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Resiliency Through Flexibility

Lower yields are signaling the possibility of a slowing recovery, but PIMCO has several ideas to stay flexible to help maintain returns and hedge against risk, according to Group CIO Dan Ivascyn.

Text on screen: PIMCO

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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.

There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

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. 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. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. U.S. agency mortgage-backed securities issued by Ginnie Mae (GNMA) are backed by the full faith and credit of the United States government. Securities issued by Freddie Mac (FHLMC) and Fannie Mae (FNMA) provide an agency guarantee of timely repayment of principal and interest but are not backed by the full faith and credit of the U.S. government. Alternative investments involve a high degree of risk and can be illiquid due to restrictions on transfer and lack of a secondary trading market. They can be highly leveraged, speculative and volatile, and an investor could lose all or a substantial amount of an investment. Alternative investments may lack transparency as to share price, valuation and portfolio holdings. Complex tax structures often result in delayed tax reporting. Diversification does not ensure against loss.

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