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The Long View: la liquidité, enjeu d'une bonne gestion sur le long terme - PIMCO

Le directeur des investissements de PIMCO, Dan Ivascyn, explique l'approche prudente de la société de gestion et l'utilisation des liquidités pour se protéger des risques croissants sur les marchés financiers.

Jeffrey Ptak 12.09.2019

Our guest this week is Dan Ivascyn. Ivascyn is group chief investment officer of PIMCO, where he leads the firm's income, credit hedge fund, and mortgage opportunistic strategies and sits on its executive and investment committees. Ivascyn is perhaps best known as the longtime manager of PIMCO Income, where he's produced one of the best records of any bond manager since taking the helm in 2007. In 2013, Morningstar named Ivascyn as its Fixed-Income Fund Manager of the Year. Ivascyn has been in the investment business for nearly three decades. He joined PIMCO in 1998, following stints at Bear Stearns, T. Rowe Price, and Fidelity Investments.

Jeffrey PtakHi, and welcome to The Long View. I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Christine BenzAnd I'm Christine Benz, director of personal finance for Morningstar, Inc. Our guest this week is Dan Ivascyn. Dan is group chief investment officer of PIMCO, where he leads the firm's income, credit hedge fund, and mortgage opportunistic strategies and sits on its executive and investment committees. Dan is perhaps best known as the longtime manager of the PIMCO Income Fund, where he's produced one of the best records of any bond manager since taking the helm in 2007. In 2013, Morningstar named Dan our Fixed-Income Manager of the Year. Dan has been in the investment business for nearly three decades. He joined PIMCO in 1998, following stints at Bear Stearns, T. Rowe Price, and Fidelity Investments, and we're delighted to have him as our guest.

Dan, welcome to The Long View.

Daniel IvascynThanks, Jeff. Excited to be here.

PtakSo, maybe we'll start off with PIMCO Income, one of your charges. You built an outstanding record there. This year is a bit different, though; you're lagging. When we ask underperforming managers whether they do anything differently when they lag, they always say no, it's sort of business as usual. And I wouldn't expect you to say otherwise. But I would imagine it has to change the tenor of some of the conversations you might have internally, whether it's to reassure an analyst about their thesis maybe for a piece of paper or to ask them to revisit their assumptions. So, can you take us into those committee discussions, those rooms where those meetings are held, and talk about maybe how the process has changed, if it has at all?

IvascynAbsolutely, and maybe I'll surprise everyone a bit and answer differently. We would do things differently if we knew that markets were going to move in the direction they moved year-to-date. With that said, the Income strategy is a bit unique or a bit different than other mandates in that its primary objective is a consistent dividend stream, with the secondary objective being capital preservation or total return. So, we tend to focus a bit more on the income or the yield component than other strategies that are out there in the marketplace or even available at PIMCO. Secondly, we take a longer-term approach. Our investment process at the firm, in our mindset, for the income strategy is to look at themes impacting markets over multiple year periods. But with that said, this year, we've lagged the rallying markets. And that's primarily due to the overall duration position of the fund. And if we knew with a high degree of certainty that we would have rallied as much as we rallied this year, even in the context of an income-oriented strategy, where we're looking for typically positive nominal returns or ideally positive returns adjusted for inflation, we still would have had more duration exposure. So, that's point one and it explains a good portion of the lagging performance year-to-date.

When we look at the portfolio from the perspective of our other key goals, which is long-term capital preservation and a steady income, and we look at building risks out there in markets, in stretched valuations, we are comfortable with our overall asset allocation.

Now, to your other point regarding process, whether we're doing well or doing poorly relative to the available cohort group out there, we're constantly reviewing positioning, constantly reviewing assumptions, both macro assumptions as well as more micro or bottom-up themes across portfolios. And we do that at the investment committee where we meet four days a week. We're not always speaking about Income but talking about a variety of PIMCO portfolios, and we're typically reassessing our macro outlook and then understanding how we're implementing those views across portfolios, again, including the Income strategy, and then supplementing that analysis with a lot of other more detailed discussions with members of the analytics team and the risk management team and really getting into more detail or more nuance in terms of how positions are interacting with one another across portfolios as well.

And anytime you have these very, very large moves like we've seen in the fixed-income markets this year, you take an even harder look at your prior assumptions and a harder look at the way portfolios are being structured. So, we spend a lot of time doing this. And again, it's not related to how we happen to be doing at the moment. It's really with the goal of constantly looking to get different, ideally independent objective perspectives on markets, portfolio construction, with the ultimate goal of generating the best risk-adjusted returns that we can within the strategy.

BenzOne thing that comes up sometimes in periods of relatively weak performance, even short stretches like the one you're going through, is clients demand time from managers to explain what's going on. Do you find that you're having to divert more of your time and attention to counseling clients?

