Low Duration Income: Balancing Income Generation and Downside Protection

Text on screen: PIMCO

Text on screen: Prerna Gupta, Portfolio Strategist

Gupta: Alfred thank you so much for joining us, to start us off, can you tell us the top three themes for low duration income from your perspective?

Text on screen: Alfred Murata, Portfolio Manager, Mortgage Credit

Murata: So first, the low duration income strategy is a strategy where we're trying to generate attractive level of income. We're trying to protect against the downside. In contrast to the income

Text on screen: Low duration income aims to reduce interest rate risk, credit risk, and overall volatility

Images on screen: Housing market

strategy the main differences are that we're trying to have lower interest rate risk and to have lower credit risk and overall hopefully have less volatility as well. Now in today's environment we think that the volatility will continue, but the starting point it yields is very elevated today. So that's positive for return generation, nothing happens.

Greater potential for capital appreciation if you do have an optimistic environment and better downside protection if you do have a more challenging economic environment.

Text on screen: Capitalizing on bank de-leveraging is our most compelling trade theme

Images on screen: Credit card transactions

And the trade theme that we find most compelling today in the low duration income strategy is to take advantage of the de-leveraging of the banks. What we're seeing today is that we have this unusual phenomenon where we have the ability to move up in credit qualityand pickup spread. So that's a top theme that we have today.

Gupta: So hearing that some investors may think it is simply the flagship income strategy with the lower duration profile, is that how you and the team manage the strategy?

Murata: I'd say that in general we are using the same macroeconomic themes.

So the objective is to try to have less volatility in the low duration income strategy than income strategy. So it's not just an income strategy with less interest rate risk, it's also in general trying to have less credit risk and hopefully then in combination have less volatility overall. 

Gupta: You mentioned that low duration income invests across global bond sectors. How do you feel that differs from a single sector approach in the short term category?

Murata: So we think it's very beneficial to have both flexibility to take advantage of the global opportunity set but also have the resources of PIMCO to capitalize on the global opportunity set. What we've seen in financial markets is that there's volatility from time to time and some asset classes and some periods are very attractively priced. Other periods, other asset classes are more attractively priced.

Text on screen: Flexibility to rotate sectors and resources to capitalize on this flexibility enhances fixed income benefits

Images on screen: PIMCO trade floor

So having the flexibility to rotate between various sectors of the global fixed income universe, we think is beneficial. But it's also important to have the resource of PIMCO to capitalize on this flexibility.

If you just have flexibility but don't have resources capitalized on them, it's actually not going to be particularly beneficial for investors. So with respect to the low duration income strategy, having the flexibility but the resources to capitalize them, that's something that we think has worked very well over the years for our investors. 

Gupta: So what specifically about today's environment makes low duration income strategy particularly attractive, and how should investors think about this in light of interest rate volatility and monetary policy uncertainty?

Murata: So I'd say the investment theme that we find most compelling today is to take advantage of the de-leveraging of the banks. What has occurred is that the banks today are trying to de-risk their balance sheets. The banks lost hundreds of billions of dollars in 2022 when rates sold off dramatically. And today the banks are trying to hoard capital. So investments that the banks typically have found attractive to invest in, such as agency mortgage-backed securities or other higher quality asset-backed securities.

Today, the banks are not investing in those asset classes.

Images on screen: Houses / neighborhood

And what we've seen today is that you're actually getting a wider spread if you invest in agency mortgage backed securities which are bonds that are backed for residential loans that are guaranteed for the government or agency of the government, than if you invest in investment grade corporate bonds, which might be say triple B rated.

So we like the idea of moving up in credit qualitybut also picking up spread at the same time. That's something that's unusual in the fixed income universe. So that's the main theme that we find attractive to invest in. With respect to interest rate risk, we think that today the level of rates is quite elevated. We think over time interest rates are going to be coming down. So that's another area that can supplement returns.

And then with respect to credit exposures,

Text on screen: Tactical credit approach is essential in today's market

Images on screen: PIMCO trade floor

we think that having a tactical approach with respect to credit is something that's warranted in today's marketplace. We think there'll be lots of volatility and having ability to deploy capital and take advantage of its volatility is something that's, we think that's something that's very compelling for the low duration income strategy. 

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Past performance is not a guarantee or a reliable indicator of future results

This material reflects the current opinions of the manager, and such opinions are subject to change without notice.  There can be no assurance that such opinions are or will remain accurate, or that other opinions or methodologies would not produce different results.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.  Actual events or results may differ materially from those reflected or contemplated in any opinions contained herein. Certain information presented herein is as of a specified reference date, and may have changed significantly since such date.  None of the Fund, PIMCO or any of their affiliates shall have any duty to update any of the information presented herein.

A word about risk: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. 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. Investing in derivatives could lose more than the amount invested.

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