Posted inFixed Income

Tapping into renewed value in bonds

Investors like Pimco which believe central banks will ultimately get control of inflation in the coming years are starting to get paid more.
Both funds invest the majority of their assets in large-cap stocks. The funds employ quantitative screen filters and look for value-oriented names, according to Yew. He noted, however, that the AB fund’s portfolio is more value-oriented while Nomura’s would sit between value and growth. Both funds use the Topix index as their benchmark. While the investment process is similar for both funds, the main difference between them is the number of names they hold in their portfolios. The AB fund has a concentrated portfolio of just around 40-50 stocks, while the Nomura fund is more diversified with 150-200 stocks, according to Yew. In addition, the AB fund does not invest in small-cap stocks, while the Nomura fund does. The Nomura fund manager believes that the fund could capture some opportunities from small-caps since they have been flying under the radar in Japan, according to Yew. Asset allocation by market cap (%) Market cap AB Nomura Category Giant/large 78.3 68 81.3 Mid 21.7 26.3 16.6 Small/micro 0 5.7 5.3 Source: Morningstar There are also some differences in sector allocation. For example, the AB fund has a higher weighting in technology, while the Nomura fund is overweight in basic materials. The differences in sector allocations are not a result of a top-down process, but derive from the bottom-up stock selection of both managers of the fund, Yew said. Sector allocation (%) Equity sectors AB Nomura Category Defensive 10.4 7.4 14.3 Consumer defensive 5.1 2.8 7.3 Healthcare 3.9 4.2 5.5 Utilities 1.5 0.4 1.5 Sensitive 47.4 45 41.7 Communication services 6.3 4.3 4.8 Energy 3.3 3.1 2 Industrials 12.8 17.1 18.9 Technology 25.1 20.5 16 Cyclical 42.1 47.6 44 Basic materials 9.6 12.6 8.3 Consumer cyclical 18.1 19.3 18 Financial services 11.9 10.7 13.8 Real estate 2.6 5 3.9 Source: Morningstar

Investors can increasingly find more value in markets, despite the uncertain outlook, if they are optimistic about the ability of central banks to manage inflation over the next two to three years.

This is Pimco’s view, with the US fund house becoming more constructive about interest rate levels more broadly.

“This volatility, although it feels terrible living through it, is creating potential opportunities across sectors that could generate an attractive yield without going down the credit spectrum too significantly,” said Daniel J Ivascyn, group chief investment officer at Pimco.

Taking a high-quality investment grade bond as an example, it if returns 4%, 5% or even 6% today, that instrument would offer good value relative to recent markets if there is a return to inflation of 2.5% to 3%.

“There is a degree of optimism that we haven’t witnessed in quite a long time,” Ivascyn added.

Caution in credit markets

For the time being, the rising risk of recession should breed caution among investors about credit-sensitive investments.

“The big challenge is that we have an inflation problem, so you have policymakers tightening when growth is already relatively low. And it’s been a long time since there has been a recession without massive policy support,” explained Ivascyn.

For example, the wave of capital that has flowed into credit-related assets over the past decade in search of incremental returns has spurred significant growth in some of the lower-rated or private segments of the corporate credit market. There has been deterioration of fundamentals in certain areas.

“Those areas warrant caution, especially those within the private space that haven’t repriced yet,” added Ivascyn.

By contrast, he sees resiliency and attractive spread levels in household credit, asset-backed credit, mortgage credit, banking credit and financial sector credit.

Public and private pockets of potential

In the public space, Pimco sees a lender’s market, based on its view that many deals within the corporate and financial sectors will be resilient during more volatile economic times.

As a result, the higher-quality areas of the investment-grade universe might generate extra yield. “High-quality bank paper is one example. You could see one-and-a-half, even two, percentage points above a Treasury yield,” added Ivascyn.

Meanwhile, there has been some widening in lower-rated, more credit-sensitive areas of the markets.

“One of the most exciting areas… that we see over the next several years would be contingent capital vehicles to take advantage of the dislocation that’s almost certain to exist within the large stock of existing corporate credit assets,” said Ivascyn.

Emerging market value

Pimco also believes emerging markets look interesting from a valuation perspective, assuming investors can navigate what the asset manager describes as “a tremendous amount of idiosyncratic uncertainty”.

Such opportunities that stem from this situation require a selective approach in terms of the country, instrument and sector.

“Be careful, but don’t avoid the asset class, because we think it will be quite target-rich,” said Ivascyn.

Part of the Mark Allen Group.