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Investment Strategies

Q4 Credit Market Update: PIMCO Flexible Credit Income Fund (PFLEX)

Now, more than ever, a flexible approach to investing can help clients navigate the complexities of the current market. For more insights please visit https://www.pimco.com/us/en/investment-strategies/interval-funds.

Text on screen: PIMCO

Text on screen: The Market

Text on screen: TITLE - Credit markets in review: 2023; SUBTITLE – Credit returns: YTD 2023 (%)

Image on screen: A bar chart shows the market returns for six different categories of credit for the year of 2023. The first three bars, shaded in blue on the left-hand side, represent corporate credit, showing a 13.5% return for high yield, 10.2% for leveraged loans, and 8.4% for investment grade. On the right, three bars show the performance for securitized credit: a loss of -6.1% for commercial mortgage-backed securities, and a gain of 6.8% for residential mortgages and 8.3% for specialty finance.

This year was marked by strong performance in credit markets, with positive returns continuing into the fourth quarter as markets began pricing in the likelihood of looser policy in 2024. We saw a more significant rally in fixed income markets into the end of the year, and tightening across credit sectors. Economic data was generally constructive with inflation trending lower towards central bank targets. However, we don’t think we are out of the woods yet from the standpoint of inflation or the risks of a harder landing.

Investors continued to gravitate towards floating-rate leveraged loans because they don’t have exposure to duration, which created a lot of volatility up until Q4. Because of this, more narrowly defined strategies such as direct lending have had an easier time over the past couple years. But floating rate borrowers are being impacted by higher interest rates, and in many cases have lower overall credit ratings, and less business flexibility.

Structured credit, including assets tied to the consumer or U.S. households as opposed to U.S. corporates, also performed well. This is a sector that is not only well insulated from deteriorating economic fundamentals, but could perform well even if home prices were to drop. 

Text on screen: PFLEX Portfolio positioning

Text on screen: TITLE – The PFLEX strategy takes a flexible approach to investing across a broad opportunity set; SUBTITLE – The portfolio has shifted allocation over time to capture opportunities across credit markets

Image on screen: A bar chart shows the allocation of five different asset classes within PFLEX for the last 9 quarters. The first bar represents the quarter ending in December 2021. Each bar shows colored shaded regions that help show the changes over time in the allocations. It’s clear that corporate credit is the largest single holding in all of the allocations over time. By December 2023, corporate credit makes up 33% of holdings, down from a peak of 43% in the third quarter of 2021. Residential mortgages represents the next largest allocation in December 2023, with a 22% allocation, up from its lowest level of 14% in March 2022. Commercial mortgages in December 2023 represented 18% of the holdings, down 14% in December 2021. Allocation to specialty finance in December 2023 is 9%, which is close to its average across the period. Other holdings, including cash, equities, emerging markets, and smaller sectors, represent about 18% of the allocation.

PFLEX is a flexible, income-oriented solution to help enhance return potential for your clients, but doing so with a focus on diversification.

The Fund has been focused on investing in areas of the market that have repriced lower, taking advantage of volatility brought on by the rapid rise in interest rate. We believe that there’s an opportunity for investors to get into a portfolio marked at a pretty meaningful discount to par.

In structured credit, we’ve been focused on assets tied to U.S. households, mostly seasoned residential mortgage assets. Borrowers in many cases have been in their properties for 15 years or even longer, and have benefitted from significant price appreciation throughout the years where Loan to Value ratios are now in the 50s and 60s.

We’ve also built a diversified portfolio of commercial mortgage-backed securities (CMBS) where higher interest rates and changes in work-from-home trends have contributed to substantial uncertainty, and an opportunity to acquire bonds at what we believe are attractive discounts to par. The Fund’s CMBS exposure is mostly backed by hotel and hospitality assets where fundamentals are more attractive compared to other sectors.

