Resiliency Through Flexibility
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Text on screen: Kimberley Stafford, Global Head of Product Strategy
Kim Stafford: Hello. I’m Kim Stafford, and I’m here again with PIMCO group CIO Dan Ivascyn, to give you an inside look at some of the recent discussions taking place within PIMCO’s investment committee, or IC. Thank you for joining us, Dan.
Dan Ivascyn: Thanks, Kim.
Kim Stafford: Many investors have been surprised about the decline in yields over the recent period. So, can you discuss why yields have been falling, and if bond markets are trying to signal to any important trends to investors, particularly in light of the fact that we’ve seen equities reach new highs?
Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer
Dan Ivascyn: Sure. It’s of course always tough to know for sure what’s driving moves in interest rates, but let me bucket them in two categories, the first being technical. We still are in a world where there’s very little yield.
So this is a market environment, or a trading environment, that feels like people want to add duration or interest rate exposure.
Text on screen: Driving factors behind interest rate moves: 1. Pent up demand for interest rate exposure
Images on screen: PIMCO trade floor
Of course, there are some legitimate concerns around inflation but in general, a lot of pent-up demand for interest rate exposure. We think that is helping support yields, even driving yields lower.
But from a fundamental perspective, looking at economic data carefully over the course of the last couple of months,
Text on screen: Driving factors behind interest rate moves: 2. Signs we have reached peak growth
Images on screen: PIMCO trade floor
there have been signs that we have reached peak growth, that a lot of the impact of the stimulus that occurred last year is beginning to dissipate, that these COVID variants, led by Delta, of course, is leading to some growth pressure or reopening pressure that we’re seeing across the economy here in this country, but in other regions around the world, particularly emerging markets, as well. And that has, we think, caused the market to reduce their growth assumptions somewhat.
Kim Stafford: You mentioned low yields, you mentioned the search for return. So, we’ve definitely seen an uptick in interest in alternative investments, particularly for clients who can give up liquidity. So, how are you thinking about investing across public and private markets, and how do you assess which strategies may or may not be appropriate for different investors?
Dan Ivascyn: Clients are looking to be creative to maintain returns they’ve grown to expect, or given pretty full valuations, looking for resiliency and protection where they can find it.
Text on screen: Maintaining flexibility may help clients looking for resiliency
Images on screen: PIMCO trade floor
And one way to achieve that, of course, is to be more flexible in terms of the mandates that you focus on. That may mean giving up liquidity, it may mean straying away from what is typically in a more traditional fixed income or equity benchmark type product.
And that, of course, is what PIMCO is trying to assist our investors with. Be solutions providers, look to create flexible mandates when a client can afford to give up some liquidity.
Images on screen: The Federal Reserve building
And in the current environment, with central bank support being so impactful to more traditional areas of the market, we think it makes perfect sense to look for that flexibility, and that sometimes means tapping into opportunities on the private side of the opportunity set, but certainly expanding the mandate, being more flexible, sometimes working in a very non-traditional way as true partners in various types of strategic mandates, as well. And I think by doing that, you can pick up meaningful incremental return, incremental yield, if you’re talking about the fixed income opportunity set. The relative attractiveness of some of these more off the run sectors remains quite wide, from a historical perspective.
Kim Stafford: And any examples of alternatives that you’re seeing that you find opportunity today?
Dan Ivascyn: Sure. Looking at the commercial real estate markets,
Text on screen: Areas of opportunity: 1. Commercial mortgage-backed securities
Images on screen: Corporate office buildings
the CMBS, more traditional segment of the public opportunity set have seen spreads compress significantly, across the capital structure. AAA risk, but also lower-rated risk, even higher-yielding segments of a typical CMBS capital structure have become a bit expensive, again, from a historical perspective. You look at the same or similar risk over in parts of the private opportunity set, and there continues to be significant value.
Similar example in the corporate credit space.
Text on screen: Areas of opportunity: 2. Corporate credit COVID-19 recovery themes
Images on screen: Gaming, a couple dining outside, hotel exterior
In the more liquid segments of the market, certain Covid recovery themes and trades we continue to find attractive. Gaming, hospitality, the leisure sectors, as examples of segments of the market that we expect to continue to perform. But when you cross over to the private opportunity set, similar themes, the ability to invest with more direct control, potentially better protective covenants, and an expanded opportunity set.
Kim Stafford: You mention commercial real estate, maybe we’ll delve a little bit deeper there. An area that straddles both public and private markets, one that has had a little bit of upheaval during the pandemic. So, maybe specific opportunities in commercial real estate from your perspective.
Dan Ivascyn: Absolutely right. There’s the opportunity to potentially generate returns,
Text on screen: Commercial real estate opportunities: 1. Lodging
Images on screen: Hotel exteriors
by targeting areas of the market that were most significantly hit by the Covid situation, the lodging sector as an example.
Text on screen: Commercial real estate opportunities: 2. Office space
Images on screen: Corporate office buildings
But there’s also ways to invest with a more resilient profile. Segments of the higher quality areas of the office space, as an example. Then, finally, from a very top-down perspective, although we’re early in the recovery process, from a valuation perspective, things feel late cycle. There’s a lot of debt out there in the world. A lot of debt within the more traditional corporate credit markets. And because of this demand for yield globally, you don’t get the same type of protective covenants. So it’s nice, late in the cycle, to have an investment that’s backed by a real building, backed by a hard asset.
Text on screen: Commercial real estate opportunities: 3. Commercial mortgage-backed securities
Images on screen: Residential neighborhoods
The commercial real estate, even commercial mortgage backed securities, are an example of a profile that typically is more resilient than securing corporate debt alternatives. Not alone; we still like asset-backed investments, housing related investments, particularly seasoned investments that don’t rely on home prices to continue to increase, but have benefited from the significant increases we’ve seen the last year or two.
But we think those are good later cycle investments from a valuation perspective.
Kim Stafford: So where else where PIMCO’s seeing, what are other high-conviction ideas right now, and importantly, where are we avoiding in markets?
Dan Ivascyn: Sure. So,
Text on screen: TITLE – High conviction ideas and market areas to avoid: BULLETS – Defensive on interest rate exposure, Constructive on inflation in the base case, Cautious on generic corporate credit, Selective in emerging markets
we’re defensive on interest rate exposure here. We’re fairly constructive, at least in the base case, that inflation will remain relatively under control, and revert back to levels that central banks are comfortable with.
You’re just not getting paid a lot, to take significant inflation risk across portfolios, high quality segments of the bond market look a little expensive to us.
Also, more generic areas of the corporate credit markets, we think look a lot less interesting to us.
Then finally there are areas of the emerging markets that we think make sense to diversify portfolio exposure, generate some incremental returns. But you have to be incredibly selective, down at the country level, and then even within a country, determining what the best way to express views are, where it’s external debt, local rates, currency.
Kim Stafford: Thanks very much, Dan, and thanks to all of you for joining us, and we’ll see you next time.
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Please note that the following contains the opinions of the manager as of the date noted, and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.
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