IvascynNot too much. And again, we have a great team that works in the product strategy area that does a lot of this work on our behalf. We are certainly making ourselves available to communicate with market participants, and we've done a few additional client calls. Again, I think, a lot of the customers and shareholders within the strategy have been with us for a very long period of time. And I think they appreciate the longer-term orientation and the fact that you'll have some ups and downs in terms of short-term performance but have been generally comfortable with the overall philosophy for the strategy.

PtakMaybe going back to duration, you mentioned the fund's duration positioning has gone against you short term and that's something that even very successful managers are accustomed to, these periods of short-term adversity. But maybe take us back into those, sort of, committee and decision-making settings. I would imagine that maybe there's some views around the table that you should be getting longer. And perhaps they posit a rationale for why that's so. So, can you talk to us about how you sort of balance that sort of view off with the other kinds of views that would be expressed in that setting, forming a consensus view, which, in this case, it sounds like you're comfortable with your duration positioning, but I would imagine those conversations must be had in light of what you've experienced year-to-date.

IvascynWe do talk about duration frequently. It is typically the most important risk factor across different portfolios. Now, other PIMCO strategies based on their unique mandate have been longer duration. When we think about it in the Income context, and as I mentioned, we have that primary objective of generating a consistent dividend stream, when you get into a situation where yields are negative on a nominal basis, in some sense, they conflict directly with that primary objective of generating an income when they in fact are generating negative yields. Also, even in some of the higher-quality developed markets, and I'll use the United States or Australia as examples, you've seen now yields adjusted for inflation dip into negative territory. So, again, from the perspective of a strategy that's focusing on maximizing current income or at least generating a higher and a consistent income, it becomes more challenging for strategy like that. It's a bit out of mandate to look to target investments that have very lower negative yields based on the prospects that they're going to get more negative or go even lower from here.

So, from the standpoint of our approach to these types of assets, we do take a longer-term view. We're willing, or at least more willing, to give up a bit of short-term total return to look to optimize the portfolio around a steady reasonably defensive source of income over time. But these are the types of discussions that we have at PIMCO. We weigh our conviction level regarding factors impacting interest-rate exposure more broadly; then we zero in on areas where we see value, even the potential for short-term return; and then when we implement across portfolios, we look very, very closely at client objectives, with each strategy being a little bit different and therefore warranting a different overall positioning. But we have had these discussions and continue to have these discussions and to the extent that our views changed materially, we will add or reduce duration further from here. I think it's key as an asset manager to come in fresh each day, be forward-looking and make the optimal decisions on a go-forward basis as opposed to dwelling on what may have been the case based on decisions that you made earlier in time.

PtakSince you mentioned it, there are trillions in negatively yielding securities around the world. I think the number that you gave via maybe Bloomberg was 15 trillion. On the face of it, it's kind of nuts, right? It seems absurd. But your team has argued that there's a rational explanation for it. And so, I wondered if you can paraphrase that for our listeners and further explain what a good justification for owning such paper would be. I know that you've alluded to sort of nonrational buyers that are in the market, maybe they're looking to immunize a liability that they have--that there's some sort of balance sheet management they have to do--but what's a fundamental case that one would make for owning that type of paper?

IvascynYeah, there are a couple of reasons that easily come to mind and even others, but one reason would be that your primary focus is on capital preservation or capital protection in that you're looking to lock in assets that are highly likely to pay you back par at the end of the day. And in a world with increasing global uncertainty, increasing risk in a world with debt levels already being quite excessive, and with central banks taking high-quality bonds out of the market, many, many investors are just looking for safety in their bond allocation. And in the current environment, safety means achieving in some markets a negative nominal return. So, I think that's got a lot to do with why we see the type of market setup that we see currently.

Another related reason why people may be willing to lock in negative nominal yields over the long run relates to the outlook for global prices. And the last few years, the markets have been at least moderately concerned about inflation. That has changed. It really swung deeply in the other direction late last year when we saw a big uptick in volatility across risk markets, and now we see increasing uncertainty around global growth. And there are a variety of reasons, and PIMCO has talked about this for many, many years, why considerable disinflationary or even deflationary pressure exists around the globe. And although this isn't our base case by any stretch, there's certainly scenarios out there where we look back on this period and if we got into a situation where the price level actually declined, then some of these low or negative yields could certainly be justified fundamentally and may not be as irrational as some forecasters or some market practitioners suggest.

So, again, we do think that if you were to see further deterioration in economic growth, even these levels that look expensive, at least from a historical perspective, can certainly drop in yields from here and even areas of the world where you see negative yields, you could see even more negative yields. Again, that type of mindset doesn't fit neatly within the objectives of some of our strategies, but we have others that have a bit more of a total return focus, a bit more of an index focus, that actually have overweights to some of those markets and would benefit if we did see a further flight to quality.

BenzThough your forecast calls for relatively muted inflation, and you just talked about that, you'd indicated that one of the risks of higher inflation is that closer monetary fiscal policy cooperation could compromise central bank independence. Can you explain that scenario, as well as some other factors that could spur higher-than-expected inflation?

