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Real assets and the net-zero pathway
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The sustainable forces driving change in real assets
The real asset green premium explained
e release this Spotlight guide as 2022 nears its conclusion. It has been a really tough year for fixed income markets, with rising interest rates and high
inflation prompting a major sell-off. Now, however, a substantial amount of interest rate risk has been priced in, and higher yields are making for an attractive entry point.
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“Net zero commitments are set to revolutionise the world of long-dated real assets”
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FIXED INCOME
Mark Meiklejon on the Aviva Investors’ Climate Transition Real Assets Fund
How can pension funds use ESG to futureproof portfolios?
Professional Investors Only
Featured in this Spotlight
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Ketish Pothalingam Portfolio Manager, EVP
Ketish is a member of PIMCO’s ESG team, focusing on corporate credit and global bond ESG portfolios
Samuel Mary ESG Research Analyst, SVP
Samuel focuses on the integration of ESG factors into PIMCO's portfolio management and credit research
Sectors in focus: real estate, banking and more
Spotlight on: GIS Income Fund
'Bend but don't break': the portfolio view
Big picture outlook with Dan Ivascyn
In this Spotlight guide, we hear from PIMCO's Group CIO Dan Ivascyn and fellow Portfolio Managers Alfred Murata and Josh Anderson on the prospects for fixed income investors. We also discuss how to ensure a resilient portfolio at a time of volatility, what it means to follow a “bend but don't break” philosophy and what sectors are particularly attractive at present.
"A substantial amount of interest rate risk has been priced in, and higher yields are making for an attractive entry point"
BENCHMARK Unless referenced in the prospectus and relevant key investor information document, a benchmark or index in this material is not used in the active management of the Fund, in particular for performance comparison purposes. Where referenced in the prospectus and relevant key investor information document a benchmark may be used as part of the active management of the Fund including, but not limited to, for duration measurement, as a benchmark which the Fund seeks to outperform, performance comparison purposes and/or relative VaR measurement. Any reference to an index or benchmark in this material, and which is not referenced in the prospectus and relevant key investor information document, is purely for illustrative or informational purposes (such as to provide general financial information or market context) and is not for performance comparison purposes. Please contact your PIMCO representative for further details. CHART Performance results for certain charts and graphs may be limited by date ranges specified on those charts and graphs; different time periods may produce different results. 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 the current low interest rate environment increases this risk. Current 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. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. 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. 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. STRATEGY AVAILABILITY Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors. Please contact your PIMCO representative for more information. FORECAST Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve. OUTLOOK 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, 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. 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 or registered trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2022, PIMCO
Is now the time for investors to return to bonds?
Green shoots
MARKETING COMMUNICATION This is a marketing communication. This is not a contractually binding document and its issuance is not mandated under any law or regulation of the European Union or the United Kingdom. This marketing communication does not include sufficient detail to enable the recipient to make an informed investment decision. Please refer to the Prospectus of the UCITS and to the KIID before making any final investment decisions. The services & products described in this communication are only available to professional clients as defined in the FCA's Handbook. PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. ESG Category Article 6 Article 6 funds do not have sustainable investment as its objective, nor do they promote environmental and/or social characteristics. While such funds integrate sustainability risks into its investment policy (as further outlined in the Prospectus) and this integration process forms part of the investment level due diligence of the fund, ESG information is not the sole or primary consideration for any investment decision with respect to the fund. The climate statistics provided on the next slide are for informational purposes only. As the Fund is actively managed and does not promote environmental or social characteristics, the climate related holdings are not static and may vary considerably overtime. A Prospectus is available for PIMCO Funds and Key Investor Information Documents (KIIDs) are available for each share class of each the sub-funds of the Company. The Company’s Prospectus can be obtained from www.fundinfo.com and is available in English, French, German, Italian, Portuguese and Spanish.The KIIDs can be obtained from www.fundinfo.com and are available in one of the official languages of each of the EU Member States into which each sub-fund has been notified for marketing under the Directive 2009/65/EC (the UCITS Directive). In addition, a summary of investor rights is available from www.pimco.com .The summary is available in English. The sub-funds of the Company are currently notified for marketing into a number of EU Member States under the UCITS Directive. PIMCO Global Advisors (Ireland) Limited can terminate such notifications for any share class and/or sub-fund of the Company at any time using the process contained in Article 93a of the UCITS Directive. Past performance is not a guarantee or a reliable indicator of future results. The “gross of fees” performance figures are presented before management fees and custodial fees, but do reflect commissions, other expenses and reinvestment of earnings. The “net of fees" performance figures reflect the deduction of ongoing charges. All periods longer than one year are annualized. Investments made by a Fund and the results achieved by a 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 Fund may be forced to sell a comparatively large portion of its portfolio to meet significant shareholder redemptions for cash, or hold a comparatively large portion of its portfolio in cash due to significant share purchases for cash, in each case when the Fund otherwise would not seek to do so, which may adversely affect performance.
