Dan Ivascyn is the Chief Investment Officer and co-manages the Pimco Income Fund with Alfred Murata. Mr. Ivascyn, along with Mr. Murata, was named fund manager of the year by Morningstar in 2013. On Tuesday, Bloomberg reported that it is time to ‘take a more cautious and defensive strategy’ with the $113B Pimco Income Fund. According to Bloomberg, The Pimco Income Fund has outperformed 99% of its peers in the past 5 years.
• Pimco’s outlook moves to one of ‘caution’
• Pimco Income Fund will increase liquidity and diversification.
• Ivascyn sees greater volatility and lower returns as global central banks reduce their balance sheets.
Let’s Break this down.
Why is Pimco getting more cautious?
Pimco posted a webcast for June that provides greater insight into their thinking found here.
The webcast discusses Pimco’s 2-5 year outlook. Ivascyn says that ‘looking back over the last ten years we have experienced low economic volatility and by extension relatively low financial volatility’. He continues, ‘looking forward we think economics and markets will exhibit very different characteristics’. He thinks investors will experience increased uncertainty and therefore, should become more cautious. He also indicated that he expects to see continued positive economic growth, but with lower base case return expectations.
He does not see a recession in the next twelve months, but noted that risks have increased. Over next 3-5 years there is a material chance of recession. He acknowledges that it is very hard to get the timing precisely right. So, he argued for early preparation.
He said that in the short term Pimco expects interest rates to trend up, but noted that there are scenarios where they could go down. He said that in recent days where the market has been volatile due to issues in emerging markets or Europe, we have seen high quality bonds rally.
How with this change how Pimco Income Fund invests?
The Bloomberg article indicated that the plan calls for increasing diversification and liquidity. Ivascyn will be cautious on U.S. credit and look for smaller opportunities in the global fixed-income market.
My expectation is that this would likely lead to reductions in Pimco holdings in US Corporate Bonds, lower quality asset-backed securities and international bonds. According to Morningstar, as of the end of Q1, Pimco Income Fund allocation to these sectors was approximately 15%, 25% and 20%, respectively.
My Take
Previously, I posted a note about a recession model from the Federal Reserve here. As we showed, prior to recessions, there is typically a rise in the excess bond premium. When bond premiums rise, bond prices fall. Lower quality bonds (i.e. corporate bonds or credit bonds as noted by Ivascyn) are expected to underperform in periods of volatility prior to the onset of a recession.
As far as recessions, the Fed model showed that there is some ability to predict the likelihood of a recession in the next 4 quarters. However, as Ivascyn noted, predicting exactly when is hard. Therefore, by moving away from lower quality bonds one is able to prepare against the potential for loss, should we actually experience a recession.
Based on current data, the model is not signaling a recession. However, given that central banks are reducing assets and we are 6-8 years into the current business cycle, the case for a bit more caution is prudent. In addition, given that short and intermediate term bond rates have come up, we have a much better environment for income in US government bonds.
Disclosure. The author and Brightwood Ventures, LLC clients hold the Pimco Income Fund.