Alfred Murata, manager of the $9 billion PIMCO GIS Income fund, has been reducing his exposure to high yield to cut his portfolio's risk in anticipation of the Fed's rate hike.
'We expect that the Fed fiscal tightening could lead to a lot of volatility in 2015. Therefore we reduced our high yield exposure in the portfolio and have been adding mortgage backed securities since December 2014, due to their stable performance and attractive prices,' said the Citywire AAA-rated manager.
'We expect property prices to go up by 3% a year in the next two years, while yields on non-agency mortgages should provide 5-6%.'
As such, Murata has been strategically adding MBS with the fund’s exposure currently standing at around 30%, whereas his high yield credit is now down to 14%.
'The rally that occurred in high yield was also a good selling opportunity and a chance to reduce risk in the portfolio,' the fund manager added
MBS on a discount
Furthermore, Murata said he used a flaw in rating agency methodology to acquire MBS on a discount.
'We buy non-agency mortgage-backed securities at about 80 cents and could potentially get back 90 cents if housing prices go up 3%,' he explained.
'Agencies rate even securities with CCC rating where we know we would get 99 cents on the dollar back.'
Apparently, this very flaw in rating agency methodology has reduced the number of natural buyers of non-agency securities. For many investors it would not be possible to own these bonds due to their credit ratings. Consequently, this lack of demand would lead to the opportunity to provide liquidity to the market and purchase them at a discount.
One Portfolio, two components
If economic growth turns out to be weaker than expected, Murata is still well positioned. After all the portfolio was split into two components.
'We have found it attractive to divide the portfolio into two components, a higher yield component which we expect will perform well if economic growth is stronger than anticipated, and a higher quality bucket which we expect to perform well if economic growth is weaker than anticipated.'
One high quality asset class that the fund manager finds particularly attractive is Australian interest rate duration.
'Australian securities are very high quality and the market is very liquid. These securities help to protect the portfolio against economic uncertainty and downside events when there is a flight to quality,' Murata said.
'Australian GDP growth is falling below the US and rates could potentially drop, whereas we expect rate increases in the US.'
Due to the importance of Australian mining exports to China for Australia’s economic growth, a Chinese slowdown could catalyse a reduction in Australian interest rates, he added.
Over the past three years to February 2015, the PIMCO GIS Income E USD Acc returned 37.87%. Its Citywire-assigned benchmark, the Barclays Global Aggregate USD TR USD, rose 21.7% over the same period.