Resilience: the secular theme shaping the future
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making fixed income markets look much more attractive.
year or two ago, fixed income investors were facing a combination of high inflation and extremely low yields. Today, the prospects for the asset class are very different. Real yields are now positive across much of the Western world,
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“An active bond strategy can look to generate 6%+ yields even with very high-quality assets”
‘We think this is a very exciting time for fixed income markets’
Bond markets have had a tough year but are looking increasingly attractive for investors to make a return, says Dan Ivascyn
Passive, high-quality fixed income benchmarks are now offering yields in the region of 5%. And according to Dan Ivascyn, Group CIO at PIMCO, this means that an active bond strategy can look to generate yields upwards of 6% even when sticking to very high-quality assets. By making use of a global opportunity set and adopting a flexible approach, investors could even achieve yields higher than that.
Indeed, it is not just the potential financial returns that make fixed income attractive right now, but the ability to do so with a lower risk profile. This, explains Ivascyn, stems from a substantial rebalancing of public and private market valuations – the former having outstripped the latter significantly in recent times.
Opportunity with a lower risk profile
“We think this is a very exciting time for these markets after the recent sell-off,” he says. “Things can certainly get worse before they get better, but for an intermediate-to-longer-term investor with income needs, we are very excited about the opportunity set.”
“We have had a truly global rise in ESG regulations. The growing number of jurisdictions has enabled related-disclosure mandates with a focus on climate change”
Ivascyn is lead Portfolio Manager for PIMCO’s GIS Income Fund, and says one of the fund’s key differentiators is its ability to generate a predictable income stream without exposing shareholders to too much downside risk in a challenging environment. As well as utilising PIMCO’s size and global platform to do this, the fund has been taking steps to enhance its resilience. “That’s almost a principle of the strategy as opposed to a tactical view,” he says.
Income with resilience
Ivascyn highlights the potential not only for those investors who have been taking refuge in cash, a very defensive asset class, but also for those who reallocated into equities. “You can now generate expected returns in the mid-to-high single digits, and do so through more conservative investments and with much more cash flow and return certainty than you are able to get in the equity markets,” he says.
Samuel Mary, ESG research analyst
“Those investors that have felt forced or compelled to move into more exotic, less-liquid segments of the market can now return to the public markets that are offering similar yields in very, very high quality and resilient investments,” he says.
This preference for lower risk is not only desirable but necessary given ongoing macroeconomic challenges. Ivascyn emphasises that it is premature to try being aggressive in areas of the market that are likely to significantly underperform expectations in the event of a hard landing for the global economy.
“Despite the fact that spreads are wider across the board, our preference is to stay more defensive in terms of the sectors of the market we’re targeting, with the idea that we’re likely to have a better opportunity to pivot into higher-yielding instruments as we move forward in time,” he explains. “And then using our flexibility to go on the offence on behalf of our shareholders when we see better valuations.”
