PIMCO Tactical Opportunities Strategy Update

Sharad Bansal, Portfolio Manager, Tactical Opportunities Strategy

Question: Why do we expect the Tactical Opportunities Strategy to perform well in 2025 given the current macro environment?

I would say that one of the top reasons to be excited about in 2025 is the absolute level of yield is very high in Tac Opps.

Ex-Venture Global, we have a yield of about 12.2%, which is almost 5% higher above the high yield market in the United States. So we think that 500 basis point 5% pickup in yield, that your Tac Opps provides, with very similar interest rate kind of a risk profile, is very attractive. Secondly, I would say, the absolute level of base level yields in the United States in terms of Treasury markets is still quite high. So we feel the monetary policy is still kind of restrictive. We think there is a lot of good potential for a rate cutting cycle to start in the probably the second half of the year or so, so I think, that could provide a good lift to the portfolio, given our focus on mortgage-backed securities and other collateralised assets.

Thirdly I would say, like, we are keeping the yield very high, and we still have a lot of flexibility in the fund to take advantage of dislocations in the market and be tactical in nature. So I think that sets us up in case we get surprises in the geopolitical front or the US Tariff regime.

And finally, I would say, the large position, as I mentioned in Venture Global, that we've had, had an IPO last month. So that also, we feel, has a good potential upside in the portfolio where we sit today.

Question: As at the end of February 2025, the market generally expects a few rate cuts after the December FOMC. What is PIMCO’s view?

So today in the United States we had a release of January's CPI inflation data which came slightly hotter than expected. So markets kind of priced in for one cut this year. Our view is that we are going, there's a reasonable chance, we'll get more than that. We might get a couple of cuts so that can create a good potential upside for the portfolio going forward.

We feel a lot of the drivers of inflation, namely on the wages side is heading in the right direction, as well as the economy generally is in the slowdown mode. So we feel on the second half of the year, there's a good potential to get like a couple of cuts versus what's markets priced in, and that could be actually a great lift for the Tac Opps portfolio given our already current high level of yield in the portfolio.

Question: What is our longer-term view going into 2026?

So basically, the longer you hold, we feel more you have to cut. One of the biggest things that we watch out when we're managing Tac Opps portfolio is where the mortgage rates are. And the mortgage rates in United States are still very high. So housing is unaffordable on a mortgage basis, which is why you see very little housing trading, even though there's lots of demand – natural demand for housing. So we feel that's the biggest credit part of the portfolio in the United States. If that's not trading as frequently as people need to. Given the formation of households, it just tells you the policy is restrictive. So the longer they hold, we feel the more they will have to cut. And there is definitely a move on the new administration to structurally start reducing, I would say, wasteful spending in the government sector and generally in the economy, which is also very good for a fixed income investor.

Question: Ex-Venture Global, the portfolio is yielding 12.2%. How is PIMCO generating that level of yield?

So ex-Venture Global the portfolio yields about 12.2%. And that includes the cost of hedging that we spend. So it's definitely higher if you even exclude hedges if you want to make a fair comparison with high yield. The differential would be even more than 5% that I mentioned earlier. So going back into Tac Opps portfolio construction, first of all, our biggest focus is to build what we call as a core part of the portfolio in which our big focus is that for Tac Opps, unlike other high yield and other private credit corporate kind of opportunities, the focus here is very much on secured assets, secured cash flows backed by hard assets.

So mortgages, be it on the commercial real estate side, or the residential side, or more contracts are essentially securing your cash flows. So when we construct the portfolio, we try to keep that core part, the safe part of the portfolio as big as possible, and I think right now it's very attractive where it sits in terms of yield.

So once we have that base part of the portfolio core yielding decent yield in the highest single digits low double digits, then we overlay them with more, I would say convex bets in the portfolio, and that's how Venture Global was formed. So, to give you an example, overall, the portfolio yields 12.2%, and it's broadly, I would say the largest contributor to the yield is coming from the residential side, which is driven by legacy mortgages in the US as well as agency mortgage book.

