Pimco is not too worried about the economic slowdown and rising inflation, as these are largely related to a temporary disruption. Opportunities in the credit and bond markets have become scarcer and finding them requires a lot of effort.
This is what emerges from an interview with Eve Tournier, Head of European Credit Portfolio Management at Pimco and manager of the GIS Euro Credit Fund, among others.
Central banks: don’t overreact
The Pimco manager is not too worried about the recent economic downturn. “It is normal that the European economy is easing a bit after the strong rebound in recent months. And despite the current problems in supply chains and rising energy prices, we expect growth to continue, albeit at a more moderate pace. We are still in the post-pandemic catch-up phase.” And she says much of what we are seeing in terms of inflation is related to the re-opening of the economy and disruption in labour and production. “These issues are more difficult to resolve than expected, but they should ease in the medium term.”
Tournier stresses that central banks do not want to overreact to temporary phenomena and will continue to focus on longer-term inflation expectations, which for the moment are close to the 2% target. “And as long as this is the case, we do not expect central banks to intervene quickly. In the short term, there is upward inflationary pressure, but in the longer term, there are trends that reduce inflation and will not go away directly.” Tournier also expects the European Central Bank to phase out its bond-buying programme.
But it will not reduce its balance sheet: the purchased bonds remain on the balance sheet and the maturing paper money will be reinvested. The better it informs the market about how it will reduce its programme, the easier it will be to withdraw from the market. It has done this in the past. Tournier concludes that with so much government debt in the system, central banks will not have the opportunity to raise interest rates much.
Opportunities outside the box
In an ultra-low interest rate environment, it is difficult to generate returns, said Tournier. “Investors are generally taking less duration risk and a little more credit risk. A further narrowing of credit spreads is unlikely as they have returned to pre-pandemic levels.” But how can it generate returns for its funds?
First, it looks for so-called idiosyncratic opportunities or stories. “These are companies that were downgraded during the pandemic and are now rated higher by the rating agencies again. These companies then see their own credit spread decrease. We look for these companies in particular, which are also known as ‘rising stars’. There are opportunities, as the ratio of rating upgrades to downgrades has recently risen sharply,” explained Tournier, adding that this requires a lot of bottom-up research.
The fund manager also points out that she is overweight paper money, especially senior bank debt. “There are a lot of mergers and acquisitions in the banking sector, which can create opportunities.” She also sees opportunities in the property market, a relatively new sector in the European credit market.
“The real estate market is currently experiencing some volatility, but some segments, such as residential, logistics and data centres, are still doing very well. “It’s about finding bonds from issuers whose properties are doing well in the market.” Tournier also believes that good substitutes for credit can be found in other asset classes, and that they offer good diversification.
“Some AAA rated CLOs (Collateralised Loan Obligations) have spreads as high as BBB rated corporate bonds. The extra yield is a liquidity premium instead of a default premium. Danish mortgages, also a AAA asset, are another opportunity. Although they have performed less well in the market in recent months due to the lengthening of duration, their valuation is now attractive. All in all, we are thus increasing the average quality of the portfolio and generating additional liquidity premiums.