Three tenets of income investing to drive consistent yield
The risk-conscious fund manager has used its three core tenets of income investing to generate solid returns over a range of market environments, and an extended period of time. Consistency, flexibility and a focus on downside risk have seen PIMCO deliver yield of over 4% pa since inception. It has even recently increased its monthly distributions. No mean feat in an otherwise challenging environment.
“Whenever we buy credit securities, we stress-test them such that even in stressed economic environments, we expect the cashflows of these securities to remain true,” says Manusha Samaraweera, Fixed Income Strategist for PIMCO.
This stress-testing process is known as PIMCO’s “bend but don’t break” philosophy. In fact, this process has even led to some surprising high conviction ideas in the current portfolio, discussed later in this wire.
In this edition of Fund in Focus, we look at PIMCO’s three tenets of income investing and the high conviction ideas identified for the PIMCO Income Fund.
Read or watch below to find out why consistency, flexibility and downside risk management matter more than ever for income investors.
Let start with a quick introduction to PIMCO for those of you that don’t know of us.
Our journey started over 50 years ago when we pioneered an innovative approach to active investing in the bond markets. Since that time, we have grown to be one the largest investment managers in the world, now managing almost $US2 trillion in assets on behalf of clients all around the world. We’ve also had a presence in Australia since the late 90s and we now manage money on behalf of a very wide variety of clients, including Super funds, government entities, financial advisers and individual investors.
2022 secular outlook
As one of the foundations of our investment process, every year we produce a long-term or Secular outlook for markets.
To sum up the key findings of our most recent outlook, we think the coming 3-5 years will be characterised by government and corporate decision makers using strategic decisions to increase certainty. In turn, reaching for resilience.
In the government context, this would come through in the form of:
- increased defense spending.
- increasing protection of borders and sovereign interests, such as investment in energy and food security.
- a trend towards more deglobalisation in decision making.
In the corporate context, this will mean building more diversified and resilient supply chains.
Instead of choosing the cheapest-to-deliver options in manufacturing, companies are likely to focus more on resiliency to reduce risk in their supply chains.
There are a number of key implications of this view.
Firstly, the trend towards more resiliency may come at the cost of increasing economic inefficiencies, which in turn can increase inflationary pressures. Secondly, we expect a period of structurally higher volatility across asset classes and an elevated risk of recession over the next few years.
Given the environment I just described, investors need to be careful about how they go about investing and we believe that fixed income will continue to play a very important role in portfolios.
We also think investors need to factor in the risks I just mentioned and think about how diversified their portfolios are. But having said this, investors still need income, still need returns, and we believe it’s important to stay invested.
The three key tenets of income investing
PIMCO developed its income investing philosophy to deliver through all market environments
As an active manager, PIMCO makes use of a very broad toolkit to provide benefits for investors, but there are three key tenets that we think are vitally important in today’s investing environment.
The first one is a global opportunity set. The global bond universe is huge, at around $US130tn. We think that in today’s environment, it makes sense for investors to broaden their investment horizons and take advantage of different opportunities that exist around the globe and to avoid investing in regions or sectors that are unattractive.
The second one is flexibility. Too often, we see Australian investors investing their bond portfolios in a single sector to try to earn income. The problem with this type of investing is returns can be more cyclical and quite volatile over time as the sector goes in and out of favour.
Our income strategy takes a more flexible approach to investing across sectors and regions, with diversification in mind, so that it doesn’t take too much risk in one sector of the market, with the goal of producing returns that are more consistent over time.
The final important tool is a focus on downside risk. Active management is not only about increasing returns but carefully managing risks, something that we think is vitally important in light of our economic outlook.
Our income strategy puts an emphasis on risk management, with a focus on high-quality bonds as well as senior and secured bonds where appropriate, to help reduce downside risk in stressed markets.
One of the most popular income solutions on the market
We launched the PIMCO Income Fund in Australia in 2015 and it has quickly become one of the most popular income solutions available in the market.
The PIMCO Income Fund is a multi-sector fixed income strategy that has a primary objective of achieving an attractive current income while also seeking to achieve long-term capital appreciation and preserving capital. It aims to do this by seeking out the best income opportunities across the globe. Importantly in the current environment, the Fund aims not to sacrifice quality or capital in its pursuit of income.