IvascynYeah. So, when we look at the world today, and the feedback we receive even from our internal advisors, and this is consistent with communication from global central banks is that if economies weaken further, central banks are going to pull out the tool kit that they've used in the past, which means lower rates, even rates going more negative, extended forward guidance, quantitative easing, tools that the market generally believes worked reasonably well and helping to stabilize growth during periods over the last decade. But looking forward, looking at absolute valuations across risk markets, looking at the starting point for yields today, we think this type of policy will be less effective as we move forward in time. A more scary outlook for markets would involve this type of stimulus being quite ineffective this go-around. So, we believe there will be continued pressure to think about other, more-creative ways to stimulate growth. And you combine those existing pressures with the political dynamic we see around the globe, more inequality across regions of the world and within countries as well, which very well may have been exacerbated by some of the central bank policy thus far, could lead to more unpredictable political outcomes, more fiscal spending, even very aggressive fiscal spending, perhaps in coordination with central banks and that coordination could be either explicit or implicit but could change the overall dynamic or lead to a different paradigm than we've been in for much of the last decade.

Now, again, timing is uncertain. These types of trends and themes can play out over extended periods of time, even multiyear periods. But if you did see this type of policy gain traction, then we do think you could see an uptick in inflation and inflation expectations, you could see the market end up becoming concerned again regarding debt sustainability. And that could lead to, at some point in the future, a snap-back in yields. So, as yields go lower as you get into situations where you're outside historical norms, it's important to think about those type of tails as well. And with market participants not spending too much time talking about that now with the focus on how much lower will yields go, we think it is prudent to think about shifts in the mindset that could lead to very negative outcomes for holders of fixed-income assets.

PtakIn your most recent secular outlook, you sounded a cautious note. You thought there'd be lackluster growth, low inflation, continued low interest rates, with a shallow recession being a distinct possibility. So, I wondered if you could update us on your views, particularly in view of the recent plunge in yields.

IvascynSure. And our secular outlook, that comes out after our big annual meeting that we have in the early summer each year when we look at trends impacting markets, typically over three to five years or in some cases, even five years or longer. So, you're absolutely right, our view over the course of the next few years was an increased prospect of what we felt would be a shallow recession. Now, again, markets don't always know that they're shallow when you enter a recession. So, you can end up with a lot more volatility and price action, at least initially. And then, over the long run, we talked about greater concerns regarding some of these imbalances or this more extreme political uncertainty that could lead to surprises, and I mentioned earlier one of those surprises that could take place if you see a meaningful change in policy around different political outcomes. That still is generally our view.

Now, since we had our secular forum a few months ago, we've seen weaker economic growth, primarily coming from the manufacturing sector, consumers held up reasonably well, but also more extreme forms of political uncertainty driven primarily by the trade uncertainty between the U.S. and China. But we also have some sources of uncertainty building in Hong Kong as an example, the Brexit situation has deteriorated and presents another source of uncertainty. So, we think that not only is a recession likely over the course of the next few years that the probabilities of recession have gone up a little bit. That needs to be put in context, though, based on our economic forecasts, both in the U.S. and across Europe, Japan, other areas of the developed world, we see growth slowing but not yet getting to levels that represent a recession in a traditional sense. So, the numbers in terms of the base case still suggest slowing growth, maybe even some slight signs of stabilization outside of the United States. But given this extreme uncertainty, and an upcoming likely to be highly contentious election in 2020 here in the United States, we do think recession risks are elevated. And that's what markets are reacting to.

BenzDelving into the portfolio a little bit more, one key ingredient to the fund's historical success have been nonagency mortgage securities. Can we talk about what role these securities have played in PIMCO Income's success and also the way that market has evolved through the years? Why is it shrinking?

IvascynSure. And I'd maybe step back a little bit. I think one of the key themes across the PIMCO Income fund as well as other PIMCO portfolios was to take advantage of frictions associated with the last financial crisis. Typically, when you have a crisis like we saw a little over a decade ago, you get a very aggressive reaction. You get an aggressive reaction from regulators, you get an aggressive reaction from rating agencies, you get an aggressive reaction from market participants in the form of pretty extreme risk aversion. And you've seen that in the sectors that caused the most harm during that highly volatile period. The mortgage or the housing markets are a great example of where that dynamic has existed. You've also seen it within the banking sector or the financial sector as well, where you've had massive regulation requirements that these banks and other financial institutions hold a lot more capital than they've been required to hold historically. And they've been limited in their ability to take risk like they have in the past. Those are all great characteristics from the perspective of institutions or funds lending into those companies.

So, what you've seen in the housing market is this postcrisis regulation still having a big impact on credit extension within this space. This is certainly true in the United States. It's true in areas across Europe as well. So, you have a very unique environment where you haven't seen a significant return of securitization. You have legacy assets, either securities that were created before the financial crisis or loans that were originated before the financial crisis, that could be turned into new securities that have very, very attractive credit in collateral characteristics. So, we've had a decade of generally positive job growth, we've had a decade of steadily rising home prices, we've had a decade of borrowers that ran into challenges during the financial crisis improving their overall credit profile. And then there's something called burnout in these markets, when you have borrowers that have gone through a tough time but have been staying in their property for now over a decade, even if they get into a more challenging environment from a household budget perspective, there typically is a strong tendency to want to stay within that property, and then of course, equity levels now have increased significantly. 

