In this Q&A we are joined by Alfred T. Murata, fund manager at PIMCO, to discuss where the biggest opportunities and challenges are within Fixed Income markets, the outlook for the year ahead, and the factors he believes advisers should consider in today’s uncertain market conditions.
PIMCO is a global leader in active bond management, with deep expertise across public and private markets. It manages $1.86 trillion* in assets across a broad range of strategies and has more than 50 years of experience navigating shifting risks and opportunities in financial markets. Here in the UK, last year marked the 25th anniversary of the opening of PIMCO’s London office, which is home to over 400 employees and its second largest trade floor. Their extensive resources, global presence and time-tested investment process are designed to help provide clients with an edge as they pursue their long-term goals.
From PIMCO’s perspective, what is the outlook for Fixed Income over the coming years?
Alfred T. Murata (ATM): Today’s market offers a very exciting outlook for Fixed Income assets and active management over the coming years. The combination of elevated volatility with less synchronized global growth cycles has created a significant opportunity for active managers to generate returns through relative value across markets and dislocations in different sectors.
In Fixed Income, starting yields have historically been a good predictor of future returns. Today’s elevated yields mean that allocating to an income-oriented bond strategy can offer the potential for equity-like returns from much higher-quality assets. At the same time, historically high starting yields can provide a consistent, attractive income stream to help dampen volatility. Additionally, as central banks across developed markets embark on a rate-cutting cycle, price appreciation could potentially lift these returns even higher.
It’s understandable that many investors are looking at the unpredictability of financial markets and are keen to add protection to their portfolios against unexpected downside risk scenarios. An actively managed strategy like the PIMCO Income strategy for example, is able to embed higher levels of resiliency in its portfolio to weather a range of market outcomes. For instance, as opportunities have presented themselves in higher-quality segments of the market, we have taken advantage of our flexible, multi-sector mandate to significantly shift exposure from lower-rated, more cyclically sensitive segments of the corporate credit market towards higher quality, more liquid bonds. This tactical shift enables us to potentially earn an attractive yield while staying high quality and retaining a good level of dry powder to target other opportunities that arise across the global bond market.
Where are you seeing the biggest opportunities in Fixed-Income markets today – and on the flip side, where do you see the biggest challenges?
ATM: One of our highest areas of conviction is in US Agency Mortgage-Backed Securities (“MBS”). These are government-guaranteed assets that offer additional yield over US Treasuries and a strong liquidity profile. The asset class offers exceptional value today as the extra yield compared to Treasuries is at very high levels, driven predominantly by technical factors amongst the biggest buyers of MBS, such as the Fed’s balance sheet reduction and bank retrenchment amid challenged deposit growth. Meanwhile, the government guarantee means investors are not exposed to credit risk in the same way as corporate bonds. PIMCO, as well as other asset managers more recently, have stepped in to take advantage of this dislocation as investors are being compensated at similar levels to investment grade corporate bonds for a credit-risk free asset.
It’s also apparent that there is substantial value today in higher-quality segments of the securitised credit market, and we continue to add exposure to non-agency MBS within the Income strategy. Amid economic uncertainty, we generally favour high-quality securitised products backed by strong collateral over corporate credit. And in doing so, we expose the strategy to less risk of downgrade or principal loss as well as generating attractive returns for an income-oriented investor. Within corporate credit, we think financials are attractive following significant improvements in balance sheet strength for the large national champion banks since the financial crisis. Elsewhere we also find select opportunities within emerging markets, many of which have been very successful in bringing down inflation and have already embarked on easing cycles.
On the other hand, we have reduced sectors where valuations are fair or tight, and where the opportunity is not as attractive as high quality securitized bonds, such as high yield bonds. Caution is also warranted within bank loans due to their floating interest rates, which could lead to higher debt service costs for smaller, heavily leveraged companies and potential market deterioration if short-term rates remain elevated.
Overall, we think the Income strategy is very well positioned for the current environment, with high credit quality, an attractive yield and plenty of liquidity to take advantage of opportunities wherever they arise across the global bond market.
Given those opportunities you’ve highlighted in Fixed Income in 2024, what should advisers be thinking about, on behalf of their clients, when investing in Fixed Income today?