Second biggest contributor is, I would say, specialty finance where we have a variety of trades ranging from financing commercial like backed asset cash flows to airplanes. Third I would say the contributor is coming from the corporate side, and finally from the commercial side. Across the board, almost all those 4 buckets I mentioned specialty finance, residential, corporates, commercial, they're roughly contributing almost very similar, 12-13%. So it's very well balanced kind of distribution. But you can tell from our allocation of risk that we are more lighter in contribution in the commercial real estate side, because we feel the opportunity sets lies elsewhere.

Question: Post Covid there has been distress in commercial real estate. What is the outlook in 2025 and beyond for portfolio allocation to this sector?

So you're correct. So we went. We've been, we went quite aggressive during Covid time period in the commercial real estate sector and we went for the assets which were hit the hardest where we felt the recovery was not relying so much on behavioural patterns – like people not coming back to the office – so obviously at that time period all the sectors got hit very equally hard ranging from hospitality assets as well as office buildings. And we basically made a conscious decision not to address the office sector because we felt that for us to better recovery, we have to basically make a better recovery from work from office trends which we thought could last a bit longer. So we were quite aggressive in the hospitality space. We bought hotels, we bought refurbishment projects, transitional loans.

We also bought entire buildings in New York City – apartment buildings which people just ran away from, and we did really well with that. But now we felt, with their base level rates higher, the cap rates in commercial real estate has gone up. So you expect the price of those assets to go down.

So while on paper they're down, I would say you haven't seen that much distressed assets really come out because most of the borrowers are hanging on to their assets hoping rates rally, or they hope that they'll be able to get a modification on the loan and many times they just have to put equity back into the trades. So it's a bit of a defense mode for those kind of operators. So we kind of shied away because we felt that it wasn't that distressed enough for Tac Opps to be very active in it.

In 2025, you can expect us to get more active if there's another dislocation like we saw in the regional bank crisis like for at least 2 years in a row in 23-24 when we had banks basically go out of business in Silicon Valley. If you see anything like that come back, I would say we'll go back into it, but until then I think you should assume we are going to be very patient with deploying capital there. We want to be tactical and not essentially just buy the market and commercial real estate.

Question: From a corporate perspective, what is the outlook for allocation to this sector? 

So the corporates you know, in generally the spreads in corporate start with investment grade corporates. They are one of the tightest levels we've seen on an absolute basis. The spreads, not the yields.

They are basically through to 2019 kind of levels. Pre-Covid kind of levels. Similarly, high yield spreads are super tight as well. So we've been very careful about adding risk generic risk in the United States in that. So I would say, we are not looking to add much more risk in that space in the corporate side. Where we have been able to add, is more to take advantage of the relative slowdown in the European economy, where their GDP is generally on the much substantially slower trajectory than the United States.

That's an area where we've been able to find, and we have some good trades in the pipeline to add in that space. So I think that's relatively more attractive on the corporate side, we are actually in the US, our focus is so much has been on the hedging side. We're actually using the tight spreads to take the opposite side of the market, where we can short corporate bonds and high yield bonds, cash bonds given that how relatively tight they are. We are starting to see some distress on, I would say, in the private credit side, where we're seeing loans getting renegotiated. Where terms are getting extended, some of the coupons turning into more like big coupons, where you actually don't pay a coupon. But technically you are in a default. But they just buy time. So we are seeing a little bit early stages of that, but largely, I would say, still well behaved market. But there's not that much distress to buy in that space.

Question: In terms of portfolio construction, what role do residential mortgages play in the portfolio?

So residential mortgage plays a very substantial role in the portfolio construction. Going back to like the Tac Opps portfolio construction, we have the center, the core part of the book, which is typically 60 to 70% of the funds capital goes into that sector. These are the areas where we don't expect to lose money in the long run where we feel we will earn a positive yield in basically most states of the world. So residential is a big part of the core part of the portfolio.