So, the bottom line in these sectors of the market is that despite almost 10 years passing since the last financial crisis, you have a situation where you have a very, very resilient, very, very defensive profile. And that continues to be a key theme across the Income strategy, where what we're looking for is a responsible steady income stream with material downside protection if we were to get into a much weaker economic environment. And that's in contrast to what we've seen in other segments of the market, like the nonfinancial corporate sector, which bounced back relatively quickly after the financial crisis, where – and you folks have reported on this significantly – where we've seen very high issuance relative to historical patterns, very weak covenants relative to historical covenants, and deteriorating credit fundamentals. So, we think that this is a great place to be on a go-forward basis and somewhat unique in terms of this focus relative to other products that are out there in the marketplace.

BenzDan, before I ask the more detailed question, I should have asked you to explain in lay person's terms what a nonagency mortgage security is, for people who aren't as steeped in the bond market as you are?

IvascynSure. I'm happy to do that. So, these instruments are pools of mortgages typically to individual homeowners. The vast majority of the supply represents mortgage loans that were originated prefinancial crisis, so back in 2004, 2005, 2006, 2007. There are some pools representing new issuance in the marketplace that are in newer securitizations. Typically, within the PIMCO strategies that own this type of risk, there are senior positions in the capital structure. In many cases, there's additional credit support above and beyond the value of the home that helps protect your overall cash flows. And typically, you'll have, again, hundreds, if not thousands of different borrowers that have pretty broad diversification across the United States or if it's a pool of mortgages outside the United States across the respective country that we are targeting. And to give you a sense of what typical credit looks like at this stage, these would have been situations where back 10 years ago the value of the property was a lot less than the loan balance that existed at that point in time, which again is a very dangerous situation from a credit perspective.

Typically, today when we look at these pools of mortgages, in almost all cases, the value of the home is materially greater than the remaining loan balance. So, typically, today, when we look at loan to value ratios, or the difference between the loan balance and the value of the property, you have these numbers now down in the 50%, 60%, 70% type range, meaning that you have between 30 and 50 points of equity in that home. And for all of us on this call that own homes and have mortgages on homes realize that when you're in a position where the value of the home is that much greater than the remaining loan balance, you tend to pay off that loan, even if you get into a period of temporary economic stress and even if, unfortunately, because of a change in situation you're not able to do that, typically, your recovery on that asset is very, very high given this equity. So, again, a pretty straightforward type of security, not particularly complicated in structure like they used to be in the old days, but with very, very strong fundamental credit characteristics.

PtakI think Christine alluded to it before, you've described some of the steps PIMCO has taken to adapt to a shrinking nonagency MBS market, and that's included directly sourcing some of the mortgages participating, it sounds like in the securitization process. So, my question for you is whether this is sustainable and how you ensure that you aren't straying outside your area of expertise, so to speak, recognizing how familiar and steeped you are in this part of the market.

IvascynYeah. So, that'd be clear with the Income strategy, similar to our total return funds or dynamic bond or unconstrained products, these aren't mortgage-specific strategies. It's an area of the market that's been heavily represented because it has offered such significant value to clients. But to the extent that we don't see value in that market, and there were periods back a few years ago where this sector of the market began to get quite expensive versus other alternatives, we will absolutely shift exposure into other areas. And looking at the performance over time, although mortgages have been heavily represented within the strategy, when you take the impact from mortgages out of returns and you look at some of the other strategies we run within this portfolio, you'll see pretty steady contributions from other sectors of the market. So, to the extent we got into a situation and we haven't seen this – and don't expect this to be the case – where we don't have enough assets that have sufficient resiliency, and that's what we're really looking for within this strategy, we will become more defensive. We will tend to hold higher-quality assets, assets that have lower yields and that may at some point impact the distribution rate on the fund but lead to, again, a more resilient portfolio than otherwise would be the case.

I think one other point I'll mention. Within the Income strategy, we've always had a philosophy and the term we use internally is--we look for assets that bend but don't break. So, the vast majority of the assets that we have, whether they are mortgages or corporate bonds or other sectors or segments of the market, we want to own assets that are typically senior in their respective capital structures; we want to find assets that have sufficient coverage or sufficient protections that even if you did get into a more challenging environment, you would end up with a very attractive recovery or the type of resiliency that we've really, really set out to achieve. And that means that there'll be lots of segments of the market that we're simply not comfortable with. An example of that would be a big portion of the corporate credit market that simply doesn't fit to that type of criteria that we are looking for.

So, mortgages have been a good source of resiliency over much of the last decade. But the next decade, as we see volatility in different segments of the market, we could see new areas that have these characteristics outside the mortgage sector. And as you guys know, we have, an investment process and an investment approach that looks at the full global opportunity set, and to the extent we need even more resources to target areas of opportunity, we will go out there and find them.

