Income Update: Strategies for a Shifting Market

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Text on screen: Esteban Burbano, FIXED INCOME STRATEGIST

ESTEBAN BURBANO: Hello everyone and happy New Year. Thank you for joining our Income Strategy Update.

So Dan let's start with a recap of 2024, the year where central banks embarked in cutting cycles and interest rates were quite volatile. Credit spreads did well, and equities markets also continued to rally. Can you give us your view of what were the key takeaways of 2024?

Text on screen: Daniel J. Ivascyn, GROUP CHIEF INVESTMENT OFFICER

DAN IVASCYN: Sure, so I think 2024 was an example where the higher yields, you know, going into the year, helped provide cushion from rate volatility and the sell off that we witnessed towards the end of 2024. I think that's an important reminder for end investors. When yields are high, there's inherent cushion within the fixed income markets. So, although we had a decent amount of volatility, you know, within the bond markets and even a selloff after the Trump election outcome, we were able to still generate attractive, you know, overall returns for end investors.

And I think looking into 2025 a similar dynamic still plenty of uncertainty probably a decent amount of volatility and, volatility for a broad based strategy, like income means opportunity at the end of the day. But, you know, it will be challenging. But again, you know, looking back at 2024, generally pleased with the performance.

But I think the key point going into the new year is that there's great value within the fixed income markets. And similar to my point about 2024, when you have attractive yields, there's this inherent cushion. I think investors have to remember that you don't have to get every zig or zag right in the market. We don't need central banks cutting rates aggressively to be able to achieve attractive returns within the fixed income markets, especially when you take into account a global opportunity set.

When we look forward, we think that risks are, are gonna be a little bit more symmetric. We do think that the Federal Reserve and other central banks would like to get rates lower to the extent that the inflation data and the economic data allows them to do so. But they're also gonna be watching policymakers very, very closely. They're gonna be looking at the degree in which policy could impact both growth and inflation to the extent they think that they should be more conservative and cautious in terms of staying on hold for an extended period of time.

We think they'll do that. There's also some scenarios within the distribution where interest rates, policy rates have to go a little bit higher as well. And that could have implications for certain areas of the credit sectors, of course, implications for yield curve shape. So a lot going on. And it could be a little bit intimidating for both institutional and retail investors, but I think the key point is that there's attractive long-term value. And in fixed income, the yield typically is the driver of returns. We haven't seen these yields in many, many years.

ESTEBAN BURBANO: So let's dive into what to do within the bond market. Of course, our income strategy, global multi-sector is perhaps our go-to strategy for what PIMCO is doing across the entire bond markets. Let's think big picture first, you know, as we think about bond strategies, our interest rate exposure, our overall credit risk exposure, so big picture, how are you thinking about both?

DAN IVASCYN: Yeah. Start as top down as you can get in reinforce this very important point. Yields are attractive. Credit spreads are tight from historical perspective, equity valuations appear stretched. There's a lot of optimism regarding the economy. Even PIMCO believes that the US will likely grow at 2% or so, perhaps even a little bit more over the course of the next 12 months. But the challenge for investors is a lot of that optimism is embedded in market pricing.

So we think this is a time where investors should be reducing credit exposure, reducing some sensitivity to the economy, sensitivity to equity valuations, and come up with a creative way to generate yield in the higher quality areas of the marketplace. So as you've seen, credit spreads tighten, as you've seen optimism or growth optimism build over the course of the last several months, we have incrementally brought down some of our lower quality credit risk or economically sensitive credit risk.

We've begun to, you know, further leverage that global opportunity set. So, you know, we do think going up in quality makes sense. Not hunkering down in the lowest yielding highest quality segments of the market, but looking to diversify into areas that will be resilient if we do have some type of unanticipated growth shock or the need for central banks to tighten policy far more than currently is envisioned by markets.

So it hasn't been a radical shift in asset allocation. It's just been that classic steady shift into higher quality areas of the market as spreads have tightened as equity valuations for the most part have continued to go higher. That's theme number one. The second relates to the fact that yields are quite attractive. But there's plenty of near term uncertainty, particularly policy uncertainty from Trump.

We have also steadily taken our interest rate exposure higher as well. We're not yet at the point we were at back in that, you know, the beginning of the fourth quarter 2023, when there was a lot of pessimism, you know, tied to, you know, both the trajectory of policy as well as, you know, the broad direction of longer maturity yields, but we have used this sell off to steadily increase our overall interest rate exposure in the portfolio.

We're still defensive versus passive alternatives. So we're not, you know, quite at a, you know, the type of interest rate exposure you'd see in the Barclays aggregate index, but we're heading in that direction and we have a lot more room to add interest rate sensitivity to the portfolio to the extent that this sell off continues. So again, fine-tuning of the portfolio shifts in asset allocation, and then really leveraging the overall global opportunity set.

Disclosure

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.

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. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Diversification does not ensure against loss.

The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.

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