View from the Investment Committee

Value Returns to Fixed Income Markets

Group CIO Dan Ivascyn discusses how the volatility of the past two years has set the stage for bonds to offer greater downside cushion and improved return potential ahead.

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Text on screen: PIMCO

Text on screen: PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Text on screen: Kimberley Stafford, Global Head of Product Strategy

Kim Stafford: Hello, I'm Kim Stafford and I'm here again with PIMCO Group CIO Dan Ivascyn to give you an inside look at some of the recent discussions taking place within PIMCO's Investment Committee or IC. Dan, thanks for joining us.

Dan Ivascyn: Thanks, Kim.

Kim Stafford: Before we get started, it’s the holiday season, happy holidays to you and your family and happy holidays to all of our clients. Thank you so much for your partnership. We really appreciate it.

Dan, interest rates have endured a period of long lasting volatility in 2023, even as we've begun to see signs of stabilizing in recent weeks. What factors have driven this volatility and what sorts of conditions might be needed in order for us to see more long lasting stability in 2024?

Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer

Dan Ivascyn: So I think the driver of this volatility is still this tug of war between slowing growth, at least in key parts of the world, and inflation remaining above central bank targets. And the resulting uncertainty both from a policy perspective as well as how the fundamental data may look. Drop on top of that, a little bit of geopolitical uncertainty and a highly uncertain election cycle right around the corner, we think is going to lead to continued uncertainty.

Volatility will probably be higher than it has been historically, but we do think and are a bit more constructive about inflation heading back towards central bank targets. Policymakers on hold perhaps for an extended period of time, but with the bulk of the tightening over, that should lead to a better, more constructive investment environment.

Text on screen: Value has returned to fixed income markets

Images on screen: PIMCO trade floor

And last but not least, of course, this great value back in the market, particularly on the fixed income side.

Higher yields, higher inflation adjusted yields provide some inherent cushion. So we do think investors can expect a more resilient return profile from fixed income and we're excited about that.

Kim Stafford: One question that investors are wondering are why not just sit in cash? Why should investors invest in bonds versus cash today?

Dan Ivascyn: Yeah, that's a tough one. Cash has been kind to investors and it's been rough to be in more interest rate sensitive assets. Probably the best example I can come up with has been the performance of the bond market over the last few weeks. Very, very quickly, and really based on just a little bit of economic weakness in the data, we've seen long bonds generate total returns of 10% or so, even intermediate bond type funds over the last month have generated positive returns of 3, 4% or even greater in some instances.

Text on screen:

Images on screen: Retail bank

Just a reminder that with cash you are able to lock in these high yields on an overnight basis, but there's no guarantee on how long you'll be able to achieve those yields. In an environment like this one, with inflation gradually heading back towards central bank targets, 2024 may be about rate cuts and the ability to generate not only very, very attractive yields in longer maturity investments, but also the prospect for price appreciation.

One of the favorite areas of the yield curve that we like is somewhere in that 3 to 5 year range. You're not locking in bond yields for 10, 20, 30 years. You're just extending out the curve,

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Images on screen: PIMCO trade floor

being able to achieve and the high quality bonds yields of 6, 7, 8% or even greater in some instances. And we think that's a nice balance between the safety and at least predictability overnight of a cash yield with being able to lock in yields for an extended period of time.

Kim Stafford: Great. So let's get to opportunities, how we’re approaching opportunities across public and private markets. How would we deploy the next investable dollar in public fixed income and in private markets?

Dan Ivascyn: So what you're seeing is that the public markets have repriced and repriced quite significantly.

You can focus on areas of the market with very, very strong fundamentals and generate very, very attractive returns, both absolute and relative to less liquid alternatives. The private markets, though, are going through a significant adjustment period, private debt originated or deals done in that late 20, 20, 21, early 22 period under considerable strain and stress.

Images on screen: The Federal Reserve

It's mostly a floating rate market, at least on the debt side, borrowers are susceptible to very, very high central bank policy rates that are likely going to stay higher than some investors anticipate.

So there are going to be challenges in that space and it's going to be a great opportunity for private capital to exploit opportunities with the banks used to satisfy that demand for lending and take advantage of a series of restructuring activity both in commercial real estate, in the private corporate credit markets.

Text on screen: Area of high-conviction: Specialty finance

Images on screen: Auto and aviation

Then an area we like a lot is specialty finance. That's true both on the public and the private side. That's a segment of the market benefiting from a strong consumer. It's benefiting from the post global financial crisis regulation that hasn't impacted non-financial corporate direct lending and why we think there's a little bit of froth in that space.

Text on screen: TITLE – Fixed Income Opportunities Today: BULLETS – Treasury Inflation-Protected Securities (TIPS), Commodities, Agency Mortgage-Backed Securities, Structured products

We still think that it makes sense to source inflation protection in markets if you're doing it in the fixed income market. Good old fashioned U.S. Treasury inflation protected securities look attractive here. Very, very high. Real yields, relatively low break even inflation rates.

We think investors probably own too little commodity exposure across portfolios. We think that's a very, very attractive area of the markets as well. Probably our favorite trade at the moment, agency mortgage backed securities. They're very, very high quality asset trading at very, very wide spreads versus corporate bonds versus treasuries. That's an area of the market that we think makes sense to overweight across a variety of strategies.

We think the risk of a recession next year is somewhere around 50%. But we think the market's more optimistic. So consistent with an upward quality theme, we have significant overweight two very, very high quality structured products, in many cases triple-A rated structured product and in up in quality bias across investment.

So bottom line, get excited about today's public opportunities. Be prepared for steady, incredibly attractive opportunities within the private space.

Volatility could be higher than what we've grown accustomed to. And that's a great environment for active asset management, for active asset allocation decisions. We're here to help our clients in those areas, but we're pretty excited about the prospects for returns into 2024 and haven't been this excited in in several years.

Kim Stafford: All right. Well, thank you very much, Dan, and thanks to all of you for joining us. Happy holidays and we'll see you next time.

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