PtakMaybe widening out for a second to focus on portfolio construction, though I'm sure you never tire of talking about mortgage-backed securities, Dan, if you had – it's a bit of a hokey question – but if you had a day to train an apprentice to build PIMCO Income from scratch, just to pick out one of the strategies you're responsible for, what would be the most important lessons you'd want to impart? What are the defining features of how the portfolio is structured, and how do you think that would compare to when the fund was a 10th of its current size?

IvascynWell, the principles that we adhere to are identical to when the fund was launched, and you can even see this in the books we use to describe the strategy--consistent dividend income, but an income stream that's responsible, given the risks out there in the marketplace--and then looking for this type of resiliency, this type of defensive profile across the assets that drive yield within the strategy. So, we will take targeted risks in higher-yielding segments of the market. But in general, when you look at the fund, we're really, really focusing on distinguishing ourselves when you get into really, really difficult market environments. And that's a process and in some sense, we have a checklist across the various markets that we operate in where we're looking for that type of resiliency. So, even if we have a very positive outlook for the world, there's certain principles that we continue to adhere to, which may mean giving up a little bit of return over the short term to generate the much more stable profile going forward.

I also firmly believe and have tried to instill the mindset that you have to stay with the program. It's very, very easy to get whipped around by short-term information flow, especially over the course of the last few years. So, in many sense, we try to focus on a process that's more industrial, involves looking at a lot of things, going through checklists, and really having a longer-term orientation, trying not to focus on predicting things that are very, very hard to predict with a high degree of certainty. And that's the principle. And from the standpoint of the team, I've been involved in the beginning. We've had Alfred Murata, my colleague; he and I had been a two-person team for a very long time on this strategy. We recently added Josh Anderson, and even a gentleman named Michael Levinson, who has more of a corporate background, has been working with the group as well. So, we intend on expanding the team as necessary on a go-forward basis. But it's these key principles, these non-negotiables, that have been so important to the performance of the strategy thus far and will continue to contribute to the importance regarding future performance as well.

BenzAnd how about the size question? It sounds like you're saying that these principles have stayed relatively fixed. But have they evolved a little bit to the point where you emphasize some and deemphasize others simply because of the size of assets that you're needing to invest?

IvascynNot at all. And when you look at the asset allocation over time, even from the initial launch of the strategy, we've always used the same general tools and have had the same overall philosophy. Now, valuations have changed. We launched the fund prior to the financial crisis. You obviously had a big period of dislocation in the years immediately following that market shock, and now you're in a situation where markets look much more expensive again. But when we think about size, there's some things that we can do given our large size, which typically involves accessing certain types of collateral in a manner that reduces costs to the end investor, but the overall philosophy is the same. And as we've talked about in the past, when we think about the fund, the size, we look at our opportunity set.

As you guys know, we have a global opportunity set. We're not constrained by a specific benchmark. We have large teams at PIMCO, and we want to be top-quartile performers on a risk-adjusted basis over a full cycle. If we feel that we can't achieve that objective on behalf of clients, then we'll close strategies, and at PIMCO, we've closed strategies in the past when we haven't felt we could meet that objective. And I guess the objective is somewhat arbitrary, but that's how we've tended to think about size, and we have no issues with size at the present time. In fact, the opportunity set globally, given anticipated increases in volatility, likely will be sufficient to have the ability to realize on that objective.

PtakIf you were us and you were trying to maybe assess a bond strategy's capacity – let's maybe take PIMCO out of it. I know it's hard to do that but take PIMCO out of it. You're sort of sitting in our chair and you're looking at a given fixed-income strategy and you have to make some sort of assessment of when the manager should cry uncle and close it, what are the key things that you think we ought to look at?

IvascynWell, I'll explain what we look at, and your areas of focus probably should be similar. One would be the size of the mandate relative to the opportunity set that's out there. Of course, as you guys know, understanding fund size in relation to how many other assets are being run with a similar strategy matter as well. So, a lot of asset managers will have a mutual fund that has a particular amount of assets in them but also be running almost identical separate accounts in considerable size as well. But looking at that strategy in the context of the overall size of the market is usually a good first cut at the amount of overall capacity for that strategy. And then secondly, of course, and this will be somewhat of a lagging indicator, but historical performance matters as well, at least in assessing whether, as a function of size, the asset manager has been able to realize on that objective. And I think in the case of the Income fund, this year's underperformance notwithstanding, when you look at the growth of the strategy and you look at performance versus appropriate cohort groups on a risk-adjusted basis, I believe you'd conclude that we've been able to meet that objective, perhaps doing even better than top-quartile performance on a risk-adjusted basis.