As such, his team has significantly increased the fund’s liquidity profile over the past couple of years. “We’re running more fund-level liquidity today than we’ve probably had at any point in the life of the strategy,” says Ivascyn. “The idea being that resilience will be rewarded in this highly volatile environment where we can be a liquidity provider for other motivated or even forced sellers down the road.”
The fund also places great value on flexibility and isn’t tethered to any benchmarks. Although the fund’s stated index is the Bloomberg US Aggregate Bond Index and it aims to outperform that, the team never refer to the index when positioning the fund.
This flexibility is an essential component of the fund’s active management approach, says Ivascyn. “In a world of heightened volatility on a global basis, with less synchronised cycles and less central bank volatility suppression, there are lots of opportunities as an active asset manager. To be a liquidity provider; to take advantage of regulatory and political rigidities.
“The current environment offers opportunities like nothing we’ve seen, frankly, over much of the last decade, other than of course that Covid blip. So it really is a very unique time to be nimble and flexible, and to react to what we think is going to be a sustained period of significant volatility.”
FIXED INCOME IS CURRENTLY OFFERING INVESTORS ATTRACTIVE YIELD LEVELS
As of 31 October 2022. Source: Bloomberg, PIMCO. Past performance is not a guarantee or a reliable indicator of future results. Index proxies for asset classes displayed are as follows: Core: Bloomberg US Aggregate (incept: 30 January 1976), Agency MBS: Bloomberg MBS Fixed Rate Index (incept: 30 January 1976), IG credit: Bloomberg US Credit Index (incept: 31 January 1973), HY credit: ICE BofAUS HY BB-B Rated Index (incept: 31 December 1996), EM: JPMorgan EMBI Global (incept: 31 December 1993), 1 The yield to worst is the yield resulting from the most adverse set of circumstances from the investor's point of view; the lowest of all possible yields.
Yields have increased meaningfully across sectors
As of 31 October 2022. Source: PIMCO. *”Government related” and “non-US developed”: excludes any interest rate linked derivatives used to manage our duration exposure in the following countries: US, Japan, United Kingdom, Australia, Canada and European Union (ex-peripheral countries). Derivative instruments may include interest rate swaps, futures and swap option. All other government related and non-US government related securities such as government bonds, Treasury inflation protected securities, FDIC-guaranteed and government-guaranteed corporate securities are included Bond exposure is defined as the market exposure inclusive of notional values.
A flexible approach to managing duration
As of 31 October 2022. Source: PIMCO. Past performance is not indicative of future results.
31/12/2021 yields
31/10/2022 yields
YTD change in yields (bps)
+329
+328
+352
+435
+358
5.0%
5.8%
8.1%
8.0%
4.4%
3.8%
2.3%
1.7%
A flexible fund: How the PIMCO GIS Income Fund adjusts its exposures dynamically
‘Bend but don’t break’, evolving the portfolio, and looking past the peak
he global sustainable bond market has materially grown and evolved over the past few years. PIMCO recognises the impact that climate change will have on the global economy and offers investors – through their bond allocations – the means
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to manage climate-related risks and take advantage of the opportunities associated with the transition to a net zero emissions economy.
This year, the GIS Income Fund is celebrating its 10th birthday. Here Alfred Murata and Josh Anderson outline its approach. Alfred and Joshua are co Portfolio Managers of the GIS Income Fund, along with Group CIO Dan Ivascyn
Sustainable investment examples
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We have specifically been investing in legacy NAMBSs that were issued before the global financial crisis. The underlying borrowers here have benefited from more than a decade of house-price appreciation, and the loan to valuation on many of these is now less than 50%. So even if you have a downturn in the housing market, you still expect to get positive yields on a hold-to-maturity basis.
