Strategy Spotlight

PIMCO Introduces the PIMCO TRENDS Managed Futures Strategy

The strategy aims to provide returns that are uncorrelated with traditional asset classes.

PIMCO recently introduced the PIMCO TRENDS Managed Futures Strategy, a quantitative alternative strategy that seeks positive returns by capturing momentum across major asset classes. The strategy is informed by PIMCO’s market knowledge, macroeconomic insights and quantitative research capabilities. In addition, PIMCO TRENDS leverages the firm’s global trading platform across cash and derivatives markets and its expertise in active fixed income management.

As portfolio manager Vineer Bhansali explains in the following interview, the strategy can serve as an alternative source of returns that are expected to be uncorrelated with traditional asset classes, potentially enhancing both overall returns and portfolio diversification.

Q: What is the PIMCO TRENDS Managed Futures Strategy?
A: PIMCO TRENDS is a quantitative alternative strategy that seeks to capitalize on the tendency of markets to move in trends. Numerous studies show that over short periods of time, assets that rise in price tend to keep rising; those that decline tend to keep declining. We aim to capitalize on these price trends via investments in futures contracts across major asset classes, including equities, interest rates, commodities and currencies. Because futures contracts are derivatives, cash is freed up and invested in a collateral portfolio of fixed income securities that is actively managed consistent with PIMCO’s broader economic views and within our risk- and collateral-management frameworks.

In broad terms, the PIMCO TRENDS Managed Futures Strategy would be considered a “trend-following” or “time-series momentum” strategy.

Q: Why invest in this strategy today?
A: We think today’s environment, where investors face volatile and uncertain conditions, is an opportune time to add strategies, such as managed futures, which can offer alternative sources of return and portfolio diversification.

PIMCO’s New Normal thesis anticipates higher volatility and lower returns across traditional asset classes such as stocks and bonds. Particularly in this environment, investors are looking for complementary strategies to help augment traditional portfolios and provide cost-effective diversification, reduce volatility and improve returns. Managed futures has the potential to offer these benefits.

Q: Could you elaborate on behavioral biases and talk about the theory behind this strategy? What is trend-following and why does it exist?
A: There are multiple explanations, most of which relate to the fact that people do not have complete and pure forecasts of the future, they do not all have the same data, and they are not all completely rational. There is a behavioral bias, for instance, that leads some investors to discount the importance of fundamental news. As markets further digest this information, however, trends may evolve. There also are social dynamics, such as those that give rise to a “herding mentality,” which can lead investors to buy perceived winners and sell losers. In general, people may trade based on recent performance of markets, so trends reinforce themselves.

Then, of course, there are demand and supply issues. When the Federal Reserve raises or cuts rates, for example, they do not move all at once; they tend do so over time. For all these reasons, markets tend to move slowly and that can result in trends.

Q: Based on the historical record, when are trend-following strategies likely to excel or underperform?
A: Our research suggests these strategies tend to do best when there are large readjustments, especially when risk assets decline considerably. These strategies generally did well in 2008, for example, which was a period of major secular readjustment. On the other hand, these strategies tend to do only moderately well or underperform when markets meander or when sharp, unexpected reversals occur.

Q: What is different about PIMCO’s approach?
A: PIMCO’s view is that trend-following, or momentum, has evolved from an alpha strategy to an alternative beta. Our research suggests the major characteristics of these strategies are obtainable through a relatively straight-forward method. Our approach, which has been embedded in some of our asset allocation and hedge fund strategies, seeks to capture the core trend-following attributes while applying PIMCO’s knowledge of the global markets to inform our quantitative trading strategy.

My team, the Quantitative Portfolio Group, collaborates with the Research Advisory Group, which is comprised of senior portfolio managers representing all major risk markets, to regularly scrutinize and refine our approach. As an example, markets and contracts traded may be influenced by bottom-up and top-down views from group members.

Managed futures strategies are attractive to investors because of their potential for portfolio diversification, outperformance in periods of market crises and a positive return in many market environments. Given our use of this strategy in our asset allocation products, we focus on all three of these attributes instead of solely on absolute return.

Finally, and we believe this is a big advantage, PIMCO has a well-established program to manage the underlying cash equivalents and short- to intermediate-term bonds held as collateral on the derivatives contracts. The strategy seeks additional sources of return without taking on too much risk.

Q: How might investors implement this strategy in their portfolios?
A: The strategy may provide diversification potential in many traditional portfolios. It is an alternative beta (defined as a systematic source of return potential that cannot be obtained directly in the market via traditional indexes) that has been shown theoretically and empirically to be critical to robust portfolio construction. As a stand-alone investment, the strategy can be used as a cost-effective absolute return vehicle that may provide diversification and attractive left tail performance potential.

Q: How does the PIMCO TRENDS Managed Futures Strategy advance PIMCO’s suite of innovative strategies?
A: PIMCO has built an array of non-traditional approaches that we believe have an important role to play in portfolio construction. The PIMCO TRENDS Managed Futures Strategy is the first stand-alone, predominantly quantitative strategy that we have developed. This offering is integral to PIMCO’s efforts to provide clients with strategies that seek to manage risk, enhance diversification and maintain attractive risk-adjusted returns.

Disclosures

Past performance is not a guarantee or a reliable indicator of future results. Absolute return portfolios may not fully participate in strong positive market rallies. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. The models evaluate securities or securities markets based on certain assumptions concerning the interplay of market factors. Models used may not adequately take into account certain factors, may not perform as intended, and may result in a decline in the value of your investment, which could be substantial. Diversification does not ensure against loss. 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. Investors should consult their investment professional prior to making an investment decision.

This material contains the opinions of the author but not necessarily those of PIMCO 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 and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2014, PIMCO.