/CMBS/CLOs); IG industrials + senior financials + munis; Bank capital + high quality EM; High yield + bank loans + low quality EM; and Equities + direct real estate.
PIMCO has historically used a framework of concentric circles really ever since the global financial crisis. And the concept behind the concentric circles is that risk really emanates from the center, which would be Fed funds and overnight interest rates, overnight repo extending out to short and intermediate maturity, treasuries, then asset back and mortgage-backed type securities, eventually out to investment grade credit, and then to higher yield credit levered finance and then to equities, and even real estate. What's interesting about the concentric circle framework from 2022 is that it was the center of those circles that was the source of volatility.
It was a dramatic rise in short-term interest rates driven by central banks that caused the volatility across all financial markets and created that challenging return environment for 2022. As we look forward to 2023, I think it's very fair to say that the center of those concentric circles is not going to be the source of volatility
FULL PAGE GRAPHIC: TITLE – Rising yields a strong case for bonds The vertically-oriented bar chart compares yields across fixed income asset classes bar as of 12/31/21 and 12/31/22; the three asset classes at the top of the chart are Core, which had a 1.7% yield at 12/2021 and a 4.6% yield in 12/2022; Global Agg, which had a 1.2% yield at 12/201 and a 5.2% yield in 12/2022. Agency MBS, which had a yield of 1/7% in 12/2021, and a 4.6% yield in 12/2022; AAA-Securitized, which had a yield of 1.8% at 12/2021 and a 5.5% yield in 12/2022. Those three asset classes have a box with dotted line around them and the box to the right with the text: Prioritizing Resilience, Offer compelling yields and lower risk. Under those three asset classes, the following asset classes are also included: Munis, which had a yield of 1.8% at 12/2021 and a 6.0% yield in 12/2022; Investment Grade Credit, which had a yield of 2.3% at 12/2021 and a 5.3% yield in 12/2022; High Yield Credit, which had a yield of 3.8% at 12/2021 and a 8.1% yield in 12/2022; and Emerging Markets, which had a yield of 4.4% at 12/2021 and a 7.3% yield in 12/2022.
and so once the center of that universe settles down, the concentric circle is just adjacent to the center of the universe, become much more attractive.
You're getting spreads there that are historically wide top decile in terms of their attractiveness. You're getting starting points of yields that are very attractive. You're getting triple A credit quality,
you're getting securitization or hard assets backing your investments. And that to us at this stage of the cycle and at this stage of the outlook look incredibly attractive to us.
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