David: Hello. I’m David Fisher, and I’m here again today with PIMCO’s group CIO Dan Ivascyn to talk about some of the recent discussions taking place in PIMCO’s investment committee, or IC. Since we last spoke, we’ve seen a pretty dramatic drop in US Bond Yields, and globally, we’re at a point where about 30 percent of the Investment Grade bond universe is now trading at negative yield. There’s actually been, even, some talk about US rates going negative in the case of a recession. But how is this influencing conversations in the IC? How is it affecting our view of where the investment opportunities are?
Dan: Sure. Within the investment committee, we’ve been spending a lot of time talking about the themes or the drivers of yields going lower. And what we’ve noticed, since late last year, is a pretty significant slowing in global growth, driven primarily by the manufacturing sectors, but pretty coordinated or consistent slowing across the various economies that we track. That, combined with significant political uncertainty, primarily focused on trade, has certainly contributed to a lot of momentum in the higher-quality fixed income markets over the course of the last several weeks, and the investment committee’s spending a lot of time talking about not only what has occurred, but the likely outlook for growth going forward as well as the likely path regarding these ongoing trade negotiations as well.
In terms of the outlook going forward, we continue to be overweight U.S. rates. When you look at interest rates in the United States, you have some of the highest nominal yields across the developed world, and this is one of the few markets that has room to rally more significantly if economic growth were to deteriorate further, or the trade situation were to deteriorate as well, which we think would ultimately flow into global growth.
However, we acknowledge, when we look at US rates today, after the rally that we’ve seen there’s no longer a lot of value there. Looking at our own inflation expectations in yields adjusted for inflation here in the United States now, real rates, or these inflation adjusted rates, are zero in many cases, even outright negative. In much of the rest of the developed world, outright rates are negative.
Although, with that said, there’s a lot of momentum in these markets, there’s a lot of fear out there in these markets. So, these yields, although getting expensive under more traditional metrics, certainly could get more expensive over the course of the next several weeks, especially if we see continued economic weakness.
David: So one of the areas that you've talked about opportunities is in emerging markets. Clearly, interest rates are a bit higher in many emerging markets than they are in the developed world. What’s the IC's current view on whether there are still good opportunities within EM?
Dan: So I’d categorize our current view on EM as cautiously optimistic. The emerging markets have been volatile of late.
Emerging markets will be very sensitive to further deterioration in trade negotiations, or an uptick in trade wars globally would not be friendly events for emerging markets. When we think in the context of a global and a diversified portfolio, there’s still going to be select opportunities in emerging markets.
As long as you stay diversified, and you look at them in the higher risk bucket of the particular portfolio that you're focusing on.
David: So a selective approach to taking risk in emerging markets. Where else is the IC finding opportunities? Where are the highest-conviction ideas globally?
Dan: Conceptually, what we’re looking to do is find attractive spread. We’re looking for ways to pick up incremental return in some of the higher-quality, more defensive segments of markets, two areas that I’ll note that have lagged in terms of performance over the course of the last several weeks.
One, agency mortgage-backed securities. This is a sector of the market where you benefit from a direct US government guarantee, or at least a guarantee from two major agencies of the federal government, and where you’re in a very high quality and a very liquid asset that provides attractive returns versus other high quality corporate alternatives as an example.
We also like select inflation-protected bond markets. Although our base case is for inflation to remain relatively low, when you look at the break-even inflation rates currently embedded in the pricing of these instruments, these securities increasingly offer value as well.
David: So one last question, given the volatility in markets and all of the headlines, has this changed the way the IC approaches investing?
Dan: It really hasn’t, David. We — for many, many years at PIMCO, try to take a longer-term approach into constructing portfolios. What we try to really do is get together, think sufficiently long-term in nature, think about the world with a few key top-down constructs when making decisions, and most importantly, be patient.
You will not catch every rally. You'll make some good local decisions, some poor decisions from time to time. But we always feel it’s important to stick to a longer-term game plan. You also need to be respectful of the pretty significant uncertainty that we operate in as market participants today.
I know our secular forums, where we get together once a year to talk about themes impacting markets for three to five years, or even longer, have talked about these rude awakenings, or these types of disruptions that we’ll need to get used to.
So we can’t be complacent, from a risk management perspective. What we’re really trying to do is protect downside as primarily fixed-income investors, be very, very prudent in portfolio structure, be good liquidity managers. And if we do this well, with a long-term focus, we can react and add value during these bouts of market illiquidity. And it’s that same structure, that same philosophy, that’s worked pretty well over the long run, on behalf of investors, and we’re still sticking to that general approach.
David: Great. Well, thanks for your time today, Dan, and thanks to you all for joining us.
Past performance is not a guarantee or a reliable indicator of future results.
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 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. 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. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. 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. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value.
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