A top fixed-income manager discusses the possibility of a soft landing, the prospects for lower-quality bonds, and key lessons from 2022's challenging bond market.
Our guest this week is Sonali Pier. Sonali is a managing director and portfolio manager at Pimco, a global leader in fixed-income investing based in Newport Beach, California. Sonali is lead manager for the Pimco Diversified Income Fund, which carries a Gold rating from Morningstar, and she comanages a number of other strategies, including Pimco High Yield and two ETFs. She serves on various committees at Pimco, and she was honored early in her career as a Rising Talent by Morningstar’s Manager Research team. Prior to joining Pimco, Sonali was a senior credit trader at J.P. Morgan. She has a bachelor’s in economics from Princeton.
Background
“The Top Female Portfolio Managers to Invest With Now,” by Megan Pacholok and Amrutha Alladi, Morningstar.com, March 6, 2023.
Pimco Dynamic Income Opportunities Fund
Pimco Enhanced Low Duration Active ETF
Pimco Multisector Bond Active ETF
Pimco Credit Opportunities Bond Fund
Pimco High Yield Spectrum Fund
Pimco Low Duration Credit Fund
Macro Views and Asset-Class Reflections
“Prime Time for Bonds,” by Erin Browne, Geraldine Sundstrom, and Emmanuel E. Sharef, pimco.com, Nov. 14, 2023.
“Why Fixed Income Is Looking ‘Rather Attractive’ Given Potential Recession Risks,” Video interview, finance.yahoo.com, July 20, 2023.
“The Power of Flexibility in Multi-Sector Credit,” Video, pimco.com, July 2023.
“Inflation: ‘There’s Certainly a Pathway Towards a Soft Landing,’ Portfolio Manager Says,” Video interview, finance.yahoo.com, June 7, 2022.
“Bond Market: Strategist Details Where to Find the ‘Sweet Spot’ in Fixed Income,” Video interview, finance.yahoo.com, Jan. 4, 2023.
“Fed ‘Likely to Pause’ Following 25 Basis Point Rate Hike, Portfolio Manager Says,” Video interview, finance.yahoo.com, May 4, 2023.
“Spotting Opportunities in the High Yield Ratings Migration,” by Sonali Pier and Sabeen Firozali, pimco.com, Jan. 24, 2022.
Dan Lefkovitz: Hi, and welcome to The Long View. I’m Dan Lefkovitz, strategist for Morningstar Indexes.
Christine Benz: And I’m Christine Benz, director of personal finance and retirement planning for Morningstar.
Lefkovitz: Our guest this week is Sonali Pier. Sonali is a managing director and portfolio manager at Pimco, a global leader in fixed-income investing based in Newport Beach, California. Sonali is lead manager for the Pimco Diversified Income Fund, which carries a Gold rating from Morningstar, and she comanages a number of other strategies, including Pimco High Yield and two ETFs. She serves on various committees at Pimco, and she was honored early in her career as a Rising Talent by Morningstar’s Manager Research team. Prior to joining Pimco, Sonali was a senior credit trader at J.P. Morgan. She has a bachelor’s in economics from Princeton.
Sonali, thanks so much for joining us on The Long View.
Sonali Pier: Well, thank you, Dan, and Christine, for having me.
Lefkovitz: Absolutely. You’re a very accomplished fixed-income investor, and these are interesting times for the asset class. Pimco put out a 2024 outlook called “Prime Time for Bonds,” and it noted how compelling fixed income is right now relative to equities. We are hitting new highs in the stock market in February 2024. Why so bullish on bonds?
