PIMCO Monthly Income Fund Update – A call with:
Stuart Graham, Head of PIMCO Canada
Alfred Murata, Managing Director and Portfolio Manager – PIMCO Monthly Income Fund
We tuned into a conference call being held by PIMCO to discuss what has been occurring in the past few weeks in the fixed income market. We received some insight on their current positioning and how they view the path forward directly from the Portfolio Manager, Alfred Murataed Murata. PIMCO Monthly Income Fund is one of the largest fixed income funds in the world. Alfred has been known to be a steady hand in previous times of turbulence and is considered a world leader in Fixed Income Analysis and Trading. Alfred's outlook is optimistic despite the recent turbulence in the fixed income market.
A summary of Alfred’s observations and comments from the call are as follows:
There has been significant volatility as of late in credit markets, which are pricing in a more severe recession than what was priced into the equity markets. In the credit market, this has caused spreads to widen significantly. The Federal Bank has deployed unprecedented stimulus to increase the liquidity in the credit market and stabilize the economy. While the stimulus will likely help to avoid a lasting depression, we will likely still see a short term recession.
PIMCO has an optimistic view given the current conditions and sees opportunity in the marketplace. Their sheer size in the marketplaces puts the firm at an advantage to get good treatment from business partners. In addition, it allows them to buy and sell large blocks of bonds which are easier to analyze and therefore easier to trade.
So - What happened?
The volatility has impacted all sectors in the fixed income marketplace as liquidity was diminished. Government treasuries have outperformed in the current market conditions however, there was a large divergence between those sectors that have done well and those which have underperformed. Sectors that underperformed were those such as Agency Backed Mortgages and High Yield Bonds.
Alfred and the team reduced their credit risk in the Monthly Income fund by being cautious in their exposure to duration. The compensation in yield for duration as compared to the risk was not attractive enough for him to explore. The fund shortened the average time period to maturity in the basket of securities held as the payoff for longer term holdings was not worth the price. This lower risk, lower duration detracted from performance on a relative basis to other fixed income funds in the shorter term. Treasuries have rallied dramatically year to date BUT the fund was underweight in treasuries. The fund has increased their position significantly in Agency Backed Mortgages to the point where it is now their largest position.
What are Agency Backed Mortgage Securities?
Agency backed mortgage securities are high quality bonds which are secured by an underlying basket of residential mortgages and which are guaranteed by the US government. Although these securities are high quality and money good, the market volatility has caused them to be undervalued. A cascading de-leveraging has occurred in the market as leveraged companies have been forced to sell out of these MBS. The result of which has been severe pressure on the current prices. The Federal Bank has just announced in their $2 trillion stimulus package that they can (and will) purchase an unlimited amount of these Mortgage Backed securities in order to stabilize the prices going forward. These securities have performed poorly because of volatility and technical selling pressure – not by the underlying fundamentals and a significant re-pricing is likely in the near future.
Alfred indicated that the fund would have performed better if they had a longer duration and more exposure to treasuries but he believes they made the right choice by remaining risk adverse and defensive. He believes that government fiscal policy, although slow to action, will be sufficient to stabilize the economy.
What is the path forward?
The current internal yield of the portfolio is 6.8% which Alfred feels is sustainable. They don’t want to be increasing exposure to excess risk, but want to remain exposure in the marketplace overall. As the economy stabilizes and the treasury yields decline, the yields outside of treasuries will increase. Alfred is positive that compared to a treasury portfolio, his underexposure will result in positive returns. The fund will make back the losses as we are set to see significant re-pricing in the Agency Mortgage Backed Securities as well as with the current internal yield. The bottom line is that Monthly Income is a diversified, high quality mandate holding money good bonds with an excellent Yield to Maturity in a world of low cash yields. As the bonds mature, they will pull to par and clients will be made whole.
This environment represents tremendous forward looking return potential and we are confident that clients will come out on the other side of this in good shape.