“A lot of our mortgages and other structured assets are well protected from default”
Company B SECTOR: Packaging MATURITY: September 2028 COUNTRY OF DOMICILE: Ireland Green bond proceeds to be allocated towards expenditures relating to energy efficiency projects and manufacturing of sustainable packaging. PIMCO had a 1x1 call with the company to discuss best practices for ESG bond disclosure and reporting. We recommended that the company consider leveraging additional environmental indicators to quantify the environmental impacts of its sustainable aluminium products. PIMCO also shared guidance on sustainable bond issuance and examples of lifecycle impact assessments.
green bond
Company A SECTOR: Real estate finance MATURITY: 15 April 2031 COUNTRY OF DOMICILE: United States This bond focuses on energy efficiency, green buildings, infrastructure and renewable energy-generation projects. Following the issuance of the bond, PIMCO also engaged with the company to request the creation of a green bond framework to provide a deeper level of assurance to market participants. We suggested they include language regarding exclusionary categories given their investments in the natural gas value chain.
Company C SECTOR: Materials MATURITY: 15 January 2032 COUNTRY OF DOMICILE: United States The company’s second sustainability-linked bond (SLB) includes key performance indicators centred on reducing its industrial water-withdrawal intensity by the end of 2026 and increasing the representation of women in leadership positions to 30% or more by 2025. After passing up the opportunity to invest in the company's initial SLB in 2020, PIMCO met with management to discuss their ESG action plan and provide recommendations for improvement. Following our discussion, the company announced more ambitious ESG targets and issued this second SLB, where PIMCO participated.
sustainability-linked bond
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Josh Anderson, Portfolio Manager
Alfred Murata: “Bend but don’t break” means we’re trying to focus on positions where there may be some price fluctuations in volatile markets but where there is unlikely to be a long-term permanent impairment of capital. One of those sub-sectors has been non-agency mortgage-backed securities (NAMBSs). These are bonds that are backed by residential loans but not guaranteed by the government. As an investor, you’re depending on the cash flow from the underlying loans to pay you back.
What is your “bend but don’t break” philosophy and where does it take you in practice?
“We’re focusing on positions where there may be some price fluctuations but where there is unlikely to be a long-term permanent impairment of capital”
Alfred Murata, Portfolio Manager
Alfred Murata: Entering 2021, interest rates were at extremely low levels, and we thought that there was a risk they could rise. So we were extremely cautiously positioned with respect to duration.
How have you evolved the portfolio over the past couple of years?
As time has passed, we have seen significant repricing in interest rates. We’re still cautiously positioned but we’ve added more duration compared to earlier this year.
The other significant risk factor has been credit risk. Last year, there was a lot of demand from the Fed and other central banks to buy assets, and that led to a significant tightening in credit spreads. We took advantage of that to sell positions at relatively tight levels.
So far this year we’ve seen a significant widening in credit spreads. By being very cautiously positioned with regard to credit risk last year, we were able to reduce the downside risk that the strategy faced so far this year.
Josh Anderson: The resilience of the portfolio is another area where I think we did well this year. As Alfred mentioned, our bend-but-don’t-break philosophy means that effectively we want bonds with a lot of asset coverage and with seniority in the capital structure. That means we can withstand a lot of asset volatility.
A lot of the mortgages and other structured products and assets that we have are well protected from a default perspective, as they have 40, 50, 60 percentage points of asset coverage and low loan-to-value ratios. So even if you have some economic volatility, even if prices fall from here, you’re so far in the money that you don’t have to worry about that credit component.
So the core of the portfolio has held up very well. We’ve had very few credit issues and the fund has outperformed a lot of the higher beta credit assets in the market.
Josh Anderson: The benefits of active management shone through again in this past year. Just avoiding what we’d argue are inefficient positions really helped our overall performance.
How does your active management approach add value?
Looking forward, it’s going to be a great environment for active fixed income. With the volatility there’s going to be a lot of companies and countries that need financing. Different unique structures are going to be developed. And I think there are going to be a lot of ways to add incremental value.
Alfred Murata: Alongside macroeconomic uncertainty, we’ve also seen significant volatility in credit spreads, essentially across the board. Today we are finding some very compelling opportunities in sectors of the corporate credit market where spreads have widened significantly but we don’t think they will be particularly negatively impacted by elevated macroeconomic uncertainty.
