Strategy Spotlight

Building Diversified Equity Allocations: PIMCO StocksPLUS

StocksPLUS strategies seek to provide a transparent and diversifying source of potential excess returns.

Investors often have two priorities when building active equity allocations: excess returns and diversification. Confidence in a manager’s potential to deliver excess returns may come from in-depth due diligence of the manager’s resources, investment process, track record and competitive advantage. Diversification may come from combining multiple managers with complementary styles, risk/return profiles and sources of alpha. PIMCO StocksPLUS strategies can be an important component of a diversified equity allocation, seeking to provide a transparent and diversifying source of potential excess returns.

Evolution of equity diversification – from beta to alpha

Traditionally, diversification in equity allocations focused on region (developed vs. emerging markets), capitalization (large vs. small) and style (value vs. growth) – think of the classic style-box framework. While this construct did offer diversification benefits with respect to equity betas, most of the excess return potential was driven by one thing: idiosyncratic risk, or stock selection. As a result, in environments that were more challenging for stock pickers, investors risked broad portfolio underperformance.

With active equity managers as a group underperforming their benchmarks over the past decade, investors have increasingly sought to identify more reliable sources of excess returns. This trend has been most clearly observed in the rise of factor-based and smart beta equity strategies. These strategies offer the potential for outperformance arising from exposure to factors, such as value, low volatility and momentum, that have been linked to higher long-term returns. By allocating to both stock-picking and factor-based strategies, investors sought to diversify their sources of alpha in addition to diversifying their equity betas.

A step further: improving equity outcomes

Investors may seek to improve their equity allocations by continuing to identify diversifying sources of alpha potential. PIMCO StocksPLUS offers an innovative yet time-tested approach to equity investing, with a track record of more than 30 years and a nontraditional source of potential excess returns: bonds. In short, StocksPLUS seeks to provide investors exposure to the equity beta of their choice plus alpha potential driven by PIMCO’s fixed income investment process.

How it works

While the StocksPLUS strategy is nontraditional, it is nonetheless quite straightforward: 

  • We begin by providing passive exposure to the investor’s target equity index (large cap equities, small cap equities, etc.) through equity index futures or total return swaps, rather than by purchasing stocks.
  • The potential benefit of this approach is that these instruments require very little capital commitment, allowing the majority of assets to be invested in a global, flexible bond alpha strategy.
  • In this way, investors target the equity index returns they desire, and PIMCO seeks to deliver excess returns by managing the bond portfolio with an aim to outperform the money-market cost of the equity exposure.

Key benefits of StocksPLUS in an equity allocation

We believe StocksPLUS can serve as a valuable complement to more traditional equity strategies, for several reasons.

The value proposition for StocksPLUS is that it seeks to deliver excess returns if the active bond strategy outperforms traditional cash investments. Fixed income represents a large and historically reliable opportunity set from which to extract potential alpha, allowing StocksPLUS to target consistent outperformance, especially when measured over three- and five-year horizons.

This potential for more consistent outperformance means that StocksPLUS may serve as a core holding within an equity allocation, as traditional equity approaches may require a longer time horizon. Indeed, concentrated (high active share) stock-picking strategies and certain factors may be out of favor for extended periods before delivering on their long-term return expectations.

Because the performance of StocksPLUS is driven by a bond alpha strategy, excess returns tend to be largely uncorrelated (or even negatively correlated) with those of traditional active equity managers, potentially providing additional diversification benefits.

DIVERSIFYING ALPHA SOURCES IN AN

Of course, as with any active investment strategy, StocksPLUS may experience environments that are less favorable for the approach and result in periods of underperformance. However, given PIMCO’s broad resources and decades of experience managing the strategy, we believe we can continue to navigate good times and bad to deliver attractive long-term return potential for our clients.

StocksPLUS for diversification and excess return potential

Equities often represent the largest source of risk in an investor’s portfolio, so having a thoughtfully constructed and diversified portfolio is critical. While investors have long diversified across equity betas, today there are more tools available to diversify across sources of alpha as well. Indeed, many investors are looking beyond traditional equity strategies in search of excess returns.

PIMCO StocksPLUS is an innovative, nontraditional equity strategy that seeks alpha from bonds, leveraging PIMCO’s time-tested fixed income investment process. In this way, the StocksPLUS approach may provide meaningful benefits to an equity allocation by targeting excess returns from a large and diverse opportunity set with lower correlations to traditional equity alpha. In sum, StocksPLUS may serve as an important driver of performance and diversification in investors’ equity allocations.

The Author

Andrew Pyne

Equity Strategist

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Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517), PIMCO Europe, Ltd Amsterdam Branch (Company No. 24319743), and PIMCO Europe Ltd- Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Amsterdam and Italy Branches are additionally regulated by the AFM and CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act, respectively. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH(Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The services and products provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO Switzerland GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia) offers products and services to both wholesale and retail clients as defined in the Corporations Act 2001 (limited to general financial product advice in the case of retail clients). This communication is provided for general information only without taking into account the objectives, financial situation or needs of any particular investors. | PIMCO Japan Ltd (Toranomon Towers Office 18F, 4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No.382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities and values of derivative transactions in the portfolio, market conditions, interest rates, and credit risk, among others. Investments in foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Edifício Internacional Rio Praia do Flamengo, 154 1° andar, Rio de Janeiro – RJ Brasil 22210-906.

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

There is no guarantee that these investment strategies will work under all market conditions or are suitable 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 suitable 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

All investments contain risk and may lose value. 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. 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. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Swaps are a type of derivative; swaps are increasingly subject to central clearing and exchange-trading. Swaps that are not centrally cleared and exchange-traded may be less liquid than exchange-traded instruments.

This material contains the 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 L.P. in the United States and throughout the world. ©2019, PIMCO.