ATM: There are some very compelling opportunities across the global bond market right now. While we saw many investors allocate to cash over the past year or so, now may be a great time to shift some of this exposure towards bonds to lock-in elevated yields ahead of central bank rate cuts. Central banks across developed markets are expected to begin cutting rates sometime in mid-2024, and in this scenario investors holding cash would see their yields and returns decline immediately. Importantly, investors should be cautious of waiting too long and trying to time the market, with the last two months of 2023 serving as a great example of how a significant portion of annual returns can occur over short time periods. It really does pay to be invested and while there is still plenty of room for Fixed Income to outperform, investors risk missing such rallies if they stay on the sidelines to wait for an elusive perfect moment.
The high level of volatility in 2023 – with high peaks followed by a sharp rally (which saw bond yields end the year close to where they began) – also highlights the dangers of taking a passive approach to Fixed Income investing. When compared to an active strategy such as PIMCO Income strategy, passive alternatives have been typically less effective in managing duration risk to weather multiple macroeconomic outcomes or in taking advantage of market dislocations.
What do you think advisers should be looking for when it comes to selecting an investment manager for their clients’ Fixed-Income exposure?
ATM: It is an interesting question because selecting the best bond manager can mean different things than selecting the best manager in other asset classes, say equities for example. I would say that when looking for a Fixed Income manager, you really want to be focusing on a few key things – scale and access, ability to navigate complex markets, quantitative rigor, and a consistent, disciplined approach. I’ll drill down into these as follows:
1. Scale and Access
Scale and access are certainly rewarded in Fixed Income markets, and the track record of PIMCO over the past 50 years demonstrates this. The Fixed Income market is a vast and complicated place, and you need a broad and specialized global team if you want to uncover the best opportunities around the globe. PIMCO is also uniquely privileged in that it benefits from valuable top-down insights from world-renowned economic and political experts on our Global Advisory Board, including former central bankers, Ben Bernanke and Mark Carney, as well as former UK Prime Minister Gordon Brown. From a bottom-up perspective, the firm has a deep bench of 80+ credit analysts who conduct proprietary sector- and security-level analysis. And being a major global investment platform allows better access to deal flow and sourcing capabilities, on both the public and the private side.
2. Complex Markets
Just being well-resourced is not enough. Having a rigorous and nimble approach that can keep pace with global markets is also critical. PIMCO’s forward looking macroeconomic framework is developed through our quarterly cyclical forums and our annual secular forum, and is refined on a day-to-day basis by our Investment Committee and portfolio managers. In addition, our ability to allocate capital flexibly across the risk spectrum means we are able to develop holistic views of complicated and interconnected markets in real time.
3. Quantitative Rigour
When it comes to quantitative rigour, you want a manager that integrates robust risk management and portfolio implementation frameworks into its investment process, and where there is significant ongoing investment in technology, proprietary analytics, and big data. At PIMCO, we find that data-driven tools help enhance and optimise our investment decision-making, and we have dedicated portfolio implementation, analytics, and risk teams that help us focus on this.
4. Consistency and Discipline
Finally, you want a Fixed Income manager with a timetested, consistent, and disciplined approach. PIMCO’s rigorous approach to portfolio construction allows us to focus on high-conviction views while aiming to avoid any single risk dominating returns. Our strong culture of teamwork engenders tight coordination and connectivity across global teams.
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About Alfred T. Murata
Mr. Murata is a managing director and portfolio manager in PIMCO’s Newport Beach office, managing income-oriented, multi-sector credit, opportunistic and securitized strategies. Morningstar named him Fixed-Income Fund Manager of the Year (U.S.) for 2013. Before joining PIMCO in 2001, he researched and implemented exotic equity and interest rate derivatives at Nikko Financial Technologies. He has 24 years of investment experience and holds a Ph.D. in engineering-economic systems and operations research from Stanford University. He also earned a J.D. from Stanford Law School and is a member of the State Bar of California.
Disclosure
Marketing Communication – This Q&A contains the current opinions of the manager and such opinions are subject to change without notice. This piece 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. The views and expectations expressed are those of PIMCO. There can be no guarantee that the trends mentioned above will continue. Statements concerning financial market trends are based on current market conditions, which will fluctuate. An investment in any PIMCO managed investment opportunity entails a degree of risk and investors could lose all or a portion of their investment.
PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom) is authorised and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser.
*As of 31 December 2023
