Strategy Spotlight

Two Approaches to Flexible Bond Investing for an Uncertain Market

Flexible approaches to managing fixed income can help European investors navigate through uncertainty and may achieve attractive yields, even when hedging back to euros.

With the end of the European Central Bank’s asset purchases looming large, European fixed income investors are now facing many challenges. Besides domestically low yields, compressed valuations and the potential for a market correction, the cost of currency hedging on global bonds has increased significantly over the past year. Add the gradual tightening of monetary policy and global trade and political conflicts and many investors will need to navigate an increasingly uncertain environment ahead (see Figure 1).

Two Approaches to Flexible Bond Investing for an Uncertain Market

We believe investors will likely consider three approaches:

  1. Reduce risk and wait for better entry points. In this case, investors can consider short-term or low duration portfolios of high quality bonds. This approach helps to protect against higher market volatility, keeps liquidity high and maintains “dry powder” for capitalizing on opportunities down the line, although investors may sacrifice valuable returns.
  2. Choose high quality duration from the major global bond markets given its historical role as a “safe-haven,” or hedge, during market selloffs. Even though sovereign bonds yield very little right now, high quality government bonds – or hard duration – offer important characteristics over the long run that may provide portfolios with the desired balance.
  3. Take a more flexible approach to bond investing that is not tied to a benchmark, with the objective of actively navigating the changing fixed income environment and dynamically capturing available opportunities. With this approach, investors should determine whether their objective is to reach a certain income level or an absolute return target over a certain time.

The advantages of flexibility

Investors accustomed to, or who favor, a more traditional approach to fixed income investing may lean toward the first two options. In our view, however, a flexible approach to managing key fixed income risk factors such as duration, credit and currency risk can enable European investors to navigate through the current environment and achieve attractive yields — even when hedging back to euros. Furthermore, a globally oriented bond portfolio can potentially provide geographical diversification, greater alpha opportunities and higher downside cushion in an economic slowdown.

There are several approaches to global flexible investing, but we see two distinct strategies as viable options to play important roles in investment portfolios over the coming years: Investors need to determine whether their objective is 1) to focus on a dynamic strategy with an absolute return target over market cycles, or 2) to reach a consistent income level. The choice depends on the investor’s risk/return profile and objectives. Flexible strategies including the Dynamic Bond Strategy and the Income Strategy may be solutions for investors attempting to navigate the late stage economic cycle.

Investing for long-term return

The Dynamic Bond Strategy seeks attractive return over the long term, consistent with preservation of capital, and draws on the full spectrum of PIMCO’s expertise across global fixed income markets. Importantly, the strategy employs stringent risk management to aim for attractive risk-adjusted returns over a market cycle with volatility similar to that of core bonds. We have removed the typical focus on traditional bond benchmarks and instead diversify portfolio exposures across global interest rate, credit, volatility and currency markets, which allows us to implement PIMCO’s highest-conviction investment ideas.

The strategy has the ability to be very flexible. It can blend structural and tactical approaches, taking defensive positions today and then becoming more constructive when the market environment changes. Its dynamic nature, flexibility and wide duration range (-3 to +8 years) allow the strategy to exploit opportunities and hedge against risks through long and short positions that reflect our views on fundamental risk factors. The strategy can take short positions in credit, for example, when the macro environment is very unfavorable or valuations are so stretched that negative returns in credit seem likely. Currently, the strategy has a defensive tilt in duration with a focus on relative value, and it is selective in high quality credit. When more opportunities arise in credit, however, the strategy can re-engage quickly, while maintaining an overall investment grade portfolio quality.

Figure 2 shows how actively a dynamic strategy can steer tactical exposures to factors like interest rate risk (duration).

Two Approaches to Flexible Bond Investing for an Uncertain Market

The strategy implements PIMCO’s high conviction ideas in a measured way and draws on a wide range of return sources, aiming for a smooth return profile and low correlations to other asset classes. The Dynamic Bond Strategy has the flexibility, the broad discretion and the risk management in place to complement core bond allocations and is designed to withstand even times of rising rates, as we have seen in the first half of this year.

Investing for income

Investors seeking a steady income stream while still protecting their capital should consider a different approach to flexible bond investing. The Income Strategy at PIMCO was designed exactly for this purpose: to generate current income while preserving capital, with capital appreciation as a secondary goal. It is a multisector approach that aims to meet its income objective in any market climate, while maintaining the overall high quality of the strategy.

The Income Strategy is divided into two broad components. The first consists of higher-yielding assets, such as non-agency mortgage-backed securities, which we expect to perform well if economic growth is stronger than predicted. The other component is invested in higher-quality assets that are likely to perform well if growth is lower than expected, thus acting as a strong diversifier and helping to protect against downside risk. In the current environment, we favor U.S. Treasury bonds for the higher-quality portion of the Income Strategy, given their higher yields and the Federal Reserve’s lead over other central banks in raising rates.

To reach high consistent income, we seek out the best income-generating ideas, depending on the environment, and target multiple sources of income from the global opportunity set. The strategy is structurally exposed to credit in meeting its objective: At the moment, we are opportunistic in corporate credit, favoring housing-related securities and financial companies and taking select positions in high quality emerging market debt to add yield. We also see occasional opportunities in what we refer to as “bend-but-not-break” assets that will likely perform well even in more challenging environments.

Bringing the two portfolio components together, the Income Strategy stays broadly diversified and avoids single positions (either in higher-yielding or higher-quality assets) dominating the return and volatility of the strategy. Figure 3 shows the strategy’s diversification and how it has adapted to different environments over the past several years.

Two Approaches to Flexible Bond Investing for an Uncertain Market

Since its inception, the Income Strategy has achieved its goal of offering investors high consistent income with low volatility. Flexibility, liquidity and diversification were the essential drivers of past performance, and we are convinced that the underlying philosophy of the strategy is the right one to help clients achieve consistent high income without sacrificing liquidity or quality.

The bottom line

The current environment of low domestic yields, upward-trending global interest rates and recurring bouts of volatility is challenging many investors in Europe. The good news is there are strategies for today’s uncertain fixed income markets. While limiting interest rate risk or allocating to high quality bonds are viable options, we see a flexible investing approach as the smart way to navigate changing bond market conditions. PIMCO’s flexible bond strategies, including Dynamic Bond and Income, are designed specifically to meet many investors’ goals of long-term return and steady income.

The Author

Berdibek Ahmedov

Product Strategist, Equities and Multi-Asset

Philip Bufe

Account Manager



PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

PIMCO Europe GmbH - Italy
Via Turati nn. 25/27
20121 Milan, Italy
+39 02 9475 5400

PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe GmbH - Spain
Paseo de la Castellana, 43
28046 Madrid, Spain
Tel: +34 810 809 912

PIMCO Europe GmbH - France
50–52 Boulevard Haussmann,
75009 Paris

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market liquidity. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Sovereign securities are generally backed by the issuing government. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more the amount invested. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Diversification does not ensure against loss. Management risk is the risk that the investment techniques and risk analyses applied by an active manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. There is no guarantee that stated results will be achieved.

| PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London, E20 1JN) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication.| PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Deutschland GmbH Italian Branch (Company No. 10005170963) and PIMCO Deutschland GmbH Swedish Branch (SCRO Reg. No. 516410-9190) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch and Swedish Branch are additionally supervised by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act and the Swedish Financial Supervisory Authority (Finansinspektionen) in accordance with Chapter 25 Sections 12-14 of the Swedish Securities Markets Act, respectively. The services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-, Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2018, PIMCO.