Fixed income investors should view the market sell-off and re-pricing in recent months as a long-term opportunity.
This stems from a combination of yields rising, spreads widening and carry increasing – three key elements that Pimco believes will provide a potentially powerful source of return.
At the same time, the firm is cautious about inflation, which it sees as a significant risk factor for investors, amid uncertainty over the war in Ukraine, other geopolitical risks and how Covid-19 evolves.
It is therefore positioning its approach to income with an emphasis on resilience.
“We are targeting higher-quality assets with spreads that have widened in sympathy with more credit-sensitive assets,” said Daniel Ivascyn, group chief investment officer at Pimco.
“The recent sell-off opened an opportunity to add back credit risk in the front end of the yield curve, though we remain a bit defensive relative to our historical norm,” he added.
Pimco is also taking advantage of higher rates to gradually add a little interest rate exposure to its income strategy.
Careful with corporate credit
Within corporate credit, to balance wider spreads with rising recession risks, the firm is taking a fairly defensive stance.
The core focus continues to be on senior financials, especially banks. “Many banks have historically high levels of capital and over the last several months spreads have widened more than we think fundamentals suggest they should,” said Ivascyn.
Pimco also has exposures to liquid indices to help maintain flexibility as part of the corporate credit strategy. “We view this as a defensive form of exposure that should outperform other areas of the corporate market in a more stressed environment,” he explained.
Further, the firm is making a few small tactical allocations to special situations at yields that should positively impact overall returns. Ivascyn said this is in response to improvements in covenant protections and pricing that lenders can receive in the corporate market.
Diversifying in emerging markets
To find income within the emerging markets (EM) asset class, Pimco prefers the higher-quality, more liquid segments of the market – sovereign risk, quasi-sovereign risk and currencies of higher-quality countries.
“We have little emerging market corporate credit exposure and little local rates exposure, particularly in less liquid areas,” said Ivascyn.
The last few months has seen the firm reduced its overall EM exposure, paring back in Asia, particularly China, and in Latin America. It also avoids Eastern Europe.
“Our allocation focuses on higher-quality areas, including Brazil and Mexico, with small positions in South Africa and Israel,” explained Ivascyn.