PIMCO’s economic forums are integral to our firm’s time-tested investment process. Three times a year, we gather from all corners of the world to discussour outlook for the cyclical horizon ‒ i.e., the next six to 12 months. These discussions inform and influence portfolio positioning and day-todaymanagement. But PIMCO has long known that an appreciation of long-term, or secular, realities is equally (if not more) important; forthat reason, once a year, for more than 30 years, we have convened a multi-day session to look out over a longer, three-to five- year period.
PIMCO’s 2016 Secular Outlook highlights a world that, over the next three to five years, will be stable but not secure. Discussion anddebate among our investment professionals, Global Advisory Board and outside speakers at our Secular Forum in May led us to conclude thatwhile we do not see a global economy heading toward recession, we also do not see readily available means to stimulate aggregate demand and driveaccelerated growth. The marginal benefits of monetary policy will likely continue to decline, and fiscal policy will likely fail to fill the gaps. Thisdynamic creates volatility and leaves investors more exposed to shocks ‒ both negative and positive. Protecting future returns therefore requires a nuancedapproach.
After our forum, our Group CIO Dan Ivascyn, Global Strategic Advisor Rich Clarida and Global Fixed Income CIO Andrew Balls outlined the key implicationsand risks for investors globally.
For Asia-Pacific investors, there are unique and specific applications of our outlook, especially in light of local market dynamics and regulatory changes.Here we consider three different Asia-Pacific investor groups and highlight the specific themes and investment strategies that we think will help eachgroup navigate the stable but not secure investment landscape.
Asia-Pacific individual investors
Whether they are retirees in Japan facing negative interest rates, Australians with superfund balances beginning the decumulation phase or Asian high networth investors transitioning from first-generation family-owned enterprises to diversified portfolios, individual investors face similar challenges. Theyneed to generate sustainable income to support spending ‒ and must do so in an environment where interest rates and risk premiums are low and volatility ishigh.
We find four of our secular strategies most relevant for individual investors:
- Preserve capital
- Grind out alpha
- Favor bottom-up over beta
- Scour the world and diversify
Because central bank policy is becoming increasingly less effective, forward-looking returns are likely to be lower. Moreover, our secular outlook citesseveral additional left tail events that could increase the potential for capital losses and write-downs ‒ populist shocks like the recent “Brexit” voteand political gridlock are two examples. In this environment, capital preservation is the number-one priority. Indeed, riding a wave of unstable betas ‒all correlated to central bank policies ‒ is no longer a strategy for success.
Particularly for investors in the decumulation phase of their investment strategies, this is an uncomfortable reality. Low passive returns are likely to bein many cases insufficient for both retirees and high net worth individual investors.
What can individual investors do to boost potential returns?
We believe active management can provide much-needed support.Our income- and credit-oriented strategies focus on scouring the globe for sources of value with the aim of providing stable returns for investors. Ourcredit portfolio managers, led by CIO Global Credit Mark Kiesel, are laser-focused on picking winners and generating alpha, while also preserving capital.Our income strategies, led by Group CIO Dan Ivascyn, have continued to seek sustainable income for investors through a combination of careful riskmanagement, relative value maximization and bottom-up security selection.
Both our income and credit strategies are designed to achieve meaningful capital appreciation while limiting downside risk. They are potential solutionsfor individual investors focused on protecting and growing capital without sacrificing income.
Asia-Pacific institutional investors
For large institutional investors ‒ banks, sovereign wealth funds, pension and superannuation plans, foundations and endowments ‒ this environment is noless daunting. High single-digit (let alone double-digit) return targets are unlikely to be achieved through traditional betas, and risks from both theleft and right tails are real.
For institutional investors, our secular advice is threefold:
- Scour the world and diversify
- Aim to benefit from periods of volatility
- Provide liquidity when others need it
Diversification should apply to both asset classes and risk. Multi-asset solutions that are designed to provide diversified sources of return are likely togrow in importance, and because correlations in investment returns tend to increase in left-tail scenarios, investors should also focus on being adequatelydiversified from a risk perspective. PIMCO’s solutions team in Asia-Pacific can partner with institutional investors to provide asset allocation solutions.
Higher market volatility can create opportunities, and we at PIMCO continue to be opportunistic through careful portfolio construction that aims toidentify and purchase undervalued assets. Our goal is to help investors identify these potential opportunities and benefit from periods of volatilitythrough both tactical and strategic allocations. Currently, these opportunities may include alternatives, inflation-oriented strategies or creditstrategies.
With respect to providing liquidity, PIMCO’s credit and real estate alternatives strategies have track records across a wide variety of economicconditions. Whether focused on real estate, structural and regulatory opportunities brought about by bank deleveraging, middle-market credit or anevergreen, globally nimble credit relative value approach, these strategies may help boost returns and dampen volatility, while also harvesting illiquiditypremiums for our investors.
Asia-Pacific insurance companies
Insurance companies across Asia-Pacific face a challenging market environment as a result of both capital market conditions and regulatory changes. Lowinterest rates disrupt traditional insurance company asset allocations as it becomes harder to out-earn liabilities. Now, negative interest rates arecomplicating asset allocation decisions even more. In Japan, for example, life insurance companies with high domestic equity exposures may be forced tounwind these positions further if negative interest rates continue to strengthen the yen and weaken stock prices.
However, market conditions are also creating opportunities. In China, the depreciating currency is creating opportunities for Chinese insurance companiesto utilize their offshore quotas to enhance balance sheet returns. And more broadly, for many insurance companies with long-term liabilities, we believethere are opportunities to capture premiums through real estate, infrastructure and other private assets.
For insurance companies, two secular themes are most relevant:
- Guard against negative yields
- Provide liquidity when others need it
With respect to negative yields, many insurers have liabilities with longer durations (15-plus years), which is a portion of most yield curves that remainspositive in nominal terms, and so insurers with stable asset-liability matching profiles may be less directly affected by negative yields from aliability-management perspective. But they will be challenged by the reduction in available sources of return.
Given the need for more sources of return, we think insurers can potentially benefit from outsourcing certain strategies to active managers through a“satellite portfolio” approach. Satellite portfolios may be allocated to bank capital strategies, buy-and-maintain credit and credit absolute returnstrategies, which all have the potential to boost returns.
Also, to the extent that regulations and solvency requirements permit, alternatives strategies may be increasingly compelling for insurance companies. Thisis for two reasons: First, insurers can take advantage of their long investment horizons and potentially earn premiums by providing liquidity to thealternatives markets, and second, alternatives may diminish a portfolio’s sensitivity to volatility.
All of these investment strategies are built on the bedrock of our time-tested investment process, strong client service and focus on thought leadership.We look forward to continuing to engage with Asia-Pacific investors to navigate this uncertain macroeconomic environment.