So, when we're looking at the strategy, when we begin to have potential concerns, and we haven't to-date with the Income strategy, we're looking at other alternatives out there in the market, we're coming up with appropriate cohort groups, we're looking at how the economic and the financial market environment may evolve over time, and our ability to source the type of risks that we're looking to source within these markets. And I can't stress enough, there are tremendous advantages to being large and having assets concentrated in just a very small group of almost identical strategies. It gives you a lot of flexibility in how you allocate assets, how you respond to different types of market dislocation. And as you know, at PIMCO, as a platform for many, many years have been used to running large pools of assets. In fact, our footprint is a little bit smaller today than it was at its peak a few years ago. So, our investment process has been based somewhat on running large pools of capital.

But as I said in the beginning, when strategies get too large to meet those objectives, asset managers should consider closing them, even temporarily, and that would be the case and has been the case in some of our more-narrow or more-specialized strategies when we felt we couldn't be top performers on a risk-adjusted basis, and again, that's prudent in what our shareholders would expect.

BenzSo, speaking of firmwide size, PIMCO Total Return lost tens of billions of assets in outflows when Bill Gross left. There were fears at the time that the fund would enter some sort of a redemption spiral with outflows spurring security sales and that in turn getting price declines and triggering more outflows. Yet you weathered the storm, and that scenario didn't come to pass. How were you able to withstand such a huge volume of redemptions without it decimating performance? And then kind of a follow-up question on that is, how does that inform how you think about PIMCO Income, and have you thought through sort of a disaster case for that fund as well in terms of outflows?

IvascynYeah. So, these are critically important areas to think about as an active asset manager. And well before the Total Return redemptions as a result of Bill's departure in 2014, as you know, PIMCO had to deal with the global financial crisis, where not only was one particular fund seeing redemptions, you were seeing massive redemptions across the entire mutual fund complex. And that's been a time where we as a platform were able to distinguish ourselves on behalf of our clients. So, across all strategies, we're constantly thinking about what redemption scenarios may look like and not only how to meet those redemptions but how to do so in a manner that continues to generate strong returns.

So, as you know, we even had during last year's sell-off in rates, a couple of the strategies have significant redemption activity, and we were able to maintain very, very strong performance. So, that's the most important thing that a mutual fund manager needs to focus on, liquidity management. And if you do that well in an absolute and certainly a relative sense, clients are going to reward you with more business over time.

And then, the second point, and this is a critical point that we've been emphasizing across the platform, Income fund or other, one key way to differentiate ourselves as an active asset manager over time is strong liquidity management. And what I mean by that is not just defensive management, where you're meeting redemptions while maintaining the ability to just meet your performance objectives, we think it's critically important in terms of every decision you make to assess the relative liquidity of that investment and to really question whether you're getting paid enough to go down the liquidity spectrum, because we think that this is going to be an environment, as volatility increases, where a key way to generate strong returns on behalf of clients will be to take advantage of the liquidity challenges of others. And we saw that in the fourth quarter of last year, where you had a big uptick in volatility during a time where typically around the holiday season, there's not a whole lot of liquidity in markets, the ability to provide liquidity to others that need it late last year, early 2016, late 2015 has been a key source of return for the Income strategy and other PIMCO strategies. So, you don't only want to think about liquidity in a defensive sense. You want to think about liquidity from the standpoint of thoughtful portfolio construction and the ability to take advantage of these bouts of volatility to add value for clients.

So, sit back, be more defensive during periods where maybe risk-seeking behavior is occurring at too significant of a rate, wait for there to be fear in the markets, wait for big market turning points, and then go on the offence. So, using a boxing analogy, it's more of a counterpunching mindset than constantly in all market environments trying to squeeze everything you can get out of a market, especially with the need to go down into lower-liquidity investments.

PtakSince we're talking liquidity, I guess it brings the average investor to mind, they don't have the same vantage analytics perspective that you and your team have. They're just looking at a portfolio, right, a listing of securities. Do you have any suggestions that you would offer to a typical investor that is trying to make an assessment of the liquidity profile of a given portfolio that they're looking at? Let's just say it's a bond portfolio for sake of conversation, what are the key things you think they ought to look at?

IvascynWell, I think, you folks at Morningstar do a great job on behalf of investors. But one thing that is imperfect is to just look at how much cash you have on hand. I think what's important is to understand the mandate more broadly and looking at the full continuum of investments within a particular strategy. So, a strategy like the PIMCO Income fund, or the PIMCO Total Return fund, are broad-based strategies. So, they'll focus a bit on the less-liquid segments of the market like corporate high-yield bonds, or even cash investment-grade securities. But because they're broad in their mandate, they'll also own very liquid investments like agency mortgages, Treasury bonds, other government risk. And when you look at the continuum of exposures, clients can presumably get a lot more comfortable with those exposures. It's in the more concentrated portfolios, the more narrow portfolios that are almost solely focused on the less-liquid segments of the market, where much more detailed work we believe is necessary. But I think, again, for the individual investor, that may be a lot to ask, just given the fact that they are typically making these investments and have other things to do in terms of their professional and personal life. And that's why, again, I think it's helpful to get some insights from the fund company or folks like yourself to go through and understand the full continuum of investments and understand the different types of liquidity tiers that are out there in these markets.

