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Pimco’s $74bn Total Return fund changes tack on uncertain interest rate future

Pimco’s $74bn Total Return fund changes tack on uncertain interest rate future

Pimco is cautiously positioning its $74 billion Total Return fund to capitalize on the range-bound future of US interest rates after making aggressive moves on the yield curve in recent years.

Speaking to Citywire Americas sister title Citywire Selector, Scott Mather, Pimco's CIO for US core strategies and the fund's co-manager, said the team had moved to a more moderate position towards the end of 2017.

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.’

US interest rates were raised to 0.5-0.75% in December and three hikes in 2017 could bring that figure up to 1.25-1.5% by the end of this year.

Positional switch

Mather, along with co-managers Mihir Worah and Mark Kiesel, had moved away from positioning implemented by the investment committee under the stewardship of the fund’s former lead manager Bill Gross.

‘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 realized that a low rate environment would prevail in a world characterized 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 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.

EM exposure

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.’

Trade troubles

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 fund. Mortgage-backed investments account for the largest allocation in the fund, at 58%.

On a three-year basis, the Pimco Total Return Fund;Insitutional returned 7.5%. It has 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.

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