Floating rate leveraged credit has held up better than we would have expected from a pricing standpoint, but beneath the surface, we still believe there is room for caution. We’ve been much more comfortable investing in asset-based risk, and when it comes to corporate credit, capitalizing on special situations opportunities. In these more complex situations, we look to lend to companies at attractive levels, and at the same time, use our size and scale to obtain control of credit documentation, maintain seniority in the capital structure, and limit downside risk. While the Fund has been consciously defensive in its approach to corporate credit, these types of special situations opportunities still offer considerable upside potential, but may take longer to play out. In fact, we saw very positive developments over the fourth quarter in some of these investments, and a handful contributed over half the Fund’s gains during Q4. Recent strong performance in our view is growing indication that an opportunistic approach and focus on relative value outside generic corporate credit will be rewarded.

Text on screen: The opportunity

Text on screen: TITLE – Structured markets remain attractive relative to generic leveraged credit in our view; SUBTITLE – Spread valuations over the past five years

Image on screen: A chart shows the ranges of spread valuations over the past five years for five different fixed-income classes: residential mortgages, commercial mortgage-backed securities (CMBS), U.S. high yield, leveraged loans, and specialty finance. The chart plots the current spreads for the asset classes, represented by a green diamond plot on a horizontal line for each category. The X-axis shows zero to 100th percentile. To the left-hand side shows higher spreads, with the bottom quartile shaded in blue, representing cheaply-priced assets. Conversely, the right-hand side shows the top quartile, shaded in red, representing the low end of the spread ranges, which are expensively-priced assets. The first category, showing residential mortgages, indicates a current spread of 250 basis points above SOFR, putting it below the median, or just outside the cheaply-priced zone.

Looking forward, we are incredibly excited about not only our ability to potentially generate attractive levels of income for investors, but also significant prospects for capital appreciation as well. We think the current market, with high starting yields in fixed income, an increasing pipeline of exciting opportunities, and banks retrenching, is near ideal for investors looking to allocate capital today. And in PFLEX, we think investors will once again benefit from active management, a diversified approach, and disciplined relative value lens. When looking at the PFLEX portfolio, we think that you have a real accurate representation of value today, and that value is quite significant in terms of many of the sectors we’re investing in – for example, structured credit where valuations for residential mortgages, CMBS, and specialty finance are compelling. We’re trying to bring the full set of tools we have here at PIMCO on both the public and private side of our business to prudently diversify and build resiliency into the portfolio, allowing us to be ready to go on offense in 2024, and that’s exactly what the interval fund structure of PFLEX is supposed to do. We have a lot of conviction that the winning playbook for investing over the next several years will be quite different from what’s worked over the past several years.

Text on screen: The recap

Text on screen: TITLE - We think the PFLEX strategy is an attractive solution for this higher rate market environment.

Image on screen: A graphic lists bullet points that follow along with the narration of the video. The bullets are divided into three sections: Market Review, Portfolio Positioning and The Opportunity. The two bullets under Market Review read, 1) Credit markets performed strongly in 2023, with positive returns extending into Q4 due to anticipated looser policy in 2024, despite lingering inflation and economic concerns; 2) Investors leaned towards floating-rate senior secured loans for less volatility, while structured credit tied to consumers and U.S. households showed resilience and potential for good performance.

The three bullets under Portfolio Positioning read, 1) PFLEX aims to capitalize on market volatility by investing in assets that have repriced lower, offering investors the opportunity to invest at a discount to par; 2) PFLEX has invested in resilient structured credit tied to U.S. households and commercial mortgage-backed securities, particularly in the hospitality sector, offering attractive discounts to par; 3) Despite caution in floating rate leveraged credit, the Fund sees potential in corporate special situations, which contributed significantly to Q4 gains.

The three bullets under The Opportunity read, 1) We believe the current market, with high yields in fixed income and numerous opportunities, is ideal for investors looking to allocate capital today; 2) PFLEX uses active management in building a diversified portfolio focused on where we see significant value in area such as structured credit; 3) Using PIMCO's resources, PFLEX stands, ready to seize opportunities in 2024 through a flexible and opportunistic approach.

