Pimco is cautiously positioning its $74 billion Total Return fund to capitalise on the range-bound future of US interest rates after making aggressive moves on the yield curve in recent years.
Speaking to Citywire Selector, Scott A. Mather, who is CIO for US core strategies at the asset manager, said the team had moved to a more moderate position towards the back end of 2016.
Given the US election outcome and December’s Fed rate hike, which marked only the second increase since the financial crisis, he said, the Total Return team believes uncertainty is still prevalent.
‘We currently anticipate two to three Fed hikes in 2017, though believe longer-term rates are likely to remain relatively range-bound near term as uncertainty, international developments and low rates globally continue to weigh on the US yield curve.’
‘For much of the first part of 2014, the strategy was overweight the front-end of the yield curve to express our “New Neutral” hypothesis. In 2014, we felt markets had not yet realised that a low rate environment would prevail in a world characterised by low growth, debt overhangs and low inflation.
‘Through 2014, as markets came around to that view, we reduced the overweight. We shifted to a more underweight position at the front-end in 2015 and 2016 as we felt markets were overly sanguine about the potential for Fed rate hikes despite the relative strength in the US economy.’
Mather said the team, which also runs a Ucits mirror of the fund, which has $6.13 billion in assets, is focusing primarily on the intermediate portion of the yield curve and is holding inflation-protected securities.
‘This is to guard against upside surprises in inflation, along with the notion that if rates grind modestly higher, they will do so in part due to rising inflation expectations,’ he said.
Under Gross’s guidance, the blockbuster fund, which has shrunk from a peak of $293 billion in April 2013 to its current level, had singled out ‘cleanest dirty shirt’ investments. These being emerging market bets with strong fundamentals, namely Mexico and Brazil.
Despite recent political furor, the team remains exposed to Mexico. ‘The fund had slightly more emerging market exposure in 2015 and 2016 than it did in previous years, primarily via local interest rate exposure in high quality emerging markets – such as Mexico.
‘This was while maintaining a long dollar bias against many emerging market currencies. These exposures were additive to performance in 2015 even as aggregate emerging market indices lost 10-15% in the same time period.’
Mather said investments in Mexican local interest rate positions were moderated in mid-2016, which reflected challenges in the country. ‘The Mexican central bank became more concerned with combating currency depreciation via rate hikes, making interest rate exposure less attractive.’
In their current outlook, Mather, Kiesel and Worah remain cautious in emerging markets given the uncertainty around US trade policy and the impact on different emerging markets.
‘Given the extent of market moves in various EM assets, there are some attractive opportunities, particularly in some currencies. For example, China’s slowdown has put pressure on its regional trading partners to devalue their currencies so we are long the dollar against a basket of these Asian emerging market currencies.’
Emerging markets account for 9.5% of exposure in the US-domiciled fund, as at January 31, and around 1.5% in the Dublin-domiciled version. Mortgage-backed investments account for the largest allocation in both funds, at 58% and 51%, respectively.
On a three-year basis, the Pimco Total Return Fund;Insitutional returned 7.5% while the Pimco GIS Total Return Bond fund also returned 7.5%. Both funds have the Citywire-assigned benchmark of the Bloomberg Barclays U.S. Aggregate Bond TR, which rose 7.99% over the same period to the end of January 2017.