The Time for Bonds
Text on screen: PIMCO
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Text on screen: Ken Chambers Fixed Income Strategist
Kenneth Chambers: At the start of the year, we talked about the Concentric Circle framework and the idea that we'd likely see a bit more volatility on things like the outer rings, essentially higher risk assets. How is our thinking evolved given everything that's transpired over the last couple of months?
Text on screen: Marc P. Seidner, CIO Non-traditional Strategies
Marc Seidner: Yeah, that's a great question, Ken. First of all, in these sorts of uncertain times or even radically uncertain times, having a proven framework is definitely a benefit.
FULL PAGE GRAPHIC: TITLE – Proven Framework: Concentric Circles. The subtitle is: Expect volatility due to central bank policy to decline, but asset market volatility to remain elevated. The chart shows concentric circles, which represent PIMCO’s longstanding investment framework. The framework starts in the middle with federal funds and overnight repo, followed by short-term core government bonds and commercial paper, intermediate core government bonds, long core government bonds, and Agency Mortgage-Backed Securities (MBS). Moving further out the circles are AAA securitized products (which includes Asset Backed Securities [ABS]/Residential MBS/Commercial MBS and Collateralized Loan Obligations [CLOs]), followed by investment grade industrials, senior financials and municipal bonds in the middle rings. The riskier outer bands include bank capital and high quality Emerging Markets, high yield, bank loans and low quality Emerging Markets, as well as equities and direct real estate. PIMCO continues to prioritize inner-ring investments in the current environment.
With regard to the concentric circles, as we look back to 2022, to the middle of the circles, overnight rates, repo central bank, official policy rates, that was the, capital the, source of volatility for markets. We think as the central bank tightening cycle continues to mature. Eventually slows. Pauses or in fact, ends, that volatility is going to subside. And that is going to create opportunity at the center of that universe, the center of the concentric circles. We're still very cautious about the outer rings.
We're entering a really dangerous part of the economic cycle. And those outer ring assets are very economically dependent.
Kenneth Chambers: A question that we get a lot is when you look at front end yields, why not just sit in cash at this point in time? If you think about, maybe a solutions perspective, how should investors be evaluating the fixed income opportunity set and really the benefits of bonds at this time?
Marc Seidner: The simple answer is you're getting pretty attractive all-in yields on
FULL PAGE GRAPHIC: TITLE – The Fixed Income Opportunity: Attractive yields and diversification. The subhead reads: Potential for higher income as well as capital gains in a risk-off environment. The bar chart shows yields across fixed income asset classes, with March 31, 2023 yields shown in solid-colored bars, and December 31, 2021 yields shown in the striped bars. Relative to December 2021, yields across high-quality fixed income sectors rose substantially as of March 2023, including U.S. Core Bonds, Global Aggregate, Agency Mortgage Backed Securities, and AAA-Securitized Bonds. The yields on relatively higher risk sectors also rose significantly as of March 2023, including Municipal bonds, Investment Grade Credit, High Yield Credit, and Emerging Markets. The box on the right shows The case for bonds: The correlation between stocks and bonds has turned negative in recent weeks, solidifying the case for diversification.
two, three, four, five-year duration, intermediate high quality bond portfolios. And so, if you're getting those attractive yields as a starting point in a more uncertain environment, why wouldn't you want to lock them in for some period of time? Cash is a zero-duration asset, which is great when interest rates are rising because you get to reinvest. But the problem is when the cycle turns and interest rates begin to fall, it can go away real quickly. That yield, that level of income can go away very quickly versus, again, that intermediate opportunity set where you can lock in pretty attractive yields at these levels.
The question in 2022 was, well, is there a diversification benefit or are correlations permanently impaired? In other words, bonds go down, risky assets go down, and there's nowhere to hide. I think the events of March have reinforced once again that there is a diversification benefit for owning high quality fixed income. And again, my sense and I think our sense is that those correlations remain intact and that owning an intermediate or long duration bonds will once again provide that diversification benefit. So, the simple answer is avoid reinvestment risk, lock in good levels of income, yield, get yourself set up for the potential for capital appreciation and of course, the benefit of diversification.
The opportunities are coming to us. I think it's a call for action. I think we're getting to the point where there is a call for action that both on the public side now that yields have reset and we have that benefit of diversification again, combined with the growing private side opportunity, there is a call for action to deploy capital. And that would be my advice to investors over the cyclical time horizon.
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