So in terms of investing, for example, it has a few things going for it. First of all, the United States in general, I would say, is short housing units, were not created enough. Back in 2007/ 2008 great financial crisis, a lot of the mortgage originators and builders went out of business.

The US household owners themselves went through a balance sheet recession where they had lost money. So you went through a period of almost 10 years, you didn't build so much in the US. And suddenly post Covid, you realise that you're short housing units. So you're structurally, you've got something positive. Supply is limited.

Secondly, the job market in the US is still very good. It's still very strong. It's gradually slowing down. But it's not definitely nowhere close to like alarming levels. So the bid for housing is there. The only thing that holds people back is like the mortgage rates are generally on the higher side. So we think those technicals kind of created to be very positive on the fundamental basis.

So housing in general, we expect to grow 3 to 4% a year for the next few years, which is basically slightly above inflation. So going back, we try to harvest when once we like the fundamentals, then we look at the valuation and we feel the non-agency mortgage market.

The agency mortgage market in the US and also the UK. I would say prime borrowers. Those are very good markets to invest into, which is why you see residential being the largest contributor of yield in our portfolio. So what it brings to us is the fact that you get resiliency.

So when an asset can basically when home prices can decline 15-20% in the next two years, we still think we will make positive return in these assets. So that is the resiliency that this housing brings to the Tac Opps portfolio.

Question: What kind of highly convex or opportunistic investment opportunities are in the market right now?

So you know, by definition, highly opportunistic convex means that we generally don't know where the next one comes from. But we go through the PIMCO process on a daily basis, essentially scanning the market where we feel PIMCO has a structural advantage view on this on this dislocation or the investment is more like an option like profile.

So that's how Venture Global was formed. Another investment I can talk about which we are actually topping off right now, because it's going through a valuation round is in the defense technology space where we invested in a valuation, which is basically a hurdle of where the valuation is right now. So it's up like 200 plus percent on an valuation basis. In the business of defense, drone defense technology for drones and other related new kinds of technology. So I think that's one we are topping off right now. But other than that, I would say we are keeping those bullets kind of free. When our style in those investments, when we look for them, is generally small scale. In other words, we don't want it to be a large position in the fund. We expect to invest, maybe perhaps start off with half a percent position and maybe build up to like a 2% kind of position. And then kind of let it run from there and see how well it does because a baseline for them is definitely 30, 40% plus IRRs. So that's kind of how Venture Global started as well like we had a half a percent, and we let it, we invested over time. And then suddenly, it hits kind of a convex point, and it just kind of takes off.

So, to answer your question, I would say nothing. Nothing actionable on the horizon, but we're definitely on the lookout for more and more opportunities.

Question: Venture Global has been a successful, highly convex opportunity for Tac Opps, what are some of the details of the IPO?

Once again, like I mentioned ex-Venture Global, the yield is high. The reason I say ex, because the Venture Global essentially grew to be a large position of the fund, mostly because it had such an outsized performance in term versus the initial capital.

So that was one of the typical convex trade that has so far been a very good trade for us.

So where that you know what's happened in January is the company essentially IPO’d and our investors and us are now able to see that on every day basis where it trades and where the market values it versus us, using a third party kind of vendor reporting it. So we are very happy that you have a liquidity event, and there's a price out there. Where the position sits right now, I would say, like the price action has been, it's very early stages of price discovery for the company. The company essentially went public with a very small float.

In other words, very small number of shares were sold relative to the full size and valuation of the company. So I think that's something that's made it a little bit more technical in terms of trading. Given that, it's a new company. It's a disruptive natural gas exporter out of the United States that nobody has kind of seen in like decades to come out. So the small float is making it very technical.

The other thing I would say, is that given that how new this company is. There is not that much reporting by analysts across the street. So I think next week, there's a time period when which IPOs, the main street, the Wall Street people are not supposed to write or have recommendations or views on the stock that starts changing next week. So we feel that could change it positively. And I think, yeah, the company was probably priced a little aggressively to begin with, but that's what the market is. So we think that it's a very attractive from where we sit today.