Pier: Absolutely. If we look at what’s occurred over the last couple of years, we endured the steepest rate-hiking cycle in decades, and that essentially put fixed income in the spotlight. We do agree it’s absolutely the prime time for bonds. As we’ve reset yield higher, fixed income can help navigate a number of macro scenarios. Essentially, the income in the bonds is more reliable and predictable than the equity returns at this stage, given while the base case may be that we have 4% nominal GDP through full year 2024, and growth is coming down, inflation is coming down, and we do expect the Fed will probably continue to hold at restrictive levels and start cutting around midyear. So, our expectation is we may have three cuts. While there is still potential for a mild contraction in the US, that is our base case, the one I just painted, and with that backdrop, we’re generally favoring an up-and-quality tilt, so one that in our portfolios, we’re trying to keep up on the upside and protect on the downside with more resilient investments. Most importantly, for fixed-income investors, they stand to potentially benefit from the cuts in 2024 and potentially in 2025, and I think it’s an important time to start owning that yield and terming out in fixed income, and credit provides an opportunity as well to enhance yields.
Benz: We want to delve into some of those themes that you just mentioned, as well as Pimco’s outlook on some of these matters. But one, I think, thing that’s top of mind for a lot of investors is cash versus bonds, where you see cash yields in some cases right in line with bond yields today, and of course we’ve seen flows go into money market funds as well because of those attractive yields. So, what are investors missing in cash versus bonds, and is it Pimco’s view that investors are overdoing cash instead of bonds?
Pier: Money market bonds or cash broadly, it can be a great investment at certain points in time. But investors that moved into money markets and T-bills and CDs throughout 2022 were rewarded as cash had elevated yields, but those instruments are not designed to be a medium- or long-term solution. When you buy a money market fund, you’re renting that yield, you’re not buying that yield because it can change quite dramatically. For example, in 2024, we are expecting rates to move lower, and so instantly you’re reinvesting at lower yields if you’re in a cashlike instrument, and you don’t capture the price appreciation associated with the rate cuts without some duration or credit risk as well, where you term out that fixed-income investment. Being invested outside of cash may have been painful in 2022, but today we’ve reset those yields, and investors can enjoy the potential returns from rate cuts as well as the income that these higher yields are generating today.
Lefkovitz: You mentioned the reset that we’ve had in rates. 2022 was termed by some as the worst bond market ever. We had double-digit losses for core bond indexes, and some advisors and investors concluded that the best way to own bonds is to skip bond funds and purchase individual credits and hold them to maturity instead. What should people know if they go that route? What do you think they missed by not owning a fund?
Pier: I can see the temptation, but really diversification is so important for investors, especially as volatility increases or you hit pockets of stress. When we look at a multisector credit strategy, for example, we’re looking to diversify across risk factors and find alpha from asset allocation, regional selection, industry selection, security selection. There’s a lot of ways the market’s dynamic from which to not just generate alpha, but also have the most efficient expression. The strategy you’re describing, that passive ladder approach, can work well in a low-vol environment, but it gets very difficult when there’s stress in the market. Imagine you own 10 bonds in that scenario and one or two have an adverse outcome, that would be worse than the high-yield default rate that we see currently in the market, for example. And as we look ahead, we see stress potential in the credit markets from things like liability management exercise, creditor-on-creditor violence, that again, it really depends on the specific bond you hold and the holding period as well. So, I think of this as the market’s dynamic and that ladder approach is static.
So, when we look at what you miss from it, I would say you’re not really going to capture the trends of the market and the evolution. So, an example would be, if we look at the high-yield market today, 35% of high yield is secured. It’s only a few years ago in 2020, it had about 20% in secured bonds. So, another way to put it is over the last five years in this asset class, the benchmark has had close to 50% turnover. So, it is an evolution, and you don’t capture that evolution by buying the single bonds and holding them to maturity.
Benz: I wanted to ask about 2022 specifically—Dan just did—but it must have been a tough time to be a fixed-income fund manager. Can you talk about some of your key takeaways or lessons from that experience, and also whether there was anything that surprised you during that period?
Pier: 2022 was a tough year for all investors across both fixed income and equities. We had the fastest rate-hiking cycle we’ve seen in decades and correlations dramatically increased across asset classes with rates rising and credit spreads widening. And essentially one of the takeaways is you need to be nimble and pivot quickly to respond to a new environment. So having that liquidity and flexibility in a portfolio is very important.