BenzYou mentioned that you try to use a counterpunching strategy. So, can you walk us through the most nonconsensus view you're expressing in a big way in the portfolios, how it was deliberated, and also how you got comfortable with the risk-and-reward trade-off of that position?

IvascynYeah. So, our biggest expression, and this is, again, true across PIMCO portfolios, not just the Income strategy, is a very cautious view towards corporate credit. And corporate credit has been very, very popular over the last few years as a source of yield enhancement. The challenge with corporate credit is it's a sector that can lay dormant for a very long period of time. It's a sector that can be expensive and get more expensive, and you don't realize that you ended up being in an expensive asset class until you get a surprise regarding economic growth. Or put another way, in very expensive segments of the credit-oriented markets, you can achieve your coupon for a very long time, then you have your economic shock or your shock that drives defaults higher, and the question is, how much money do you lose during that period? So, this is a sector of the market where we may give up some short-term total return, especially in this environment of abundant liquidity, but we're more comfortable avoiding that asset class because you never know when there's that negative shock that leads to a much higher default environment. So, when we look at that sector, we think this is the sector where over the long run, investors are going to be the most disappointed, this is the sector that's going to be prone to the most significant overshooting. And I think we saw in the fourth quarter last year back to an example of where good liquidity management can allow you to go on the offence, last year in the fourth quarter, we saw an example of how these credit-sensitive sectors can overshoot when market sentiment changes.

So, when we look at our strategy versus other similar strategies, that's by far the biggest expression of ours that's different than what you'll typically see in the more income-oriented segments of the mutual fund universe. I think the mortgage position is one where it's perhaps a bit contrarian, but it's consistent with where we've invested a lot of resources over time and where we have, I believe, the benefit of having some capabilities that other managers haven't had. That's probably the biggest example.

PtakMaybe sticking with credit for a moment, I think you said in some of the pieces that you've written, you think credit yields ought to be wider to compensate for the reduced liquidity in corporate bonds. And I presume that's because market makers aren't willing to take on inventory the way they used to. So, I wonder if you can connect the dots for us and explain the scenario in which that risk manifests itself, how that plays out, especially in view of the credit market's seeming imperviousness. In recent years, it's been very resilient. So, what do you think is going to be that trigger?

IvascynYeah, it's been resilient in general, but there have been periods--and again, you don't have to go back that far to remember the early 2016 market or even prior to that, challenges in the cash corporate market associated with the weakness in energy, and we're even seeing an example of that in today's market with that sector and segment of the corporate universe. So, you have a situation where if volatility remains relatively low, if technicals remain very, very supportive, you can be in an environment where transactional liquidity appears sufficient. But it's when sentiment shifts all of a sudden and you need to transfer risk pretty quickly and pretty significantly, where you can have overshooting in this segment of the market, and presumably, given the relatively low-rate environment we've been in now for over a decade, people are in segments of the credit market for an incremental pickup in yield that aren't going to be perfectly comfortable going through even a somewhat muted default cycle. So, we see the ingredients, you touched on market structure. You combine that with yield-seeking behavior and a deterioration in underwriting standards where you have all the ingredients for overshooting when sentiment changes, and we've had enough small case studies to see that dynamic exist. So, that's the time when the Income strategy and other PIMCO strategies will likely be more involved in these markets. When you have enough price cushion or the ability to be selective and really target these investments that are widening in concert with other areas, where there's true default risk and where there's much better value for the end client. That's really the thought process.

Now, what can trigger that? Typically, when you look at prior market turning points, more often than not, they are issues that the market wasn't thinking about that much. And it's the surprise factor that sometimes could lead to this type of dislocation or overshooting. Things that we talk about today in terms of risks, and I don't think we're unique versus the rest of the market, would be further deterioration in trade, other negative outcomes of a geopolitical variety that could occur, or just further weakening in growth and the realization from markets that central banks don't necessarily have the tools that the market thought they had to deal with this economic weakness. So, a little bit of weakness is fine. If people begin to see growth slow even more significantly, and they begin to worry about a recession, that certainly could be a contributor as well. But given how stretched valuations are in a historical context, it could be something that's a surprise. And again, our goal is to be prepared for that event, not necessarily focus too much on predicting what will be the case that causes that type of weakening.

BenzSo, switching gears a little bit just to talk about philosophy more generally, you're a behavioral finance, decision science true believer, can you explain to listeners ways in which you've incorporated some of the tenets of behavioral finance into decision-making at the fund?

IvascynSure, and this is true across PIMCO but has certainly been an area of focus for us across the fund as well. One thing we try to do is take emotions out of decision-making. People talk a lot about overconfidence. You've interviewed a lot of investment managers. And you started the conversation by saying, "Wow." When people come on your podcasts, even when they underperform, they never admit it. Well, the human brain doesn't like to think that we're making bad decisions; we tend to focus on the successes and not the failures.