We definitely have plans to right size this position. We're in no urgency to right size this position. We think it's very attractive from where it sits today, and we're happy that it's trading, and I think it needs a few quarters for people, analysts and the whole, they get used to the company, start seeing the progress, the fields that are launching. You know they start cash flowing even more like in a few months from now. And I think that's starts changing the picture for the company very positively.

Question: What is the outlook for Venture Global and the LNG industry overall?

So I would say that when the initial range of IPO talks came out very early in January. I would share, I would probably be in the line of the investors. Yes, it seems like a very high valuation, and the upside is not there, but where it's now trading in the market, which is a bit which is, discounts actually to where it IPO’d, we think it's very attractive to be in this trade. This is a company which is essentially pretty on path to produce capacity to be the largest natural gas exporter in the United States, if not the world. So we think it's quite attractive, and it's a great position to be in right now. They definitely priced a bit aggressively, and then I think the low float has caused it to be more technical. But it's still very early stages. So sitting today, like as of today, I would say, it's a very attractive position. And Tac Opps by itself has a lot of potential, like, you know, ex-VG is 12%, plus-VG, I think it's even higher than that. So I think it's a very attractive trade to be in. You just have to be patient with it, and I guess, make it more comfortable with its reporting and data.

Question: What is our exit plan from Venture Global?

Yeah, I mean, firstly, I would say, like, you know, again, I'm very appreciative investors for understanding. Like, you know, we didn't exactly plan to be in a 20% position. This was a much smaller position. It just had a 4 or 5 x returns on it. So we totally are cognisant that it is a high size, high concentration. We also want to balance it with, make sure we're maximising returns for all our investors across the portfolio.

So we are definitely planning on exiting this trade. We're definitely not in a rush to exit it. We definitely have a lock up that we have to be respectful for, and we have to be mindful of that. But there are, there's definitely plans in motion to monetise it. But we definitely are price sensitive. We're not going to be price insensitive about this. So we want to make sure it's the right valuation. There are competitors in the market, you know, we look at their valuations, and we feel this right now you know where it is. It's actually a discount to the competitors, I think when it IPO’d it was kind of in line with the competitor. But so I think we are definitely going to be price sensitive to exit. But we are. We have plans to exit, but obviously not going to be a fire sale or anything like that.

Question: What risks are the team playing close attention to in 2025? How are we dealing with those risks?

Yeah, I would say, the biggest risk that I see is like, you know, the two risks. First is on the inflation side. If we're, instead of like the assumption that inflation is slowly going the right direction, we actually start, you know, right now, Fed is in a pause mode we start talking about, oh, forget about pause, it's hike mode. We feel that can be a little bit disruptive to markets, not just Tac Opps in generally the market. The equity market for sure is going to feel it. The bond market is for sure going to feel it so we feel that could be a bit disruptive. So how Tac Opps is handling that is like by maintaining our shorts. Like, as you know, direct Tac Opps is a directional strategy, but we overlay them with reasonably sized hedges, so that we can protect ourselves against, I would say, tail risk in this market.

So I think our hedges will protect us where we are short corporate bonds, short credit in general. Short, even we are long volatility in equity markets. So when volatility goes up, we make money. So we like those kind of protection in the portfolio.

I think the second is geopolitical, for sure. Given that we are in a new regime, we are only like a few month or so into the new regime. A lot is being defined. And so far it seems like everything is reasonable. There is a lot of talk, but then follow through is a bit less, because I think everybody wants to just get and figure it out so. But in case there's a massive shock. I think, that could be hurtful to the US Economy. And how are we dealing with that? Is like, for example, if tariffs by itself create inflation, then then that would hurt equity markets and bond markets, and our hedges will help us. If they are actually creating more growth. I think that's definitely going to lift all our asset flows in the portfolio.

So I think we we're very well balanced, and our hedges should protect us against the adverse scenarios.