But today the situation is quite different. Rates have reset higher; the opportunity set looks attractive for bonds. And we’re trying to take advantage of that opportunity but still cognizant of scenario analysis, not just modeling for the base case, but really how would our portfolio perform across “fatter tails”? At Pimco, we value the behavioral economic aspect throughout our investment process. And we try to limit our confirmation bias or appreciate the probability of those tails that I was mentioning when we’re looking at opportunities in the market.
Lefkovitz: Getting back to current market dynamics, we have an inverted yield curve. It’s been inverted for some time now; I think since late 2022. It’s often cited as an indicator of recession. Do you see it as predictive? What do you make of it?
Pier: It’s interesting. Because often people will say, well, if it’s inverted yield curve, we could have a recession. But the reality is every time we’ve had an inverted yield curve has not necessarily meant a recession. However, recessions are typically preceded by a yield curve that’s inverted. Inversion at this point, we are still seeing relatively low unemployment, inflation overall coming down. So, I think there is a path for the Fed to see a soft landing, especially as I shared earlier, our outlook is for rate cuts in the second half of the year. The market had been pricing more cuts than our outlook. And we believe the Fed will stand firm on restrictive rates until inflation is a bit more consistently low. And at this point, the market seems to be pricing in a bit more in terms of cuts than our base case. But we see it as a second-half event. And when we look at the probability before June, it just seems the economic data has been quite strong.
And so, if we were to evaluate what happens if rates were to remain elevated, I guess that’s the other side of it, I would be concerned about some of these low margin, low multiple businesses that have low free cash flow and also some areas of the floating rate market, like some parts of the bank loan market and some parts of the commercial mortgage market where there is a bit of stress already. But again, it’s case by case, meaning you have to be selective within each of these asset classes.
Benz: We wanted to delve into the health of the economy a little more deeply. As you mentioned, there have been some mixed indicators. The job market is strong overall, but there have been a lot of layoffs, especially in I think the technology sector. We’ve heard about the vibecession and there’s also the rolling recession concept. I’m wondering with your perspective, looking at the corporate credit market, what do you make of the rolling recession concept and what are the investment implications of it?
Pier: It’s interesting. So, the rolling recession concept is essentially that you don’t have an instantaneous or ubiquitous negative shock. So very different from what we experienced during the great financial crisis. Instead, it’s like pockets of weakness or stress that can impact one sector at a time or one geography at a time. In terms of what we’re seeing in some of our areas of concern within the corporate credit segment, again, this goes back to that high capex, low free cash flow theme, and the sector that that’s affecting, we’re seeing it already in telecom, media and cable. And then even outside of corporate credit in some segments of real estate, for example, within office commercial mortgage space. Office CMBS has repriced meaningfully, although it has started to see some green shoots in certain spots. The key is essentially to stay diversified and be selective with such exposure and have that active lens on it.
Lefkovitz: Following up on the property market, we’ve seen some tremors, as you mentioned, in commercial real estate. You have exposure to residential in your portfolios. Could you take us through your view on real estate these days? Obviously, when you’re investing in mortgage-backed securities, you’ve got your agencies and your nonagencies. So, what kinds of differences are you seeing across these markets?
Pier: So, let’s start with the residential. I think we are at a very different point than, say, the great financial crisis. I get asked that sometimes because of rates being so high and the stress that could be putting on the market. But residential housing is in a much stronger position today and lending standards are notably higher as well than during the GFC. Most homeowners have a very low mortgage rate. In fact, over 65% of American homeowners have a mortgage that’s below 4%. And that stands in quite some contrast versus the adjustable-rate mortgages that we saw in GFC. So, the strength in housing pricing has created also a large amount of equity cushion when you look at people in their homes. In fact, some of the issue is there’s limited supply and people are stuck in their homes with these low mortgages and therefore there’s less transactions taking place.