Two sectors that we find attractive in the corporate credit space would be telecoms and health care. We think these sectors will be economically resilient even if we do have a downturn in the economy or continued volatility in commodity prices, for example.
What sectors are particularly appealing at the moment?
Josh Anderson: There’s certainly potential for spread tightening and as a result we think there could be a lot of total return upside potential in that scenario.
What might we expect if yields reach a peak and spreads tighten again?
As we’re starting with a very attractive yield that has adjusted much higher and that already compensates for a lot of potential future risk, if we get a period where volatility subsides a little bit and spreads tighten, then you can have a return above your stated yield.
Mortgage credit: fundamentals continue to be supportive
2004 – 2007 vintage non-agency residential mortgage characteristics
As of 30 September 2022. Top left chart is as of 31 July 2022. Source: PIMCO, S&P Global. For illustrative purposes only. *CLTV: Combined loan-to-value ratio, which is the ratio of all loans secured by a property to the property's value.
12/31/2021 yields
10/31/2022 yields
PIMCO GIS Income Fund – Historic Returns Following Peak Yields
Past performance is not a guarantee or a reliable indicator of future results
As of 31 October 2022. Source: PIMCO. Performance is shown as an annualized return for the institutional class shares after fees. For illustrative purposes only.
2013: Taper tantrum
2016: Oil crash
2018: Rising rates
2020: Covid-19
Event description
9/13/2013
1/20/2016
11/27/2018
3/23/2020
6.27
5.93
6.69
8.16
Date
Time period
YTM
Peak yield (%)
1-year
10.94
9.67
8.83
23.83
3-year
6.54
5.96
6.03
–
5-year
5.63
6.55
Returns following peak yields (%)
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Spotlight on: The GIS Income Fund
Investment philosophy
Seek consistent income distribution as a driver of total returns over time
Seek opportunities across entire global bond market and have broad flexibility to express secular thinking and core investment themes
Focus on high quality and senior secured bonds to help diversify during periods of market stress
A renewable energy provider using green bond proceeds for wind/solar
A global bank developing innovative forms of finance to support a low carbon economy
A renewable energy company growing by acquiring and investing in low-carbon-generation assets such as solar, wind, geothermal and hydro-electricity
A municipal-owned water system financing improvements to sewage treatment works, water quality improvement projects or flood control facilities
A real estate company issuing green bonds targeting emissions reductions targets for its corporate operations and logistics
A food company planning to remove deforestation its from supply chain via a sustainable sourcing policy
As of 31st October 2022. Source: PIMCO For illustrative purposes only. Refer to Appendix for additional investment strategy, outlook and risk information.
Seek consistent income
Be global and flexible
Focus on downside risk
PIMCO GIS Income Fund has outperformed higher-risk assets
As of 31 October 2022. Source: PIMCO, Bloomberg. The chart's starting time period is since inception of the GIS Income Fund R GBP Hedged Income Share Class, which was incepted on 30 November 2012.Bloomberg US Aggregate Index GBP Hedged. US IG is the Bloomberg US Credit Index GBP Hedged. US HY is the Bloomberg US High Yield Index GBP Hedged. Periods longer than 1Y are annualized. Please note that the above indices are not used in the active management of the Fund, in particular for performance comparison purposes. They are used for information purposes only. Performance is shown for the institutional class, accumulation shares.
PIMCO GIS Income Fund GBP Hedged (after fees)
Bloomberg US Aggregate GBPH
Bloomberg US IG Credit GBPH
Bloomberg US High Yield Credit GBPH
PIMCO GIS Income Fund
Balanced, multi-sector approach to generating income
Allocate across higher-yielding and higher-quality assets in seeking to provide consistent and diversified sources of return
Award-winning portfolio management team, led by Group CIO Dan Ivascyn, Alfred Murata, and Josh Anderson
Preserve capital
Generate yield
Higher-quality sectors
Maintain modest exposure to US agency MBS, which has the potential to offer a safe spread over Treasuries.