The Fund is managed by an award-winning team, which includes PIMCO’s group Chief Investment Officer, Dan Ivascyn, supported by two very senior members of the PIMCO team, Alfred Murata and Josh Anderson. Dan, Alfred and Josh are further supported by a very deep bench of over 300 portfolio managers and over 80 credit analysts.
Since its launch in Australia, the PIMCO Income Fund has delivered on its objectives in a number of very important ways:
- First of all, staying true to the multi-sector nature of the strategy and flexibly investing across the global bond market. This has allowed the fund to allocate to PIMCO’s best income ideas but also to avoid areas of excessive risks.
- Secondly, the fund is managed in a balanced and diversified way. It allocates not only to higher yielding parts of the market but also to higher quality assets that provide downside protection and help in seeking consistent and diversified sources of return. This exposure to the higher quality parts of the market has allowed the fund to generally outperform riskier parts of the market during periods of volatility, including the volatility we’ve seen so far this year.
- Finally, the Fund has maintained its strict risk management focus by only selecting credit opportunities that we believe have resilient cashflow profiles, even in volatile and riskier investment environments.
We call this our “bend but don’t break” philosophy, which essentially means that whenever we buy credit securities, we stress test them such that even in stressed economic environments, we expect the cashflows of these securities to remain true.
These securities may see some price volatility in more challenging environments, but we would not expect them to suffer from permanent capital impairment, meaning they are still delivering income for our clients.
This approach, combined with our general income investing philosophy and experienced portfolio management team, have earned the fund some of the highest independent Fund research ratings in Australia.
Consistent levels of income since inception
I mentioned a little earlier that the primary objective of the fund is to provide attractive current income for investors, and that is exactly what the fund has done.
The Fund has successfully paid out a consistent level of income for investors in the form of monthly distributions regardless of the market environment.
These monthly distributions have amounted to a distribution yield for investors of over 4% p.a. since inception. This is through what has been a volatile investing environment characterised by incredibly low bond yields and numerous bouts of market volatility.
As further evidence of the value proposition of the fund for income-conscious investors, the Fund has recently increased its monthly distributions which translates to over 6% annualised distribution yield on the current NAV of the Fund.
While these distribution levels are not guaranteed, the fund is earning a healthy level of yield from its underlying instruments. This makes us confident that the current distribution levels are not only achievable on a forward-looking basis, but also prudent in that we believe we are able to achieve these yields without taking excessive risk.
Positioning and high conviction ideas
The final point I wanted to make is how the Fund is currently positioned. I mentioned earlier the importance of maintaining a global opportunity set and sufficient flexibility to take advantage of these opportunities.
Being one of the largest investment managers in the world and with such a focus on fixed income markets, PIMCO is in a unique position to manage a strategy like this.
We have investment professionals dedicated to every major bond market around the world, meaning we can source the best income opportunities from each sector of the entire global bond market
As you can see from this chart, the fund is genuinely diversified across many different segments of the fixed income market. It ranges from very high quality government related securities all the way to higher yielding segments like high yield credit and bank loans.
Some high-level themes to note.
We are finding attractive opportunities in each of the sectors the fund is invested in but our highest conviction is in high quality securitized assets on our view that these securities present very resilient cashflows through a range of economic scenarios.
An example of this includes securities linked to US residential mortgages where fundamentals are very strong, benefitting from a relatively strong U.S. consumer, many years of household de-levering and strong house price gains.
On the corporate credit side, we are more cautious as some segments of the market have seen increased levels of indebtedness which makes them more susceptible to recessionary type risks. Having said this, we are relying on our bottom-up security selection to find opportunities in more defensive sectors that we believe will remain resilient in a slower growth environment.
We also continue to like investing in the banking sector, where we believe fundamentals are strong and balance sheets look resilient.
Positioned for the future
So in conclusion, not only has the PIMCO Income Fund delivered on a number of objectives since its launch in Australia, but we believe it is well positioned to continue to deliver for clients
Since its inception, the fund has maintained its key philosophy of investing for Income: investing globally, investing flexibly and importantly focusing on downside risk
We think this is the right way of investing for income in what PIMCO expects to be a quite uncertain investing environment.
If you are looking for any further information about the PIMCO Income Fund, please download the Fund’s PDS and Reference Guide from the PIMCO Australia website and speak to your investment adviser.
Following a flexible approach that can capture opportunities across the US$120 trillion-plus fixed income investment universe and reduce risk-exposure when market conditions demand it, the PIMCO Income Fund has helped thousands of Australian investors to weather changing markets.
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