We do prefer nonagencies because the bars are in a healthy position, as I mentioned, and especially in the legacy nonagencies where our Pimco analytics is quite impressive. We have the ability to look at how much home equity has been built there, how many years people have lived in that home, what their track record has been in paying, and the level of mortgage to have a fair amount of confidence in the forward trajectory for those legacy nonagency securities. We also find agency mortgages attractive as it’s liquid, it’s implicitly guaranteed by the government, and offering a spread that’s quite similar to, say, single-A investment-grade. So that certainly has been attractive across a number of portfolios here. And then within commercial mortgages, I would say it’s just important to be selective. We’ve had some headwinds in the space in terms of work-from-home dynamic, in terms of interest-rate increases, as you mentioned earlier, the tech layoffs. And so, within commercial mortgage space, we’re mostly looking at some of the loss-remote, AAAs, and then within industrial and hospitality, there’s some opportunities. And then I would say very select and case by case, so again, going back to that idiosyncratic risk within credit generally around the office space.
Benz: We wanted to ask about investing in fixed income globally. You’re a global investor. I would say Pimco as a firm has long looked at fixed income globally and offered, obviously, global fixed-income funds. Many investors take a global approach to their equity holdings but stick with domestic bonds. And I think the general thesis there is that the bonds are the safe portion of their portfolios. So, it’s unwise to take added risk there, especially currency risk. So maybe you can tell us what is the case for taking a more global approach to fixed income, not just being global with equity holdings.
Pier: So essentially, it’s back to that diversification point—investors can consider opportunities across regions, currencies, asset classes. And today, growth cycles are quite divergent. And when you look at our economic outlook, US growth could differ even amongst developed-market countries. So, for example, Canada and Australia, they have a shorter-dated floating rate mortgage market. And so much more sensitive to rates rising, whereas in the US, as we talked about the mortgage rates that were fixed lower, but also for longer, with the 30-year mortgage as an option in the US. And so today we’re seeing a lot of differentiation between economies, especially based on that sensitivity to variable rates. And we’d expect those with more sensitivity to grow, essentially, at a slower rate. But even when we look beyond that in emerging markets, for example, while we do prefer developed markets over emerging markets at the moment, there are some select countries in emerging markets that have actually been ahead of the cutting cycle than developed markets. And so, there’s opportunities abound. It’s just much more on a selective basis.
And then digging into it in more of a micro level for alpha opportunities across the capital structure, we see companies issue sometimes in dollar or sterling or euro and in the same capital structure. So, where there is incremental spread or certainly after compensating for liquidity differences, we will look across those currencies and look for opportunities. Similarly, we say we’re looking for those singles and doubles in alpha using that most efficient expression of a trade. So, whether we’re screening for a cash bond versus a derivative, a dollar bond versus a euro bond, or the front end of the curve versus the long end of the curve, however we can craft the portfolio to be able to benefit the most from the opportunity set that we see, we want to do so. And so, our approach is a bit different than US or global and just really taking all of that into consideration as we build a portfolio across the global credit landscape.
Lefkovitz: Maybe we can talk about how your global outlook is filtering down to your portfolio positioning. So, you run a multisector credit portfolio and you’re weighing opportunities across investment-grade corporates and high-yield corporates and emerging-markets debt. How are you assessing the risk-return profiles of those various asset classes?
Pier: So certainly, essentially, we want to be able to take advantage of the structural inefficiencies in each of these asset classes but also tactically flex when markets move, so meaning, rotating across asset classes or industries or regions. And so, when we look at these risk factors, some of the themes we’re looking at today is, as I mentioned a little earlier, developed markets over emerging markets, although there are some select attractive opportunities in emerging markets, certainly. But developed central banks have likely reached the end of their hiking cycles—we’re discussing cutting by mid-2024. When we look across, the liquidity profiles also tend to be better in many parts of developed markets. And so, I would just say that the bar for EM exposure is a little bit higher as we look at that, but certainly finding some opportunities in there, whether it’s in sovereign quasi or even corp space as well.
