Recorded 7 September 2016
Hi, I’m David Fisher, and I’m here today with Dan Ivascyn to talk a bit about the view from the Investment Committee, or the IC. Dan, thanks for joining me
today for this conversation.
I wanted to talk about a little bit of an old topic for the IC, which is this idea of The New Neutral, a concept that PIMCO developed several years ago.
Central bankers seem to have embraced PIMCO’s New Neutral. Is that true, first of all, do you think? And if so, what are the investment implications?
Sure, I think that is true. Back at our Secular Forum, the gathering of all PIMCO investment professionals, during the summer of 2014, we began focusing on
implications for policy rates. Coming out of that forum, it was a topic that Rich Clarida encouraged us to explore.
We concluded that the neutral policy rate was likely much lower than the market anticipated and much lower than would be suggested from historical analysis
alone. And I think that over the course of the last couple of years in particular, the financial markets began pricing that in. Over the past several
months, central bankers have begun focusing increasingly on neutral policy rates and believe, as we do, that the neutral rate is much lower than it has
This has a lot of implications: One is that interest rates are likely to remain low and range-bound longer than people initially anticipated. So, as an
active investor going forward, I think it’s important to realize that much of this thesis in regards to low interest rates and accommodation from
policymakers is embedded in market pricing. And, as we talked about coming out of this year’s Secular Forum, that creates considerable risks going forward
if expectations were to shift; it has created an environment that we think warrants more caution than it did a couple years ago.
Something that I hear a lot about in conversations with clients is, How do I generate returns? Yields are low, and expected returns for bonds and other
asset classes are low. That seems to have pushed people essentially all into the same trade, which is buying higher-yielding assets. Is the IC at all
concerned about the risks in the system of everyone essentially looking for that same way to generate returns?
We are concerned. Investors need to be willing to expect lower returns going forward in the fixed income markets, for example, with yields having been a
lot lower over the course of the last couple of years. It typically involves taking more risk, and we do think people are taking more risk to generate
returns. As active managers, our job is to manage portfolios with a focus on that risk ‒ to ensure that we are taking responsible exposures to key sectors
of the market and that we are looking to preserve capital during environments that typically coincide with more volatility, more downside risk across
economies and financial markets. So, this is a key consideration going forward.
Over the past year, we have seen a couple of instances where volatility has spiked: Last summer and earlier this year around the Brexit vote, we saw spikes
in volatility that were relatively short-lived. Do you think that is part and parcel of this environment ‒ these spikes in volatility ‒ and if so, how does
the IC think about taking advantage of those types of volatility?
It is. I will make a couple points there.
One, we do think that although returns will be lower than they have been historically, volatility will remain at similar levels and even trend higher over
time. We see a lot of financial assets now held in vehicles where flows could be unpredictable and lead to temporary bouts of overshooting. You also have
financial markets increasingly impacted by very powerful and significant flows from non-traditional players, like the central banks that we have been
talking about today.
So, for an active manager, patience is critically important. You want to sit back and maintain liquidity and actively manage that liquidity so you can go
on the offense during these periods of dislocation.
But a second point is arguably the more important, and that is that all volatility doesn’t need to be localized. You have a situation in the world today
where debt levels are at all-time highs, yet nominal growth remains very low. And you have uncertainty building ‒ you see it in politics ‒ and this is
leading to significant unpredictability, which at some point can lead to not only volatility, but permanent loss of capital, given these debt levels.
We had a situation with the Brexit vote where asset markets themselves began to build in some pretty negative scenarios for Brexit, regardless of the
outcome of that referendum. And there were certain segments of our business where we were able to add some risk ahead of that vote and where we have been
winding down some of that exposure in the subsequent weeks and months.
Again, that is an example of a situation with considerable uncertainty, where risk management is the number one priority. Liquidity management is closely
related to risk management, of course. Then, when we saw major shifts in pricing of assets ‒ in retrospect, a little bit of over-shooting ‒ we looked to
come in and take advantage of that on behalf of our clients across our portfolios.
Can you talk a little bit about any other major topics of conversation in the IC? Lately, we have talked a little bit about macro, but I know you don’t
just talk about macro and markets. You talk about individual securities opportunities ‒ at a granular level. What kinds of opportunities have you discussed
lately in IC?
This is a critically important point. We spend a lot of time talking about macro themes; they are very important. But we are in a pretty unique
environment. We are in an environment where we are seeing considerable re-regulation across the financial sector. There is a lot of focus on what certain
financial institutions can buy and sell in markets, and there are also these very powerful central bank flows. This is leading to a tremendous amount of
market inefficiencies. And I am probably going to put the audience to sleep for a little bit now. But you are talking about situations that don’t represent
massive value in any one trade. But they are extremely attractive, and when you look for 10, 20, hundreds of these opportunities, they could have a
powerful impact on returns.
Probably the easiest example I could provide would be a situation that we have today, where the same company’s debt will trade at materially different
levels depending on what currency it is denominated in or what region it is issued in. So you can reduce credit risk, while keeping spread constant, simply
by taking advantage of the full global opportunity set. Similar mispricing is in the front-end of yield curves today, where certain securities that are
eligible for certain types of accounts are trading much tighter than other very high-quality alternatives. We have seen this in various high-quality
investments in the front-end of yield curves. These are just a couple of examples. I could go on for quite some time.
What that means is that the Investment Committee is bringing in a lot of our specialists, bringing in even relatively new members to the investment team to
go through these ideas and provide clear direction to the specialty desks so we could implement and operate these programs and look to add value
independent of a macro view. If we could do that, with structural opportunities in markets, it just creates better risk-adjusted returns for our clients at
the end of the day.
Great, thanks for all the insights, and thank you for joining us today for this installment of the View from the IC.
Watch the full video here: View from the Investment Committee