Text on screen: TITLE – Performance

Image on screen: A disclaimer on the top about performance metrics followed by a performance table in the middle for Dec 31st 2023.

Text on screen: For more insights and information visit pimco.com

Text on screen: PIMCO


Investors should consider the investment objectives, risks, charges and expenses of the fund carefully before investing. This and other information are contained in the fund’s prospectus, which may be obtained by contacting your investment professional or PIMCO representative or by visiting www.pimco.com. Please read the prospectus carefully before you invest or send money.

The fund is an unlisted closed-end “interval fund.” Limited liquidity is provided to shareholders only through the fund’s quarterly offers to repurchase between 5% to 25% of its outstanding shares at net asset value (subject to applicable law and approval of the Board of Trustees, the Fund currently expects to offer to repurchase 5% of outstanding shares per quarter). Although interval funds provide limited liquidity to investors by offering to repurchase a limited amount of shares on a periodic basis, investors should consider shares of the Fund to be an illiquid investment.

Investments made by the Fund and the results achieved by the Fund are not expected to be the same as those made by any other PIMCO-advised Fund, including those with a similar name, investment objective or policies.  A new or smaller Fund’s performance may not represent how the Fund is expected to or may perform in the long-term.  New Funds have limited operating histories for investors to evaluate and new and smaller Funds may not attract sufficient assets to achieve investment and trading efficiencies. 

It is important to note that differences exist between the Fund’s daily internal accounting records, the fund’s financial statements prepared in accordance with U.S. GAAP, and reporting practices under income tax regulations. It is possible that the Fund may not issue a Section 19 Notice in situations where the Fund’s financial statements prepared later and in accordance with U.S. GAAP or the final tax character of those distributions might later report that the sources of those distributions included capital gains and/or a return of capital. Please see the fund’s most recent shareholder report for more details.

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-related assets and other asset-backed instruments 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. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. 

Investments in distressed loans and bankrupt companies are speculative and the repayment of default obligations contains significant uncertainties.  The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Structured products such as collateralized debt obligations are also highly complex instruments, typically involving a high degree of risk; use of these instruments may involve derivative instruments that could lose more than the principal amount invested. 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. The fund typically uses leverage by borrowing for investment purposes to purchase additional shares of other PIMCO funds in an effort to increase portfolio returns. Leveraging transactions, including borrowing, may cause a portfolio to be more volatile than if the portfolio had not been leveraged. Leveraging transactions typically involve expenses. When these interest expenses exceed the rate of return on investments purchased by the fund, with such leverage can reduce fund returns. The use of leverage may cause a portfolio to liquidate positions when it may not be advantageous to do so. Leveraging transactions may increase the fund’s sensitivity to interest rate movements

An investment in an interval fund is not appropriate for all investors. Unlike typical closed-end funds an interval fund’s shares are not typically listed on a stock exchange. Although interval funds provide limited liquidity to investors by offering to repurchase a limited amount of shares on a periodic basis, investors should consider shares of the Fund to be an illiquid investment.  Investments in interval funds are therefore subject to liquidity risk as an investor may not be able to sell the shares at an advantageous time or price. There is also no secondary market for the Fund’s shares and none is expected to develop. There is no guarantee that an investor will be able to tender all or any of their requested Fund shares in a periodic repurchase offer.

Portfolio structure is subject to change without notice and may not be representative of current or future allocations. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.

There can be no assurance that the investment approach discussed will produce the desired results or achieve any particular level of returns. 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 a long-term especially during periods of downturn in the market. Outlook and strategies are subject to change without notice. An investment in the Fund is speculative involving a high degree of risk, including the risk of a substantial loss of investment.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the current opinions of the manager 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 is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2024, PIMCO.

PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY 10019, is a company of PIMCO.


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