The secular convergence toward modest real growth rates across the global economy has many investors yearning for yield and considering credit to help them reach their longer-term goals. Mark Kiesel, Deputy Chief Investment Officer and global head of corporate bond portfolio management, explains how PIMCO uncovers credit opportunities with secular staying power. His insights derive from both the credit team’s robust research process and the firm’s top-down, long-term views, articulated recently at the PIMCO Secular Forum. We describe the modest-growth world with low central bank policy rates in the years ahead as The New Neutral.
Q: What is your secular outlook for global credit markets?
Kiesel: The secular outlook for credit remains constructive. We see healing underway in developed markets balanced against slowing growth in emerging markets. In fact, it is the slow global growth outlook that allows developed market central banks to maintain lower-for-longer interest rates, which in turn support continued high demand for high quality income-producing assets. Other secular trends, such as aging populations in developed markets, also point to continuing demand for credit.
Another secular constant is investors’ desire to find the best companies anywhere in the world and the best opportunities within those companies – up and down the capital structure. This means demand could increase for unconstrained or absolute return credit strategies that look to pinpoint those kinds of opportunities.
Q: Does your secular outlook differentiate among securities along the credit spectrum?
Kiesel: Yes, in select industries and companies, the relative value across the capital structure has changed in the past several years, leading us to invest less in investment grade credit and more in bank loans, high yield and equities – provided they meet our secular investment criteria.
We see that not all companies are being run solely for bondholders today. The banking sector offers an example: With capital having almost doubled in the banking system since the recession, at least for the largest banks, we are starting to see more shareholder-friendly actions such as stock buybacks and increased dividends.
Q: How do the firm’s top-down secular views inform and align with the credit team’s bottom-up global research?
Kiesel: Our credit team makes use of a range of resources and views. We gather significant insights on the ground, traveling thousands and thousands of miles to meet with companies and find the best credit opportunities all over the world. We compare these bottom-up views with PIMCO’s top-down secular perspectives to identify specific companies with growth potential, supportive markets, superior asset quality and long-term pricing power. We also assess each company’s value across the capital structure – equity, loans, high yield and investment grade credit.
Q: What are your secular criteria for credit investments today?
Kiesel: Our essential framework for evaluating long-term value in a company has not changed in decades. We look for three key criteria: robust long-term growth potential, superior asset quality and pricing power.
We also assess the relative attractiveness and competitiveness of countries over the secular horizon. Several factors inform this view, including demographics, rule of law, crime and corruption, property rights, access to capital, supportive institutions, the labor force, the resource base and the speed of adopting new technology. Our views on the most competitive countries on a secular and cyclical basis inform our portfolio position today.
Combining these company- and country-specific perspectives with our secular New Neutral outlook, we see several attractive opportunities, including U.S. energy and the emerging markets consumer, among other areas.
Q: What specific factors have you optimistic about U.S. energy over the secular horizon?
Kiesel: Energy meets nearly all the criteria I just mentioned at both the company and country levels. Growth and asset quality are strong, particularly in the shale regions. The U.S. is a competitive economy that offers deep liquid capital markets, cheap access to capital, rule of law, property rights, good infrastructure, relatively low crime, ease of doing business, supportive institutions, a stable tax structure, and significant energy resources. Add to that list an increasingly competitive labor market, given how real wages have increased significantly in emerging markets while remaining relatively flat in the U.S., and also the relatively high productivity and education level of U.S. workers.
The U.S. energy revolution is real. Three years ago we called it a “game changer,” and every year since, energy production in the U.S. has grown by double digits. PIMCO’s advantage is that we have been studying this industry closely for over a decade, and we have aligned our positioning with some of the best exploration and production and midstream energy assets in the country. We are also invested in long-haul pipeline networks, and recently we have taken exposure in some of the first movers who are leading the export of propane, natural gas liquids and liquefied natural gas (LNG).
Q: You also mentioned secular opportunities in credit linked to the EM consumer – could you elaborate?
Kiesel: Yes, let’s highlight two areas in particular. First, note that themes surrounding China were a significant part of the debate at our recent Secular Forum. From a credit perspective, we believe China’s evolution toward more consumption-oriented growth will be very supportive for the Asia gaming market, particularly in Macau. The government is adding infrastructure to help consumers reach Macau quickly – developments include high speed rail and improved ports, not to mention the world’s largest suspension bridge under construction between Hong Kong Airport and Macau. And over the next decade, Macau aims to transform itself from a perceived VIP market to a high growth mass market. It will offer retail, restaurants and shows, looking to become a true destination instead of a day trip.
The other area where we are optimistic is the diamond industry, thanks to supply and demand dynamics. The emergence of the EM middle class means demand is rapidly increasing as consumers purchase diamonds for jewelry or as a store of wealth. However, supply is relatively constrained and unlikely to keep up with that demand; the diamond market is consolidated among just a few players.
Q: Where else are you finding companies with superior growth outlooks, pricing power and potential for alpha generation over a secular horizon?
Kiesel: One theme we discussed at the Forum is demographics, where an aging population in developed markets has us quite constructive on healthcare and pharmaceuticals.
We also see opportunity in broadband and wireless access globally, which in many areas – including emerging and frontier markets – has really become a necessity. Speed of information is absolutely critical today to being competitive in any region or industry – people will not let go of their broadband or their cell phones.
Another secular theme is the need, and the demand, for clean energy. Nowhere is this clearer than in China, where the population’s concerns over pollution and poor air quality are making clean energy a higher priority. We think China’s government will embrace natural gas as one of its energy solutions, which in turn would be very supportive for gas distribution companies.
Finally, we are still seeing above-trend growth and strong pricing power in building materials companies and in airlines, largely due to industry consolidation following the recession. As developed markets gradually heal, demand is coming back, in turn supporting pricing power.