Many people know PIMCO as a leading manager of bonds. But on 14 March, Lipper named PIMCO the best large equity manager in the U.S. for the fourth year in a row.
We are honored by this recognition, which reflects the success of PIMCO’s StocksPLUS suite of strategies in delivering value to equity investors. Introduced in 1986, these strategies seek to combine the best of what passive indexing and active management each attempt to deliver. They replicate passive exposure to equity indexes via derivatives, an approach that requires only a small fraction of the notional value of this exposure. The capital that remains is then invested in an actively managed portfolio of fixed income securities – the PLUS component – with the potential to enhance returns.
The latest evolution in this strategy suite occurred on 22 March, when PIMCO changed the names and recommended guidelines of a majority of these strategies. The PLUS component is now labeled either AR or Absolute Return, rather than TR or Total Return. For example, the StocksPLUS Total Return suite of strategies became the StocksPLUS Absolute Return suite of strategies.
As Sabrina Callin, a managing director who oversees PIMCO’s StocksPLUS products, explains, these changes were meant to reflect a more flexible approach to the strategies’ fixed income management. There was no change, however, to the methods of replicating equity index exposures, and we expect to maintain a similar risk profile within the fixed income portfolios.
Q: How has PIMCO succeeded with the StocksPLUS suite of strategies?
A: The equity derivatives, typically futures or swaps, are priced such that investors receive the total return of the equity index in exchange for a money-market-based financing rate. As such, if PIMCO outperforms this money market cost, then it should translate directly into equity market outperformance. Our success relies on PIMCO’s active fixed income management skill set and the inherent diversification benefits from exposure to bonds. Our Fundamental IndexPLUS AR Strategies, which replicate a fundamental equity index that weights companies based on dividends, book value, cash flow and sales – rather than market capitalization – provide an additional way to gain equity exposure coupled with the diversification of the fixed income portfolio.
Q: Could you please discuss the history of the strategies?
A: In the original version of the strategy the PLUS component, which serves as collateral for equity derivatives, is an actively managed short-term bond portfolio. However, in response to demand from investors for a version that seeks a higher return, we introduced StocksPLUS Total Return in 2002. Rather than a 0-1 year short duration fixed income portfolio, the StocksPLUS Total Return collateral portfolio has attributes more commonly associated with core bond portfolios, like our Total Return strategy, albeit with a broader duration range.
Since then, the StocksPLUS TR suite has expanded to include cap-weighted indexes with large cap, small cap, emerging market and international equity strategies, and the fundamental and related market-neutral indexes designed by Research Affiliates.
Q: Will the overall StocksPLUS TR architecture or investment philosophy change?
A: Not at all. However, we are introducing increased flexibility in managing the fixed income component, and clarifying that the fixed income portfolio seeks to achieve an absolute return over a money market interest rate, rather than total return over a fixed income index benchmark.
Q: How should investors think about the bond component in an overall portfolio context?
A: Certainly, investors should consider risks related to the absolute return bond portfolio in the context of their overall asset allocation. The reality, however, is that fixed income risk as a percentage of overall risk in most investor portfolios is modest. Even for portfolios that appear to be reasonably diversified among stock, bond and alternative investments, equity risk typically dominates while the overall risk attributed to fixed income exposure tends to be quite low. Thus, the fixed income risks in these strategies may improve overall portfolio diversification.
It’s also worth noting that the duration range for the StocksPLUS TR strategies is -3 to +8 years. So, in a rising-rate environment, in which bond prices may fall and bond indexes may deliver negative returns, our absolute return bond portfolios could generate positive returns thanks to shorter- or even negative-duration bond exposures.
Q: Do you believe the StocksPLUS approach is better than traditional passive approaches to equity ownership?
A: Given the potential for the fixed income component of our strategies to deliver excess returns over traditional passive equity indexes with a similar level of risk, then yes, we believe the end result is better. In contrast, passive equity index strategies, by definition, underperform the reference equity index after fees, even when equity markets decline.
The StocksPLUS approach, particularly our Fundamental Index-based strategies, also offers additional sources of diversification and potential downside risk reduction. Unlike traditional indexes weighted by market capitalization, the Research Affiliates’ indexes reflect the economic footprint of companies, thereby breaking the stock-price link, and eliminating the performance drag that might arise from the systematic overweighting of overvalued stocks and underweighting of undervalued stocks.
Without doubt, there are active equity strategies with philosophies and processes that have the potential to deliver attractive value on a risk-adjusted basis across different market cycles. In addition to our StocksPLUS suite, PIMCO offers a variety of actively managed equity strategies targeting global deep value, emerging market and high dividend stocks, among others. We view these strategies as complementary to our StocksPLUS strategies as the alpha sources are entirely independent.
Q: Why should investors consider the StocksPLUS AR approach?
A: Our approach is not the most common way to obtain equity market exposure. However, the potential benefits for investors who are willing to consider an alternative approach can be compelling – and particularly so in a lower return environment where many investors will be seeking higher return potential. If PIMCO is able to manage an absolute return bond portfolio with a global opportunity set such that it outperforms a money market interest rate and manager fees, investors should receive equity market returns “PLUS.” In addition to PIMCO’s more than 26 years of experience managing StocksPLUS portfolios, it’s important to remember that diversity is a plus – in investments as in most aspects of life.
What matters most to us, of course, is delivering results that investors need to meet their objectives. That is, and always has been, our goal at PIMCO.