Geraldine Sundstrom, portfolio manager for the PIMCO GIS Dynamic Multi-Asset Fund, and Dan Phillipson, asset allocation product specialist, discuss how the PIMCO GIS Dynamic Multi-Asset Fund has navigated financial markets over the last year and provide insights into risks and opportunities for the fund today.
Dan Phillipson: Geraldine, can you start by telling us what the PIMCO GIS Dynamic Multi-Asset Fund is?
Geraldine Sundstrom: PIMCO GIS Dynamic Multi-Asset Fund (DMAF) is a fund we launched in February 2016. Our goal is to provide investors access to a flexible, holistic strategy that applies PIMCO’s best macro and relative value ideas across the full depth and breadth of global asset classes – including equity, credit, interest rates, currency and real asset markets – in an effort to provide attractive risk-adjusted returns over time.
By flexible, I mean having the agility to shift exposures across different economic cycles and market environments. Although DMAF typically has positive exposure to equity market and interest rate risk, we have considerable leeway to shift these risks as our outlook evolves.
Phillipson: Why do you think this approach is relevant in today’s markets?
Sundstrom: For many of our clients, a big concern is whether we are nearing the end of a market cycle. It’s now eight years since equity markets bottomed after the global financial crisis. And despite some ups and downs, risk assets have more or less been on an upward trend since then, fuelled by declining interest rates and enormous support from central banks. But we’re now faced with the prospect of less support from central banks, mature valuations in equities and low yields on bonds.
Investors are conscious of this and are looking for solutions to help navigate the path forward. Simply put, they don’t want to be stuck to a benchmark with high equity exposure when the music stops.
DMAF is designed to help with this. We have the flexibility to reduce risk exposures as our outlook evolves, and by doing so we aim to provide downside protection and a potentially smoother path of returns for investors.
Phillipson: As well as shifting its allocations, the GIS Dynamic Multi-Asset Fund has the flexibility to tilt its type of exposure, at times taking a more directional approach, and at others taking a more relative-value-driven approach. Can you tell us more about this?
Sundstrom: This is an important point and I think it’s a unique feature of the fund. In the multi- asset space, most strategies are typically either very directional, meaning having long exposure to the market while shifting allocations around their benchmark, or more relative- value-orientated, focusing on exploiting opportunities within or between asset classes. As you’d expect, the approach taken is generally driven by the background of the management team.
One of the key benefits of being at PIMCO is we have the resources to use both approaches, and can emphasise either one to varying degrees as opportunities and risks present themselves. My own background is in managing hedge fund assets, with a focus on developing markets, equities and credit, while my co-manager Mihir Worah’s expertise is in real assets and fixed income, mainly in developed markets and unlevered portfolios. At the same time we have access to 230 other portfolio managers, 50 global credit analysts and a team of analytics experts (as of 31 December 2016). This means we have the expertise to take both broad, macro-level views as well as very detailed bottom-up views, and we can change this emphasis across a market cycle.
In practice, this means we’ll typically be more directional in the early to middle stages of a market cycle, taking advantage of market beta. And then towards the end of a cycle we’ll focus less on market direction, and instead try to exploit relative value opportunities.
Phillipson: Since its inception in February 2016, the fund has generated 8.7% returns with 3.2% volatility1. What has driven this?
Sundstrom: Looking back, 2016 was quite the year – there was an awful start with risk assets selling off in the first quarter, there were major policy shifts from global central banks, and finally, momentous political events. How did we manage around that?
First, we took a view that despite the noise, economic fundamentals were fairly robust. We didn’t see signs of global recession or a large probability of a severe equity market crash, and as such we didn’t shy away from risk.
Second, we were dynamic in the asset classes we focused on. At the start of the year our focus was on credit given the sharp widening of credit spreads. We also favoured emerging market currencies on a view that commodity markets would rebound. Then in the second half of the year, as credit spreads tightened, we rotated out of corporate credit and into equities on a view that the earnings cycle was likely to exceed expectations. This resulted in contributions from a wide variety of return sources, across both developed and emerging markets.
Phillipson: How did you manage around the binary political events last year?
Sundstrom: We reduced some risk ahead of the events, while also employing various option strategies. For example, around both the UK referendum and U.S. election, we shifted some of our equity exposure into options as investors became increasingly concerned about adverse outcomes. This affected how markets priced volatility at different equity market levels and allowed us to buy close-to-the- money call options (providing exposure to equity markets if markets went up just a little bit) financed by selling out-of-the-money put options (fairly far out of the money, so we would only have exposure if markets sold off sharply). Replacing some of our long equity exposure with these positions, called “risk-reversals” in the jargon, enabled us to retain our desired equity exposure but with greater asymmetry and benefit as markets rallied sharply.
Phillipson: What’s your approach to risk management more broadly?
Sundstrom: I think our approach can best be captured by a belief in “you win by not losing”, meaning we want to avoid significant drawdowns, even if it means sacrificing some of the potential upside. It can take a disproportionately long time to make up losses that are crystallised in a downturn. Our goal is to try and limit that drawdown, making it easier for clients to stay invested over the long term.
From a portfolio management perspective this means paying a lot of attention to expected drawdowns, and it also involves what I call “not abusing the covariance matrix”. In normal markets you can expect diversification benefits between different assets classes, but in distressed markets these benefits can swiftly evaporate as correlations shift and volatility jumps. We are very conscious of that when we think about managing drawdown risk and stressing our correlation and volatility assumptions.
Phillipson: Looking ahead, how is the fund positioned for 2017?
Sundstrom: In general, we see a continued environment of sound economic growth but substantial political uncertainty. We think there are four key transitions dominating the global economy right now: a move from deflation fears to an assumption of reflation, a shift from monetary to fiscal stimulus, a move from a fixed to floating currency regime in China, and a backlash against globalisation. Taken together it’s a world of solid growth potential but with fatter tails, meaning greater risk of both positive and negative surprises. Also, with improved growth and inflation prospects, major central banks may scale back accommodation, which has implications across asset classes.
What this means for positioning is that we are maintaining risk exposure, but in a cautious way, while trying to protect against both left and right tail outcomes. As such we continue to favour US Treasury Inflation-Protected Securities (TIPS) and equities, which would benefit if growth outperforms, but we’re also using option strategies to maintain some upside, while reducing our downside risk. We also continue to like emerging markets currencies
as a way of enhancing carry. Importantly, we are keeping some powder dry and maintaining flexibility. There is a lot of uncertainty and we want to be in a position to take advantage of volatility, if and when it comes.