PIMCO Income Strategy Update – October 2024

Text on screen: PIMCO

Text on screen: Esteban Burbano, FIXED INCOME STRATEGIST

Burbano: Hello everyone and thank you for joining us for this quarter's income strategy webcast. What were your main takeaways from this quarter so far?

Text on screen: Dan Ivascyn, FIXED INCOME STRATEGIST

Ivascyn: There were signs of more significant economic weakness earlier in the quarter. The data towards the end of the quarter even more recently have been much more positive in terms of economic growth and much more mixed on the inflation front. So although we're very, very excited about absolute yields – even inflation adjusted yields – this is going to be a volatile market environment and this type of volatility with less synchronized cycles globally makes for a great time for active asset management. And we're quite pleased with the performance but it is confusing and that is creating pretty significant opportunities as well.

There's a lot of, perhaps, complacency in segments of the lower quality credit markets. So despite the fact that the macro conditions are quite strong, we view our role as managers of this income strategy as looking to target resilient areas of the opportunity set while being quite excited about the type of yield that we're able to generate in this higher-yielding environment that we're operating in.

Burbano: And this is a question that we get all the time from clients, right? You seem to have a benign economic environment, but at the same time valuations spreads seem to be very tight. So perhaps just going a step further than talking about what we're doing strategy-wise, the Income strategy is very broad multi-sector, we can go across the world. How are you thinking about the key risk factors, interest rates, credit spreads, FX, big picture? What are your views?

Ivascyn: Well, again in terms of economic risks, fundamentals are strong, but it's all priced in. Maybe there's excess optimism embedded in current equity values or current credit spreads. So you need to be cognizant of the fact that when you have very, very stretched valuations and tight spreads, it takes less negative news to cause some significant downside volatility.

Our job is to go and target areas of the market where we can generate similar yields to more economically sensitive or geopolitically sensitive areas of the marketplace and do so with appropriate downside protection around interest rate risk. As an example, it's been really target rich over the last couple of years across our income strategy and other PIMCO strategies. We've been much more active in terms of tactical duration management than we have been over the last decade or so. Today, when we look at what's priced in, in terms of Fed cuts this year and into next year, we're close to neutral. Maybe on the margin we're a little bit defensive still versus passive benchmarks. But again, we have a lot of flexibility where we don't feel obligated to take a big duration view at the moment. But I'd categorize our views as somewhat neutral regarding interest rate risk.

With these tight spreads, we've even been reducing a little bit of that exposure as well in favor of a series of up-in-quality trades going up into the investment grade segment of the capital structure. The last point I'll make just relates to the fact that we have a very flexible and a very global opportunity set.

So we're using the flexibility afforded in this strategy to target areas of the opportunity set like the interest rate markets in Australia and in the United Kingdom, diversifying in smaller size in some of the higher quality emerging markets that have even higher real yields or inflation adjusted yields than what we see here in the United States as well. And we're doing similar things across the credit markets. We’ve talked about this for years but we still have a very, very strong preference for asset-backed risk and we have been focusing on the asset-backed sectors for many years now. We continue to like that area in the market. We think at least consumer assets and real estate assets are going to continue to perform really well on an absolute and relative basis versus some of the more economically sensitive credit sectors. And that's going to become more apparent to end investors if we did get into a situation where there was more economic slowing than what's currently anticipated by markets.

Burbano: We also have seen obviously over the last few years, a significant increase in cash deposits and money market funds growth. That seems to still be the case – it doesn't seem to be changing rapidly – even though the Fed has started this cutting cycle. What do you make of this in terms of the relative value between cash and fixed income in general?

Ivascyn: Yeah, so cash yields have come down. We discussed this today and cash yields are likely to continue to go lower. How quickly we don't know, but we know from history that cash yields can drop and drop quite quickly. So we think cash is fine. Cash was one of the few areas of the market that didn't go down during the ‘22 experience. So not surprising that investors perhaps appreciate cash a little bit too much given how resilient cash was versus other areas of the financial market opportunity set during this very challenging inflationary environment that we're coming out of.

But I think it's also important to note that although inflation's not back to central bank targets just yet, in the United States, it's around 2.5%. The 10-year treasury yield is above 4%. So you are earning an attractive inflation-adjusted return today, or real yield today.

So assess your own personal situation, determine how much true cash liquidity you need and strongly consider moving up the yield curve to lock in some of these attractive nominal and real yields that we haven't seen in almost two decades. So cash is fine, but cash in some sense is risky in that it doesn't allow you to lock in these historically attractive yields.

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Disclosures

The discussion and content provided within this webcast is intended for informational purposes and may not be appropriate for all investors. The information included herein is not based on any particularized financial situation, or need, and is not intended to be, and should not be construed as, a forecast, research, investment advice or a recommendation for any specific PIMCO or other security, strategy, product or service. Fixed income is only one possible portion of an investor’s portfolio, which can also include equities and other products. Past performance is not a guarantee of future results. All investments contain risk and may lose value. Investors should speak to their financial advisors regarding the investment mix that may be right for them based on their financial situation and investment objective.

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

A word about risk: 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. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. References to Agency and non-agency mortgage-backed securities refer to mortgages issued in the United States. U.S. agency mortgage backed securities issued by Ginnie Mae (GNMA) are backed by the full faith and credit of the United States government. Securities issued by Freddie Mac (FHLMC) and Fannie Mae (FNMA) provide an agency guarantee of timely repayment of principal and interest but are not backed by the full faith and credit of the U.S. government. Structured products such as collateralized debt obligations are also highly complex instruments, typically involving a high degree of risk; use of these instruments may involve derivative instruments that could lose more than the principal amount invested. 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. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. 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. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Diversification does not ensure against loss. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.

References to liquidity are based on normal market conditions and are subject to change. 

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 appropriate 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.

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