So, what we've tried to do is incorporate more structure in decision-making and take the emotion out of a lot of the day-to-day decisions that we make. An example of that were the meetings I mentioned earlier, where we have regular sessions with the analytics team and the risk team where we let them speak first, we let them review portfolio structure, we ask them to give us their more-neutral inputs on what portfolio structure would look like in the absence of macro forecasts or macro views. And we try to use those as tools to understand what our implied conviction levels look like relative to what a pure analytical process would come up with, and on a regular basis, we'll override some of our personal views, especially when we've measured via the data throughout the years that that approach leads to better overall investment results.

Other things we've done – and as you know, we have a formal relationship with Prof. Thaler now, we also have independent researchers with purely a behavioral focus that do research on our behalf to assess the way in which we make decisions. So, does Dan Ivascyn tend to be a bit more risk-averse than other portfolio managers, does he sell his winners too soon, does he hold on to his winners too long, how do different portfolio managers respond to different types of market environments and can we isolate some of these biases and come up with more-objective ways to make decisions.

And then, finally, one other point I'll mention, and we could go on and talk about these factors all day, another tool that's quite important to us is measuring a little bit more. Asset managers, I believe – and I've been at PIMCO now for over 20 years – tend to argue almost as sport. And I think that this is probably something that occurs as you become more senior or more experienced in these markets. And a lot of times in the past we found that we will be arguing about concepts, but when we narrow down differences in actual portfolio structure, they tend to be much less significant than would be suggested by the rhetoric or the arguments going around the table. And one simple thing that we've tried to do in recent years is just to measure a lot more. So, allow all portfolio managers regardless of seniority level to express their views, what are their optimal portfolios look like before we start a discussion, what are people's views in the middle of those discussions, how have those views changed, and then on the back end of the discussions, what are their final views. And we try over time to learn from that information, understand whether there are unique perspectives or biases associated with tenure at the firm, where you happen to be located, are you on an investment committee or regional committee versus not, are you more of a bottom-up-oriented portfolio manager versus a macro-oriented portfolio manager, and in the process again, try to be self-reflective, focus on attribution in as objective a way possible and, at the end of the day, make better decisions on behalf of clients. And that's easier said than done. People don't always like that type of scrutiny and self-reflection. But by institutionalizing some of that, I think it makes it a lot easier for an organization to, again, learn from both good decisions but, even more importantly, decisions that happen to not go as well as they could.

PtakMaybe in that vein, one of the things that we've seen over time is that prominent successful managers can sometimes become quite isolated within their firms. Might not be intentional, but that's a dynamic that we've seen unfold in some places. And so, I'm curious what steps you've taken to ensure that doesn't happen to you or some of your senior colleagues? And maybe are there examples you can give of maybe a lower level person or an underling standing up to you and changing your opinion, turning you around on an issue or calling you out for an error?

IvascynSure. So, a few things there. And some of this, we have to credit Bill Gross, who launched this firm many years ago – one thing that's a little bit different is that portfolio managers at PIMCO, regardless of seniority or location, don't sit in offices. Every portfolio manager, including myself and other members of the leadership team, sit out on the trading floor 95% of the time. In fact, I don't even have my own office. I have an office I use, it's empty, and it's an office that other people can go in and use when it's open as well. So, we sit out there on the trade floor and interact both with broker/dealers directly, more-junior employees. It's a very open architecture type system to try to resist that tendency for portfolio managers as they become more senior to become more removed from the process, even the execution of the underlying trades. And fixed-income markets are very different than equity markets in the sense that it's still very, very important to get a feel for markets and the feel for how risk is transferred versus more of an exchange-oriented marketplace. So, that's something that's been in existence at PIMCO since the very beginning. It's how things started during my first days in the office back in 1998. And we still strongly reinforce that structure today.

Secondly, and this is where things have evolved over the course of the last few years, we have significantly changed the composition of committees that we use to make decisions. In the past, to get on to key decision-making committees would have required a much higher level of seniority or a more significant experience set than is the case today. Today, when we come up with either members of respective committees, or even rotating members of committees--and across all of our committees we'll typically have a couple of rotating members that stay with us for at least a quarter and sometimes longer--today, we end up with much more diversity in the types of folks that roll on to these committees. And what we found over time is that we really, really appreciate the unique perspectives of younger employees, newer employees, employees with different backgrounds than what the composition is of your more traditional senior member on the decision-making group.

So, that's something that we're continuing to work on today to try to expand the direct input of other individuals. And again, one way you do that is allow them to share their contributions and track their contributions and track their performance over time as well. But I do think that's critically important and an area of ongoing focus for us.

PtakWell, Dan, this has been great. Thank you so much for your time, insight, and perspectives. We very much enjoyed having you on The Long View. Thanks for being our guest.

IvascynThanks, Jeff and Christine. Really appreciate it. And it was a pleasure to spend time with you today.

BenzThanks, Dan.

PtakThanks again.

IvascynThank you.

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A propos de l'auteur

Jeffrey Ptak

Jeffrey Ptak  est directeur mondial de la recherche sur les fonds de Morningstar.

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