by Jake Moeller.
Lipper’s Jake Moeller reviews highlights of presentations by Mike Amey, Head of U.K. Fixed Income, PIMCO, August 28, 2014, and October 3, 2014.
The thirst for yield remains strong. According to Lipper FundFile data, August 2014 saw retail net sales into bond funds in Europe of some €4 billion, while equity funds suffered a net outflow of €1.2 billion. Indeed, for the year to date to August 2014 bond funds have received 80% of the total net flows into equity funds and bond funds combined. Against this backdrop, there might be the temptation for bond fund managers to increase the risk of their portfolios as yields compress, but Mike Amey is not chasing yield. He is unapologetically concerned about capital preservation. For him “stability of NAV” is key and a recurring theme. This is reflected by the compelling risk/ reward characteristics the fund has exhibited over three years. In the table below, the fund is firmly ensconced in the favoured “north-west” quadrant:
Table 1. Three Year Risk/ Return Chart of PIMCO Select U.K. Income Bond Fund within Lipper GBP Bond Classification (to September 2014).
Mr. Amey has been with PIMCO since 2003 and has fixed income experience across a range of retail products as well as a number of insurance portfolios. PIMCO Select UK Income Bond Fund, launched in 2011, is a recent addition to the PIMCO stable. It is conventional in nature, with two-thirds of the portfolio invested in sterling-denominated securities and with sector weightings managed in line with PIMCO’s broader investment outlook. There is some 25% exposure in government bonds (of which 15% is in gilts) and 36% in investment-grade credit. This is bar-belled with 16% high yield and 15% mortgage exposure, which provide growth kickers.
Mr. Amey isn’t critical of some of the more esoteric investments in the fixed income universe but “don’t take risk on the NAV of portfolio,” he reiterates. Hence, you won’t find unrated securities or payment-in-kind (PIK) bonds, which “have a tail inconsistent with NAV stability,” in this portfolio. He doesn’t currently hold any loans but isn’t averse to them. “The loan market has generally traded close to high yield,” so his preference has been for high yield—where, for example, he can identify better-quality U.K. residential mortgage-backed securities (RMBS) at a cheaper price than most of the loan market.
One key point of the fund is its flexibility, and Mr. Amey is prepared to invest across the full spectrum of the sterling fixed interest market. Over the last 12-18 months there has been, for example, a reduction in concentration from the 45% in asset-backed securities, which have rallied strongly, and a rotation into financials, which now constitute over 25% and the largest sector overweighted in the portfolio (+20%). The core component of the portfolio sits at a yield of 3.0%-3.5%, with an average maturity of 5-10 years.
There are two significant themes that have developed within the portfolio over the last 18 months along with the increase in high yield. Mr. Amey has increased bank exposure in European peripherals, Spain, and Italy as well as acquiring selected subordinated bank debt from the U.K., the U.S., and France. He has also increased exposure to U.K. retailers, including pubs that have benefited from restructure such as Enterprise Inns and Green King. Despite the increase in high-yield exposure, balance has been maintained at the other end with the government bonds exposure.
The flexibility of the fund to own one-third non-sterling assets has allowed Mr. Amey to acquire Spanish and Italian sovereigns. “We believe the Eurozone is going to stick together, and even if you assume these countries as investment-grade credits, then Spain and Italy are cheap relative to investment-grade corporate.” Mr. Amey also outlined a number of “special situations,” which include Spanish municipal and short-dated bonds in Slovenia that provided good opportunities to buy and hold to maturity.
Mr. Amey is sanguine on emerging-market sovereigns, and there is also some exposure in the fund to ten-year Mexico debt, which he believes is going to benefit from structural reforms. “We are more buyers of EM than natural sellers. If you can identify economies with high relative interest rates with the right reforms, then you can accept the inevitable technical volatility.”
Table 2. Three Year Performance of PIMCO Select U.K. Income Bond Fund to September 2014 against Peer and Fund Benchmark.
The fund is running a low-duration position of 3.5 years (compared to 4.2 years for its benchmark). Mr. Amey believes interest rate hikes will occur in April 2015, if not before. He doesn’t rule out an interest rate rise in 2014, given the Bank of England’s change in rhetoric over the last three months, although he believes the base rate will struggle to get above 0.5%. In this scenario five- to seven-year bonds will perform better. Front-end bonds will be mispriced; there the market will have factored in a first rate rise three to six months later than PIMCO believes the rise will occur.
The biggest fear Mr. Amey holds for the outlook for bonds is a scenario where no central banks can get rates away from zero. Although he feels this is less likely now than 18 months ago, it could occur if European economic growth collapses, Abenomics fails, and China stalls. He sees the current environment as one of “low-growth healing,” with enough power to generate a business cycle and the requisite volatility to produce a 4% income stream. Mr. Amey does recognise the temptation to increase risk to chase yield, but he reminds investors that increases equity risk. “Buy these if you think they look cheap relative to other risk assets. Don’t expect them to be a bastion of stability.”
Table 3. Current Lipper Leader Ratings for PIMCO Select U.K. Income Bond Fund:
PIMCO’s recent disruptions have been well documented, and Lipper’s Patrick Keon has outlined some of the impact this has had, particularly in the flagship PIMCO Total Return Bond Fund. High-level staff departures are always a concern to the extent they become an ongoing and destabilising distraction. However, PIMCO is a mature business with strong ownership and the ability to absorb fluctuations in asset sizes. There is also a plethora of experienced investment professionals such as Mr. Amey whose day-to-day business and funds are not materially impacted by these departures. Each fund should be considered individually and on its own merits and the Lipper Leader performance scores outlined in Table 3. indicate that Mr. Amey is doing an excellent job.
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This material is provided for as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice. The author does not own shares in this investment.