Fund manager series

Earning solid yields while retaining quality

Emerging- market fundamentals are improving in general, so there should be good opportunities for investment amid tightening valuations across countries and companies, says Mr Dan Ivascyn.
Emerging- market fundamentals are improving in general, so there should be good opportunities for investment amid tightening valuations across countries and companies, says Mr Dan Ivascyn.PHOTO: PIMCO

In the latest in our series featuring fund managers and leading market experts, Dan Ivascyn, group chief investment officer of United States investment giant Pimco, discusses his outlook on income strategies and investing opportunities.

A 26-year investment industry veteran, Mr Dan Ivascyn, is managing director at the Newport Beach office in the United States, as well as lead portfolio manager for Pimco's income strategies and credit hedge fund and mortgage opportunistic strategies. He is also a member of Pimco's executive and investment committees.

He was named by Morningstar as Fixed-Income Fund Manager of the Year in the US for 2013. Before joining Pimco in 1998, he worked at Bear Stearns in the asset-backed securities group, as well as at T. Rowe Price and Fidelity Investments. He has an MBA in analytic finance from the University of Chicago Booth School of Business and a bachelor's in economics from Occidental College.

Pimco's income strategy meets the demands of income-oriented investors who seek a bond investment that offers a relatively strong and consistent income stream with an emphasis on quality and diversification. The strategy seeks to maximise current income as its primary objective while still emphasising total returns.

Q What is the current investment outlook?

A We think the nearly eight-year-old global economic expansion will continue. Growth will be fuelled by supportive fiscal policies in most developed-market economies, easier financial conditions since the start of this year, improved consumer and business confidence, and a rebound in global trade. We expect one more Federal Reserve rate hike this year, and we forecast global gross domestic product growth of between 2.75 per cent and 3.25 per cent over the coming 12 months.

Over a three- to five-year period, we expect additional Fed rate hikes, although rates - and economic growth - are likely to peak at levels below historical norms because of demographics, the growth of public and private debt, and slow growth in productivity.

Many fixed-income investors have typically relied on either government or corporate bonds in order to achieve their objectives. Unfortunately, we are now in an environment where interest rates are rather low and credit spreads are relatively tight.

In response, investors have several potential responses - reduce risk and accept lower returns; maintain or even increase exposure to corporate credit assets in an attempt to achieve return targets; or expand the opportunity set to include the entire global fixed-income market, to find better value without necessarily taking undue risk.

Q What should investors be most worried about given such volatile market dynamics?

A Market volatility is a given, but it also represents an opportunity, particularly during an era of low interest rates. When the market overreacts, it's often a good time to seize opportunities.

Investors should be willing to accept mark-to-market volatility, but should look to protect portfolios against permanent capital loss. A focus on risk management, including maintenance of sufficient liquidity and portfolio flexibility, will be crucial in navigating volatile markets.

Q Amid rising rates and growing global uncertainties, how do you position the income strategy to continue generating a sustainable income for investors?

A Our top priority is seeking to provide consistent income and long-term capital appreciation. To help achieve these key objectives, the strategy is divided into two parts: one that is higher-yielding and one that is higher-quality.

The higher-yielding portion focuses on defensive, high-quality, short-dated and default-remote corporate and structured credit. For example, we continue to see value in non-agency mortgage-backed securities, which have attractive yields and might be resilient even during slower economic periods.

In the higher-quality bucket, we focus our duration exposure on developed countries, primarily in the US and Australia. We believe Australian rates have room for further compression should the country's growth, which is strongly tied to China's, remain sluggish. We continue to see value in diversifying exposures globally.

Q The income strategy has significant mortgage-backed securities exposure. Why overweight in this asset class? What is your outlook here? And the key risk issues?

A The strategy has historically emphasised the mortgage-backed securities sector, with a particular focus on non-agency mortgage-backed securities. Non-agency mortgage-backed securities are backed by mortgage loans in the US, but don't have a guarantee from government agencies.

Within the non-agency market, we look carefully at two main performance drivers - home prices and borrower quality.

We also periodically invest in agency mortgage-backed securities that have an implied government guarantee. They are very liquid and have a high level of secondary-market trading volume, and are helpful in keeping the portfolio diversified. They also are resilient in periods when there is a flight to quality.

We will increase or decrease our exposure based on spread levels and valuations.

The Federal National Mortgage Association, commonly known as Fannie Mae, is an example of a government-backed agency.

Q Which other markets /asset classes do you favour or avoid, and why?

A Global government bond markets have priced in low interest rates, and we see levels as being broadly fair. Across various countries, we expect to find a lot of opportunities for relative valuation positioning but, at current valuations, we expect to remain fairly neutral overall in terms of duration risk.

We hold a modestly positive view overall for risk assets. That said, there is little by way of a cushion in terms of valuations should economic growth slow down. This warrants a focus on security selection and bottom-up research, and we will invest based on an assessment of strong fundamentals, hard asset coverage and seniority in the capital structure.

We see emerging-market fundamentals as improving, generally, and our baseline global outlook is favourable for emerging markets. Valuations have again tightened, and we expect to continue to find good opportunities across countries and companies in this sector.

Q The income strategy has attracted more investors. Does that make it harder to generate returns or navigate markets swiftly? Should investors be concerned?

A We don't see any capacity issues at the moment. The strategy has the flexibility to invest across the entire US$100 trillion (S$135 trillion) global fixed-income investment universe, so it has ample room to find opportunities. Importantly, the strategy leverages Pimco's global resources to find opportunities across this vast opportunity set.

It's true that some sectors are smaller or shrinking. But the strategy has been able to find attractive opportunities from diversified sources over the years. This is why the strategy's benchmark-agnostic approach and its flexibility to invest across a broad opportunity set are so important to navigating the current market environment and seeking consistent income and attractive risk-adjusted returns.

A version of this article appeared in the print edition of The Sunday Times on September 24, 2017, with the headline 'Earning solid yields while retaining quality'. Print Edition | Subscribe