Within regions, we do prefer the US over Europe at the moment, because the US economy has not only been fairly resilient, it is also less rate sensitive as we discussed. And when we look at some of the geopolitical risk, whether that’s Middle East or Russia or trade sanctions with China, I think Europe will be a bit more sensitive to that disruption. Shifting to corporate credit markets, within investment-grade, we do prefer financials over nonfinancials. Some of the backup in spreads in terms of financials versus nonfinancials occurred as a result of some of the regional bank stress that we saw last March. And today, if we look at, for example, the big six, they are large diversified global multinational banks that are offering attractive spreads, given the need to continue to issue. And so that’s provided some new issue confession as well as incremental spread versus nonfinancials.
In terms of instrument selection, we do look at derivatives and prefer CDX at the moment versus some cash bonds, given the basis in many cases, meaning the spread between derivatives and the cash is actually positive, meaning the derivative is trading wider. So that’s from a tactical basis attractive at the moment. But from a structural perspective, it’s also providing better liquidity, carry and roll down. And it allows us to really rotate the portfolio when bonds are oversold, and you hit a period of stress to be a price maker rather than a price taker, because we can rotate out of the derivatives and actually provide a bid for the bonds.
Shifting gears to agency mortgages, we discussed those being historically cheap and certainly part of the portfolio at the moment. We also like agency mortgages because they’re trading quite wide in OAS terms, but also, given the liquidity profile, the implicit government guarantee and at this point, the levels look quite similar to say single-A IG credit, so a diversifier from a spread perspective and a pickup in liquidity as well. Tying this all together to valuations, admittedly spreads are on the tighter end in corporate credit, but it’s balanced by those wider yields, which can absorb some spread widening, some interest-rate increases, although that’s not the forecast. And so that income comes back into the picture. And I think we can find interesting opportunities across investment-grade, high yields, EM. It’s just about being selective and really digging and doing the work credit by credit.
Benz: That’s a really helpful overview. I want to delve into emerging-markets bonds. You mentioned that you generally have a preference for developed and are being more selective in emerging. We’ve seen some enthusiasm among contrarian value investors like the team at Grantham, Mayo, Van Otterloo who call EM bonds a once-in-a-generation opportunity. Some emerging-markets central banks were ahead of the Fed and the ECB raising rates early in 2021 and they’re not cutting. Maybe you could talk about how you are looking at the asset class—emerging-markets bonds?
Pier: In emerging markets, just like any of the other credit markets, it’s absolutely idiosyncratic and case by case. As you mentioned, some EM economies like Chile, Brazil, Hungary have been ahead and are cutting already ahead of the developed markets. So, there are certainly selective opportunities that are attractive across sovereign, quasi-sovereign, and in our case, off benchmark in local, FX, and corporate space as well. But when we look at it overall versus developed markets and versus the index of emerging markets, say hard currency external, some of the tighter trading countries like in the GCC, we can substitute that risk with high-quality, developed-market corporates and avoid, say, the geopolitical risk or have a bit more total return potential. Other areas within EM that we’re a bit more cautious is in the lower-quality portion. Again, there are some opportunities that we find attractive in that space, but overall, liquidity is quite constrained, especially if things do not work out. So that’s something we’re very mindful of as well as are we getting compensated for that incremental risk. So, when we look at the total portfolio within emerging markets, I would say the sweet spot has been more of the BBBs and BBs, but absolutely diving into where is the best expression across EM asset classes and then comparing versus DM as well.
Lefkovitz: Turning to high yield—high yield had a big year in 2023. Investors really got rewarded for taking on credit risk. Our high-yield index was up almost 14%. How are you approaching the high-yield space?
