Amid a new economic and geopolitical order, as well as the greater risk of recession over the next two years, investors should focus on portfolio resilience.
This stems from the more fractured nature of the world and the response that Pimco expects from governments and corporate decision-makers to increasingly focus on finding safety and building resilience.
“With the risk of military conflict more real following Russian aggression toward Ukraine, many governments – especially in Europe but also elsewhere – have announced plans to increase defense spending and invest in both energy and food security,” said Joachim Fels, global economic advisor at Pimco.
At the same time, companies are seeking more robust and reliable supply chains through efforts such as global diversification, near-shoring and friend-shoring.
“These efforts were already underway in response to US-China trade tensions and because the Covid pandemic demonstrated the fragility of elaborate value chains, and are likely to be intensified given the more insecure geopolitical environment,” added Fels.
Climate-related risks and Covid have also heightened pressure on governments and corporate leaders to mitigate and adapt to global warming, as well as to improve health security for their citizens and employees.
Towards resilient portfolios
Against this backdrop, Pimco suggests investors strive for resilience in their portfolio construction, rather than reach for yield.
This can be achieved, explained Andrew Balls, chief investment officer, global fixed income at the firm, by looking to build more robust asset allocation in the face of a more uncertain environment for macro volatility, market volatility and central bank support.
“For our part, we will look to build resilience into the portfolios we manage on behalf of clients and seek to benefit during periods of market volatility,” he added.
Investors also need to readjust their expectations for asset market returns, making them lower and more realistic.
This is based on Pimco’s view of starting valuations – despite recent weakness in asset markets – and the firm’s expectations for a more volatile macro and market environment.
Brighter for bonds
However, there are some reasons for optimism in the fixed income landscape.
This stems from the yield on core bond benchmarks having recovered from Covid-era lows. As a result, Pimco’s baseline outlook is that forward markets are either pricing in, or are close to pricing in, what is likely to be the secular high for policy rates across different countries.
“We anticipate positive returns on most bond benchmarks over the secular horizon, and fixed income investments, at higher yield levels, should play an important role in building resilience into diversified portfolios,” said Balls.
Further, in general, private credit strategies can be an attractive complement to public credit allocations, he added.
“We expect to favour higher quality corporate credit and will seek to provide liquidity, not to demand liquidity, during periods of credit market stress.”
Other investment opportunities amid higher inflationary pressures can be found, Pimco believes, in US Treasury Inflation-Protected Securities (Tips), commodities and select global inflation-linked investments that provide a reasonably priced hedge.
Real estate can also serve as an inflation hedge, added Balls, particularly in sectors such as multi-family and self-storage, where leases are generally shorter than one year.
By contrast, equity markets are likely to deliver lower prospective returns than investors have experienced since the global financial crisis, said Balls. “[This is] reinforcing our focus on quality and the importance of careful selection.”
Geographically, meanwhile, Pimco expects emerging markets to offer good opportunities.