Pimco expects the global economy to enter a recession in the next three to five years.
As a result, the $1.88tn firm is ‘relatively cautious’ on bond markets, said A-rated Mark Kiesel, its CIO for global credit.
Although passive strategies have created waves in segments like the US BBB market, he believes active managers still have the upper hand when it comes to outperforming benchmarks.
The fund, which is registered for sale in Singapore and Hong Kong, has returned 12% in the year leading to 30 November 2019.
‘There are a lot of ways to earn high quality income in the marketplace, and we do think that the market is going to consolidate to a few large players.
‘But it’s getting more challenging. There’s no question,’ Kiesel said at a UBS Wealth Insights panel this week.
This is Pimco’s base scenario for bonds:
1. Yields, yields, yields!
Investors are in a world where $11tn of bonds are trading at negative interest rates.
While high quality credit offers ‘decent returns’, yields are unlikely to jump in the near future, Kiesel said.
But bonds are still a necessary guard against geopolitical risks such as the worsening of US-China trade tensions, or an electoral upset for US President Donald Trump.
‘In that world, equities would [lose] 10% to 20%. So as part of an overall portfolio, bonds still fulfil that diversification theme,’ he added.
2. Low interest rates
Kiesel believes global central banks, including the US Federal Reserve, are unlikely to raise interest rates.
‘With the Fed for example, the bar to hike rates is extremely high. Even if inflation were to pick up a little bit, I think they're going to let the economy run hot.
‘The bar for lowering rates is lower. We’d argue that it's more likely the Fed would be lowering rates than raising them,’ he said.
3. Traditional sectors
There has been a lot of hype around innovations like the 5G rollout, which will have a large impact on markets.
But Pimco spots a specific opportunity in the US housing market, where it favours agency and non-agency mortgage exposures.
Agency mortgage-backed securities have attractive valuations, reasonable carry and an attractive liquidity profile in comparison to other spread assets.
Meanwhile, non-agency mortgages are more defensive, and have better market technicals than generic corporate credit exposure.
‘The technicals are incredibly favourable. There is no supply and demand for high quality income around the world is huge,’ Kiesel shared.
‘This is an asset that is fundamentally improving every year as home prices rise. Even if you were to have a recession, I think the fundamentals for housing would still be quite good in the US.’