Pier: The high-yield space has improved in quality as well. Part of those returns are due to—we’ve had significant rising stars. So, in 2023, we had 125 billion of rising stars, so companies going from high yield to investment-grade. In 2022, we saw 113 billion. So, one aspect is the migration of the high-quality credits, the BBs going up to BBB status. The other aspect is actually, when growth turned out to be better than expected—2023 was rather resilient compared with forecasts at the end of 2022, calling for a hard landing in many scenarios. And as a result, that really helped the CCC portion of the high-yield market also rally. And that’s really what led to those strong returns. But even today with compressed spreads, the yield cushion of high yields can really provide an opportunity from an income perspective as well as from an industry-selection perspective and a security-selection perspective. So, meaning looking up and down the capital structure and across industries. We talked a little bit earlier about some of the stress in the cable and wireline spaces in high yields. Similarly, when we look across industries, even within correlated industries, for example, we do prefer building materials over home construction, given it’s a bit more of a consistent free cash flow theme and less cyclical and less tied to, say, a big housing market cycle.
Benz: I had a bigger picture high-yield question, which is, I think some investors see high yield as equitylike, and maybe even a superfluous sort of asset class. There have been lots of blowups in the past, although not too many in the recent past. So why do you think high yield is worth the trouble?
Pier: I think actually high yield is a great asset class to own through a cycle. The income profile from those elevated yields helps also to bolster the returns. At today’s levels, especially compared with cash, the income starts to become important for investors and it helps absorb some of that underlying price volatility. Essentially, what that results in is a bit more resilient of a total return profile than investors may expect given often that discussion around defaults. Today, our outlook for defaults is roughly in line with the long-term averages, given many companies termed out their debt and rates were low, given the amount of uncertainty that was out there in the back half of 2020 and in 2021, a significant amount of longer-term debt was raised. And so, even if you look at it by rating cohort, for example, just as one metric, the median default rate for BBs is about 0.5%. For a single Bs, it’s 2%. So, the bulk of that default rate is really in the CCCs. And as I mentioned earlier, our preference is a higher-quality tilt and we’re being very selective when dipping into the lower-quality parts of high yields.
If you look at it through history, for example, high yield has not had two consecutive years of negative total returns. 2023 was a good example, where valuations and returns were very challenged in 2022, especially due to the rising rates. We bounced back quite strongly in 2023, and especially the bulk of that was in the last quarter. So, if I compare this versus equities, I’d say, high yield’s returns on average, we’ve seen over the last 20 years return 6.5% with 9% volatility for a Sharpe of about over 0.7. And versus equities, over the same time frame, they’ve returned 7.5%, so 1% more, but with close to 15% vol, so the Sharpe is just 0.5. So, when comparing the two asset classes, I’d actually say high yield is a bit more of a resilient equitylike proxy.
Lefkovitz: We’ve seen bank loans and private credit rise in prominence. They are two asset classes that are related to high yields. How have they impacted high yield?
Pier: There’s absolutely been significant growth in both the bank loan market and the private credit market. Today, all three markets are similar size, yet the growth trajectories have been quite different. So, the bank loan market has doubled over the last 10 years. The private credit market has doubled over just the last four years. It’s helped high yield actually improve in quality because over the last decade, we talked about those rising stars, but there’s also been limited net supply more recently as the debt stacks have been termed out. And so there wasn’t really a need to refinance while rates have been at, call it, peak. In contrast, the loan market has deteriorated in quality as it became a primary capital source for LBO financing with this constant prepayability at par, meaning sponsors found it quite attractive to be able to have that option to prepay at par, where typically in the high-yield market, there would be a structure where it’d be a non-call three years. And then, at that first call day, it’d be par plus half the coupon you have to pay, so both time prohibitive and cost prohibitive.
Adding to it, the CLO growth has been so tremendous that it’s led to significant growth in the loan market of loan-only structures, asset-light businesses, covenant-light growth. And so, you have to be quite selective within that asset class. As we look at private credit, some of its growth has been due to providing a partnership with a small number of holders as lenders that are looking for the control but also can provide issuers with some insights through portfolio companies.