Cautious on generic credit, but opportunistic in financials, where fundamentals are strong, as banks are operating with the highest levels of capital since the financial crisis. In addition, we are looking for opportunities in defensive sectors where we’ve seen technical widening.
Higher-yielding sectors
Selective in high yield credit, with a focus on senior bonds in the capital structure. The fund has also increased exposure to HY CDX given its superior liquidity profile versus cash bonds.
High conviction in non-agency mortgages, where we see attractive risk-adjusted yield levels and strong mortgage credit fundamentals. We expect the sector to be resilient through a range of economic scenarios.
PIMCO GIS Income Fund (% Bond Exposure)
High yield
Bank loans
Emerging markets
Non-agency MBS
IG credit
CMBS
ABS
Non-US RMBS
Agency MBS
Government related*
Cash/other
6%
13%
18%
4%
11%
8%
10%
3%
GIS Income Fund has delivered on its objectives for over a decade:
Emphasise risk management and “bend but don’t break” credit philosophy to withstand market volatility
Multi-sector approach with flexibility to invest across the entire $127trn bond market
• Duration: 0 to + 8 years • Corporate HY: Max 50% • EM: Max 20% • FX: Max 30%
Key Guidelines
PIMCO GIS Income Fund positioning
As of 31 october 2022. Source: PIMCO *”Government related” and “Non-US developed”: excludes any interest rate linked derivatives used to manage our duration exposure in the following countries: US, Japan, United Kingdom, Australia, Canada and European Union (ex-peripheral countries). Derivative instruments may include interest rate swaps, futures and swap option. All other government related and non-US government related securities such as government bonds, Treasury inflation protected securities, FDIC-guaranteed and government-guaranteed corporate securities are included. Bond exposure is defined as the market exposure inclusive of notional values.
Fund is diversified across a variety of income-generating ideas
Share value can go up as well as down and any capital invested in the Fund may be at risk. The Fund may use derivatives for hedging or as part of its investment strategy which may involve certain costs and risks. For more details on the fund’s potential risks, please read the Key Investor Information Document
Dan Ivascyn gives his views on five areas that PIMCO is monitoring
Energy transition represents a capital deployment event of historic proportions
“AMBSs are now offering an almost two-percentage-point yield advantage versus Treasuries”
Housing markets are almost certainly going to decline in real terms or inflation-adjusted terms over the next few years. There’s been a massive increase in house prices since the end of 2019, of the order of 20% in real terms. So given higher mortgage rates, actual and anticipated economic slowing, and starting valuations, we do think house prices can go down in real terms, and potentially in nominal terms as well.
Housing and real estate
However, with the types of investments we’re focusing on within this strategy, their performance is not going to be tied in a significant way to house price action because we’re not buying new originations. As mentioned before, we’re focused on legacy non-agency mortgage-backed securities, so our stock of exposures are very, very seasoned investments that have benefited from significant house price appreciation not only since the Covid shock but over the last 15 years or so.
So you’re talking about investments where borrowers have more than 50 percentage points of equity in their property. Even if house prices were to go down 10%, 20%, 25%, 30%, which would be quite significant, they’re still going to have a tremendous amount of equity cushion.
Non-agency mortgage-backed securities, which are a key theme for the GIS Income Fund, were discussed by Alfred Murata here.
The US dollar looks very, very expensive relative to other global currencies. We may have more of a negative dollar exposure at some point in the future, but given the dollar’s momentum and its flight-to-quality attributes, we’re hesitant to be more aggressive in that space. Right now we have a relatively small position in non-dollar currencies: specifically some high quality emerging markets and a few developed markets.
Currency
Historically, we have at times had significant positions in AMBSs. This is fairly atypical for income-oriented strategies because AMBSs’ high quality means they tend to have lower yields than high-yield bonds, for example.
