Fixed Income Is Back, PIMCO Says

By Nick Hedley

Investment manager PIMCO, which has $2 trillion in assets under management as of March 31, says segments of the fixed income market are attractive again, thanks in part to a normalization of valuations.

Going forward, real interest rates are likely to be higher than they have been since the onset of the global financial crisis, Daniel Ivascyn, PIMCO’s chief investment officer, said in a recent webinar. While inflation is expected to be elevated and volatile, it should remain under control and could “turn the corner soon,” he said.

Investment-grade (IG) fixed-income assets are now more attractively priced and should offer inflation protection, meaning there is now less of a need to seek high-risk, high-yield bonds.

PIMCO sees opportunities in quality bank paper, municipal bonds and agency mortgage-backed securities, among other areas.

While high quality is the priority, emerging markets “look intriguing from a valuation perspective.”

This is partly because of a global realignment of supply chains, Ivascyn said. For instance, as the U.S. moves to reduce its reliance on Chinese goods, there could be opportunities for suppliers based in Latin America.

However, investors will need to be “very selective” in the emerging market space, he said.

Ivascyn said while “recession risk is elevated,” the current downturn is unlikely to be a repeat of the global financial crisis. Household balance sheets are, for the most part, strong, and “we have an inflation problem, not a growth problem.”

Nevertheless, the lack of room for policy support means the economy could take some time to recover.

“Given the fragility that tends to flow through during a sustained period of economic weakness, investors need to be careful,” he said.

Marc Seidner, PIMCO’s CIO for non-traditional strategies, said in a separate note: “Bonds tend to perform well during recessionary periods, and if the Fed succeeds in bringing inflation lower, it could create an even stronger backdrop for fixed-income investments.”

While 10-year Treasury yields have surged and prices on existing bonds have fallen, this has created a better starting point for new investments.

Hou Wey Fook, CIO at Singapore’s DBS Bank, agrees that high-quality credit is more compelling than cash in the rising interest rate environment.

“Furthermore, good quality credit is now attractively priced, with global IG yields at about 4.4% – exceeding even the peak of the COVID crisis,” Hou wrote in his third-quarter CIO Insights report. “These attractive yields are expected to beat cash returns even with rising rates.”

The “sweet spot” lies in short-dated bonds with durations of three to five years. “Based on cumulative returns since 2003, short-duration IG has displayed a stellar track record in rising above inflation.”

Furthermore, if the Federal Reserve moderates rate hikes, short-dated, high-quality credit “will avail investors to potential capital gains,” Hou said.