So altogether, all three are about 4.5 trillion and converging into some extent. And this is having an impact on spreads, the structural protection and default. So let me explain and highlight a few examples. The growth of the private credit market, we see that all over the headlines. And they’ve taken significant share of LBO activity. This has partially been responsible for improving that credit quality we talked about in high yields, as some of these issuers that are lower-rated single-B or CCC and are no longer in the high-yield benchmark because they’ve been refinanced in private credit, the growth in private credit has also led to large multibillion-dollar deals where there’s also sometimes a public and private piece to that transaction. These prepayments address near-term maturities and have also led to negative net supply in public markets. This has been a very supportive technical to secondary prices, given credit fundamentals have also been stable. Today, there are many times where Pimco is providing a price based on whether it’s a public or private deal and showing a dual-track option to issuers.
The private credit, importantly, has provided really a lifeline for some of these B3, CCC type credits that would have otherwise had to default or led to maybe a distressed exchange in the high yield or bank loan markets, essentially doing their dirty laundry for them. In the fourth quarter ‘23 alone, we saw approximately 20 billion of public transactions refinance that were near-term maturities with low rating profiles. Again, going back to solving for what either would have been difficult for the loan market to digest given CLOs have to mark to market in excess of 7.5% CCCs and they own about 70% of that loan market. So, it’s been quite interesting how private credit has become a solution and allowed all of credit to perform perhaps better than some expected from a default perspective. And today, I would say the open question is how the secondary market will evolve as private credit continues to pursue large multibillion transactions and when this is tested in a financial downturn. At Pimco, we’ve added resources, talent to our multisector credit teams to stand ready for when that volatility comes given the significant growth in both the loan and private credit markets. Today, dispersion in credit markets is very high and I would say that diverse pools of capital are good for both issuers and lenders that can price it accordingly.
Benz: We wanted to ask about Pimco’s role in working with issuers at Pimco. You talk about creating the bonds you want to buy working with issuers as a Pimco specialty. Can you give an example of that?
Pier: So, it’s been an opportunity for us to work with issuers, in some cases, sponsors directly in sectors and companies that we prefer and sometimes in less loved by the market sectors as well. One example would be just to take it back for a moment during peak covid crisis, we had a retailer come to us. As an industry, we’ve been underweight. We had been concerned about the lower brick-and-mortar foot traffic, the fact that during peak covid, many of these stores were completely closed. For the issuer, it was cost prohibitive for them to be able to issue an unsecured bond. And so, they came to us and said, essentially, is there a scenario where you’d buy these secured bonds? And so, we teamed up our corporate credit analysts and our mortgage analysts, where the corporate credit analysts looked at the intellectual property of the company. The mortgage analysts analyzed what does a dark value look like on their headquarters and other buildings that they owned? And we essentially were able to help them come to market with a three-tranche secure deal where Pimco was an anchor, and we felt it had enough downside protection from covenants and the collateral package, but still would be able to participate from the reopening trade and that theme in covid from the upside. In fact, these bonds were issued with an 8% handle and a year and a half or so later refinanced on an unsecured basis with a 3% handle. So, it really does help to be able to sharpen our pencils, work with issuers, put our platform, the breadth and the depth of it, to work to find those opportunities.
Many of our analysts have had relationships with a lot of these management teams for some time as well. We see these reverse inquiry opportunities or being proactive on our end for helping issuers find a solution to, say, their short-term debt needs or really helping them grow into their capital structure is one which really benefits our investors in the end with either an outsize allocation or a solution to holdings that may have been in jeopardy otherwise.
Lefkovitz: So, Sonali, thinking about your outlook and how you’re positioned right now, what are some of the biggest risks out there that you’re monitoring?
Pier: I would say let’s take it from a macro and a micro perspective. So, from a macro perspective, clearly for fixed income, one of the worst scenarios would be a repeat of 2022, where, say, inflation reaccelerates, rates and spreads don’t diversify, and both widen. That’s not our base case, but certainly that would be a concern. Geopolitical risk rising can be a concern. From a micro perspective, I’d say, back to your question on rolling recessions, there’s pockets of risk absolutely even in today’s market. Even with a forecasted average default rate, we’re quite concerned about some of these companies in the telecom and wireline industries where they’re large issuers of debt. They have high levels of capex. Capital is expensive today and competition is also increasing. So how those companies navigate 2024 will be quite critical for performance in those high-yield companies.
