SUMMARY

  • Most LDI portfolios in the U.S. include a meaningful allocation to credit as well as exposure across a range of sectors. This opens up a wide gamut of opportunities to outperform the index.
  • By diversifying strategies and relying on multiple sources of alpha, we seek to generate a solid track record with a high degree of consistency.
  • With interest rates potentially on the rise and credit markets fairly valued, benchmark returns are likely to be lower – making excess returns more important. We believe investors should seek to partner with investment managers with a deep reserve of resources and experience in managing LDI portfolios through challenging environments.

In July, we rebutted the narrative that liability-driven investing (LDI) portfolios are best managed with less discretion and lower alpha targets. We believe the opposite: When risk, return and costs are properly defined, active management of LDI assets should handily beat further allocations to return-seeking assets on the efficiency scale, and thus a higher active risk LDI approach potentially leads to better risk-adjusted outcomes. (See "When More Is Less: Dialing Up Active Management in LDI Portfolios May Reduce Risk.")

But how best to implement this strategy in LDI? In the following Q&A, portfolio managers Mike Cudzil and Mohit Mittal, and the leader of pension solutions in the Americas, Rene Martel, outline PIMCO's investment approach and its potential for generating alpha.

Q: How much alpha should investors reasonably assume can be consistently achieved in long duration and long credit portfolios?

A: In the U.S., most LDI portfolios include a meaningful amount of credit exposure, with some even benchmarked 100% against long credit indexes. This opens up a wide range of opportunities to outperform the index. Our approach, which emphasizes diversified sources of alpha and balances bottom-up and top-down considerations, has historically and consistently delivered more than 100 basis points of alpha over most full market cycles (see Figure 1).

Q: Can you explain how you apply PIMCO’s investment process to long duration portfolios?

A: Essentially, it's no different than our approach to managing fixed income portfolios in general. It begins with the principle of diversification. We believe that no single risk should dominate returns. We seek to add value through a disciplined approach that combines credit selection with top-down macroeconomic forecasts and sector rotation. By diversifying strategies and relying on multiple sources of value, we seek to generate a solid track record with a high degree of consistency.

For decades, our investment process has been grounded in our Secular and Cyclical Forums, which bring together PIMCO investment professionals from around the world on an annual and quarterly basis, respectively. Our annual Secular Forum, which features several days of rigorous debate, including input from outside experts, distills a broad outlook for global macroeconomics and markets over the coming three to five years. These top-down insights help determine how portfolios will be positioned in relation to their benchmarks and broad market factors, including duration and sector exposures such as credit, mortgages and emerging markets.

We fine-tune these views at thrice-annual Cyclical Forums, which incorporate current economic and financial developments to determine our six- to 12-month views. Finally, PIMCO’s Investment Committee meets most days to further refine the firm’s model portfolio with real-time information.

Importantly, implementation and specific positioning are informed by bottom-up perspectives. These reflect input from teams of specialists in all areas of the fixed income markets. In credit, for example, more than 50 dedicated analysts conduct thorough independent research to select individual securities. Notably, we do not rely on credit rating agencies. Historically, about 60% of the 11,000-plus securities PIMCO evaluates independently have had ratings that differed from those of the agencies.