Generating income while preserving capital are important goals for many investors, yet they are increasingly difficult to achieve in today’s uncertain financial markets. Dan Ivascyn and Alfred Murata, recently named Morningstar’s 2013 Fixed-Income Managers of the Year, discuss the strategy and philosophy behind PIMCO Income Strategy’s success and what they expect in the year ahead.
Q: What, in your view, sets PIMCO Income Strategy apart?
Dan Ivascyn: While there are many strategies that focus on income generation, the Income strategy focuses on both income generation and capital preservation. Given today’s uncertain financial markets, we believe the latter is increasingly important – not only considering the return on one’s capital, but perhaps more meaningfully, concentrating on the return of one’s capital. The strategy’s combined objectives mean that we won’t stretch for yield by sacrificing downside protection – something that differentiates us from strategies that simply aim for the highest yield. Nevertheless, we think it’s possible to deliver a consistent distribution as well as attractive total return by taking advantage of the most attractive income ideas in the global bond market.
I would also like to say that both Alfred and I are very honored that Morningstar has recognized the process that we use to add value for investors. I also want to stress that the strategy’s performance has been driven by the bottom-up investment ideas provided by PIMCO portfolio managers across the globe and the top-down PIMCO investment process.
Q: Can you describe your income management philosophy?
Alfred Murata: In order to pursue our dual goals of income generation and downside protection, there are three major themes that we are looking to exploit in the Income strategy. The first is flexibility. Instead of managing the portfolio with a goal of outperforming a particular benchmark, we construct the portfolio with the goal of achieving our objectives of generating attractive income, capital appreciation and capital preservation. This provides us significant leeway in adjusting sector concentrations and risk measures as the opportunity set changes.
The second theme is harvesting a global opportunity set. Although asset valuations are becoming increasingly driven by a small number of underlying drivers such as Fed policy, there still remain significant valuation differences within and between asset classes and across geographies. A material advantage of PIMCO Income Strategy is the opportunity to use the insights from PIMCO’s top-down process combined with the bottom-up investment ideas provided by numerous portfolio managers and analysts across the globe.
The final theme relates to focusing on protecting capital. One way that we express this theme is to invest in assets that are senior in the capital structure, which we expect to be more resilient in the face of negative economic developments. Another way we implement this theme is by investing a portion of the portfolio in assets such as Australian interest rate duration and agency mortgage-backed securities, which we expect to appreciate in the event of negative economic developments.
Q: What are some other high-conviction strategies?
Ivascyn: In the current environment, we think that it’s important to focus on being defensive. In an effort to achieve the objectives of income generation and capital preservation, we divide the portfolio into two components, one component comprising higher-yielding assets, which we expect to outperform if economic growth is strong, and the other comprising higher-quality assets, which we expect to outperform if economic growth is weak.
Within the higher-yielding component of the portfolio, we continue to see value in U.S. non-agency mortgage-backed securities. We find these securities to be attractive because we’re able to buy these bonds at a significant discount from par, which provides a “cushion” in the event that economic conditions end up being worse than anticipated. These securities can also go up in price if economic conditions end up stronger than anticipated.
Within the higher-quality component of the portfolio, as Alfred mentioned, we find Australian interest rate duration to be more attractive than U.S. Treasuries given the combination of higher nominal yields, higher real yields and a central bank that has been significantly less active in compressing yield premia to date.
Q: How does PIMCO Income Strategy pursue a distribution that’s both high and consistent while still seeking an attractive return?
Murata: We don’t think that generating income and total return are mutually exclusive goals. While we’ve been able to keep the distribution steady, I can’t stress enough that the strategy will never pay out a rate that is irresponsible or compromises our goal of capital appreciation. Although the ability to take advantage of a global opportunity set maximizes our ability to pursue both objectives simultaneously, in the event that the opportunity set contracts materially, we would reduce our distributions instead of reaching for yield.