Benz: We wanted to ask about the US fiscal situation. This is an election year. Government spending has been trending up for a while. The long-term risk is that a lot of market watchers are ringing the alarm bells about US debt and the GDP ratio climbing. Can you talk about how Pimco is assessing that risk and how that affects its portfolio composition?
Pier: So, during peak covid, it was quite important that we had the fiscal policy and monetary policy be supportive. But today, that’s led to a significant amount of debt on public balance sheets and having taken some of that risk away from the private markets. If you look at, Fed had not stepped in during the great financial crisis for corporate credit markets and had offered up to $750 billion across primary and secondary markets during the peak covid experience. Although they only needed to use $14 billion of that, it was certainly a significant signal and one where now today we’re looking at very high debt/GDP ratios in many countries and navigating those next steps will be very important.
Lefkovitz: You’re an ETF manager now. Why did Pimco launch a multisector ETF?
Pier: We had client interest in the vehicle type, and we wanted to make sure that we offered our clients access to the breadth and depth of the Pimco platform across asset classes. The ETF in multisector credit is meant to be benchmark agnostic, one that’s really targeting an attractive yield and can benefit from capital appreciation through similarly asset allocation, regional selection, industry selection, and security selection as well. The ETF has that daily visibility in terms of holdings and so we’re quite cognizant about the flexibility as well as the liquidity being quite important here as well. And so, the team we’ve put together includes a PM from analytics, includes multiple PMs from the multisector credit team, as well as some specialists in single sectors really just to unlock that value in an ETF format for the clients that needed that vehicle type.
Benz: Sonali, maybe you can tell us what’s the biggest disagreement on your team right now?
Pier: Last year we had a very healthy debate about recession probabilities in terms of the right and the left tail risks, especially as markets had gone from expecting a hard landing to coalescing around a soft landing. We were very cognizant of both tails and wanted the portfolio to really be able to withstand multiple scenarios. So, we had been overweight but through high-quality, selective opportunities, say, in structured credit, in investment-grade versus really reaching for yield and adding extra low-quality beta. And so, this year, some of that conversation has shifted as the economic outlook looks a bit more clear, although those tails continue to remain in terms of could inflation reaccelerate and/or could we be in a position where the Fed is lagging in cuts? And so, we continue to weigh both sides of this and still build a portfolio that can withstand multiple scenarios. And that’s been key in the diversification, as well as managing across different geographies and asset classes.
Lefkovitz: You mentioned behavioral economics earlier. How do you avoid confirmation bias and groupthink on your team?
Pier: It’s a good question, and it’s one where we’re always looking for ways to enhance the investment process with some of the key understandings from, say, that cognitive codex. For example, when we submit best ideas as a PM team every quarter, we do so anonymously. And really, the idea there is, there’s no expectation of what is the person’s seniority or what desk are they on such that they would have a strong opinion on the topic. It really allows us to look at that with a blank slate.
And elsewhere, for example, to avoid the groupthink, we do a secular forum process every year where we bring in outside speakers to help really challenge our thinking around what could affect markets over the next three to five years, whether it’s demographics, AI, Ozempic, all of these areas could be potential for market disruption. And we really want to make sure that we’re thinking about them in the most open-minded way. And one of those aspects is, we’ll bring in the outside speaker. When they’re done, after we’ve had a Q&A session, we’ll actually send them out and have an internal discussion about what we’ve heard, what we believe, what are the investment implications. And this is a way for us to challenge what we’ve discussed over the cyclical horizon in our forum process and now think a little bit more longer-term and how the secular horizon could affect markets.
Lefkovitz: Sonali, thanks so much for joining us on The Long View.
Pier: Thank you. Appreciate it.
Benz: Thanks so much for being here.
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