Having benefited from selling many of our AMBSs when the US central bank was buying them all post-Covid, they have gone back to being a key focus for us after the recent spread-widening.
They are unlikely to default because they’re very, very high credit quality, and they’re now offering an almost two-percentage-point yield advantage versus Treasuries or other high-quality bonds. We’re in no rush to get to a higher allocation because there is going to be more supply, but we have steadily been increasing our exposure. We think they’re a great way to add yield without exposing our shareholders to any significant credit risk or downgrade risk.
AMBSs benefit from either a direct government guarantee or via an agency of the US federal government. That makes them very high quality, and they are currently at near record wide spreads versus Treasuries or other high-quality alternatives. AMBSs have widened because they tend to not do so well in periods of heightened interest rate volatility. There are also a lot of AMBSs on the Federal Reserve balance sheet that may need to come back to the marketplace over the course of the next few years.
Agency mortgage-backed securities
Banks were so heavily regulated coming out of the global financial crisis that they have very high capital positions today relative to what they’ve had in the past. The regulatory environment has made it very hard for banks to take a lot of risk. So we think this is an area that is going to provide tremendous resiliency if we get into a recessionary environment, and it remains one of our highest conviction themes in the strategy.
The banking sector
When we look at emerging markets from a global perspective, valuations look quite attractive. But emerging markets don’t tend to do very well when you have a significant central bank tightening cycle across the globe. There’s also a lot of idiosyncratic uncertainty with emerging markets, tied to US or Western friction with China, Chinese growth questions, uncertainty in Eastern Europe and various elections across Latin America.
The bottom line is that we think emerging markets will be a good diversifier for clients over the course of the next few years, but our exposure remains low. We have reduced our position over the course of the last year and our focus is almost entirely on the higher quality and more liquid segments of the emerging markets.
We have small emerging markets currency exposures and our bond exposures are almost always in sovereigns and quasi-sovereigns. We’re very hesitant to move into emerging market corporates, frontier markets and lower-rated segments in the emerging markets opportunity set.
Seek Yield and diversification via select exposures within emerging markets
Focus on higher quality and more liquid areas of the emerging markets. Mostly sovereign or quasi-sovereign positions, very limited exposure to corporates.
Scale positions small given the potential for volatility from idiosyncratic and geopolitical events.
Country breakdown (PBE)
As of 31 October 2022. Source: PIMCO. EM Index Product is exposure to the ICE CDX EM Index. "PBE" denotes "Percent Bond Exposure".
Developed markets
(AMBSs)
crucial longer-term consequence of the war in Ukraine and the responses to it is the widening of geopolitical fractures. These could accelerate the move from a unipolar world to a bipolar or multipolar one. This fracturing had
In May 2022, PIMCO held its annual Secular Forum, where its investment professionals and Global Advisory Board gathered with guest speakers for three days of intensive discussion about the economic and market trends we expect over the next three to five years. The following is a summary of why they agreed that resilience is set to be a secular theme for the foreseeable future
First, higher spending in many areas, including defence, health care, energy and food security, more resilient supply chains, and climate risk mitigation and adaptation, to the extent that it won’t be matched by cuts in other areas, may well support aggregate demand over the secular horizon.
1. Output growth unlikely to be materially higher
The EU Sustainable Finance Disclosure Regulation (SFDR), which came into force in March 2021, aims to improve financial industry transparency and consistency on sustainable investments and associated processes, discourage misleading claims about an investment’s sustainability credentials, and encourage the integration of financially material sustainability risks into the investment process. It obliges certain financial market participants to make what can be complex sets of disclosures. It is one of several measures the EU is using to create a common framework for sustainability and to reorient capital flows, with the aim of easing the transition to a more sustainable economy.
Food security is just one area where higher spending is likely
“In a more fractured world, we believe governments and corporate decision-makers will increasingly focus on searching for safety”
already been underway with the emergence of China as a major economic and geopolitical player and Western governments’ sceptical stance toward China.
