View from the Investment Committee

Year-End Volatility: Possible, But Not Probable

Group CIO Dan Ivascyn discusses how PIMCO is building portfolios in a world of lower liquidity and higher uncertainty.

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David Fisher: Hi. I'm David Fisher. And I'm here once again with PIMCO's group CIO, Dan Ivascyn, for an inside look at some of the recent conversations taking place in PIMCO's investment committee or IC. So Dan, in the press and among clients there's been an increasing amount of focus on the subject of market fragility. And in particular, many clients have asked questions about the US money markets and the fact that in September we saw a rapid increase in funding rates over a very short period of time. So is the IC concerned that markets may be more fragile than they seem? And if so, what are the signs that the IC is watching right now?

Dan Ivascyn: I guess the answer is, to a degree. We have spent a lot of time over the course of the last several weeks talking about the disruptions we've seen in the repo market. We also engaged the views of our outside advisor, Dr. Ben Bernanke. We certainly did have some funding pressures over the course of the last few months.

And the federal reserve has worked very closely with market participants to provide the necessary liquidity, to ensure that that type of volatility gradually subsides.

We do think that the Fed has the ability to control that volatility and the desire and so we very well could get into a situation as we approach year end, where we see a bit of ongoing volatility in the funding markets. But we don't think it will be that significant. And we do believe it will be manageable.

Now in terms of your overall question regarding market fragility, it is an important area of focus. Since the financial crisis there's been significant regulation impacting the banking sector. And transactional liquidity has deteriorated, there are fewer market participants today across the global financial markets to step in and provide support during these bouts of volatility.

And as an active asset manager, you need to not only appreciate that, but plan for it in terms of your overall philosophy regarding portfolio construction.

David Fisher: Sticking with the subject of market fragility, last year around this time markets were quite volatile. And I think some people are a bit concerned that heading into year-end we might see a similar situation. How is the IC thinking about this?

Dan Ivascyn: I don't think we'll necessarily see the same type of volatility we saw towards the end of last year. But I think it's important to note that all the ingredients are typically in place in late December for smaller amounts of news to cause greater than typical volatility in financial markets.

During December you typically have a banking sector that's more lightly staffed. You still have a Fed meeting. And you have a decent amount of transactional flow towards year end that's typically about more of a maintenance variety.

So it's possible. I think as an investor you need to be comfortable with more volatile financial markets on an ongoing basis. But last year's volatility in both the equity and the fixed income markets we think was somewhat unique, and the odds at least of the same level of volatility going into year end 2019 are still relatively low.

David Fisher: The geopolitical environment has also been a source of considerable uncertainty lately. You have the trade war, Brexit, the impeachment inquiry here in the US. And given the difficulty in predicting how some of these events will unfold, how is the IC preparing portfolios to be resilient to a variety of potential outcomes?

Dan Ivascyn: So as an investor, you need to become accustomed to the fact that political uncertainty is going to increasingly drive market outcomes. So not only has it been an area of focus for us, it's also important from a risk management perspective.

Given the extreme uncertainty that you mentioned, we're trying to be even more diversified than we've historically been.

Be very, very careful about position sizing. Be very, very careful about where you have an edge in a market and where you may have less of an edge than you think you have. You have to have a healthy degree of humility around your analysis structure, some of the models that you've grown comfortable with in the past.

So again, I think this is an environment that's going to lead to a lot more volatility, but also be an environment that's consistent with the strengths of a global, well-resourced, diverse, investment platform.

David Fisher: So let's talk about some of the opportunities. What can an active fixed income manager do these days to seek return opportunities? And where is the IC finding value right now?

Dan Ivascyn: So there are some areas that we think represent real good value for our clients.

We’ve spent a lot of time talking over the course of the last several years about the attractiveness of housing related investments. And even over in the corporate area. We look at corporate credit today, far fewer investments pass our credit underwriting criteria than would have been the case a few years ago. But there's still some pockets of value.

Banks are taking a lot less risk today. They still offer attractive spread to the bond investor. And capital levels are very high from a historical perspective.

So we still like overweight in financials, the focus on the United States, even some select opportunities over in Europe and even the UK. And finally within the corporate credit sector, if you focus on corporate debt tied to the consumer, which we believe is quite strong in the United States, and where household leverage has steadily come down the last few years, we think you can also pick up some incremental return while providing defensive positioning if the economy were to deteriorate further than we anticipate.

David Fisher: Are there any other thoughts you'd like to share with our clients as the year winds down and we head into 2020?

Dan Ivascyn: Just one last very important one. I wish all of our global clients a happy holiday season. I want to thank them for their continued support of PIMCO.

David Fisher: Great. Thanks very much, Dan. And thanks to you all for joining us.

Disclosure


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. 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. 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. 

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of down turn in the market. Investors should consult their investment professional prior to making an investment decision.

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.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. 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CMR2019-1114-424568

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