In a more fractured world, we believe governments and corporate decision-makers will increasingly focus on searching for safety and building resilience:
However, much of this additional spending may not help long-term productivity growth, unless companies make additional efforts at increasing productivity through accelerated investment in technology. Also, the reach for resilience will likely be accompanied by more regulation and protectionism, which could weigh on long-term growth.
Third, given these inflationary tailwinds, central banks are facing a dilemma. Supporting aggregate demand and building resilience would come at the cost of higher inflation. Conversely, bringing inflation back down to target would be costly in terms of demand and employment. For now, given how far inflation exceeds central banks’ targets, most central banks are emphasising the fight against inflation.
3. Central banks face a dilemma
The jury is out on whether they will still prioritise inflation once it has come back closer to target, or whether they will tolerate moderate overshoots. Our general view is that inflation risks over the secular horizon have shifted to the upside.
FOUR DRIVERS OF ENGAGEMENT
PIMCO has four objectives driving its ESG engagement efforts:
Steer positive impact by improving the ESG performance of the company
Expand the ESG bond universe and encourage new ESG bond issuance
Improve data quality and disclosures (e.g. data gaps on ESG KPIs and ESG bond impact reporting)
Engage to support and encourage more transparency and external reporting (e.g. alignment with industry disclosure standards)
Lorenzo Brunelli, ESG product strategist
With the risk of military conflict more real following Russian aggression toward Ukraine, many governments – especially in Europe but also elsewhere – have announced plans to increase defence spending and invest in both energy and food security. Many corporate decision-makers are focused on building more resilient supply chains through global diversification, near-shoring, and friend-shoring. These efforts were already underway in response to US–China trade tensions and because the Covid pandemic demonstrated the fragility of elaborate value chains, and are likely to be intensified given the more insecure geopolitical environment. Moreover, in response to climate-related risks and the Covid crisis, most governments and many companies have already increased efforts to mitigate and adapt to global warming and to improve health security for their citizens and employees.
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This reach for resilience and the search for security may often come at the expense of short-term economic efficiency. We see five major macroeconomic implications of this secular trend.
Overall, it thus seems unlikely to us that output growth will be materially higher over the secular horizon than in the pre-pandemic decade.
Second, the quest for resilience and security introduces some inflationary tailwinds as companies build redundancies into their supply chains and bring them closer to home. To the extent that governments become more restrictive on immigration, labour markets could become less competitive, potentially leading to higher wage pressures. Also, the green transition, which should eventually lead to lower energy prices from cheaper renewables, may well push energy prices higher for a while as the supply of brown energy may shrink faster than the supply of renewables expands.
Ultimately, however, whether these factors lead to permanently higher inflation over the secular horizon will be a policy choice by fiscal and monetary authorities, in our view.
2. Inflationary tailwinds set to depend on policy choices
Fourth, we see a higher probability of private sector credit events and default cycles over the secular horizon. Public sector and corporate balance sheets will likely be under pressure from rising spending needs on security and resilience, debt service costs will likely be higher, and the risk of a recession is real. Elevated inflation implies central banks may be less willing or able to support private sector debtors. Governments may also be less willing to help due to a further surge in debt levels during the pandemic and the need to finance rising pension and health care costs given aging demographics.
4. Higher probability of private sector credit events
“The reach for resilience will likely be accompanied by more regulation and protectionism, which could weigh on long-term growth”
Fifth but not least, we see a risk of financial deglobalisation and more fragmented capital markets over the secular horizon – a “capital war”, according to one of our forum participants. The weaponisation of financial sanctions and currency reserve holdings may well increase the home bias by public and private creditors in current account surplus countries and could lead to an ebbing of financial flows into the US dollar over time. However, given the lack of good alternative currencies with deep and liquid capital markets to the dollar, any such shifts are likely to be glacial rather than abrupt and likely lie beyond our secular horizon.
5. Long-term risk of financial deglobalisation
