Ivascyn, a die-hard Boston sports fan, joined Pimco in 1998 and was promoted to CIO Group in 2014, replacing co-founder Bill Gross. He is a lead portfolio manager for the firm’s income strategies and opportunistic credit hedge fund and mortgage lending strategies. Its $128 billion

Pimco income
fund (ticker: PIMIX), which launched in 2007, ranks in the top 1% of multi-sector bond funds for the past 10- and 15-year periods, according to Morningstar.

Ivascyn recently spoke with Barrons from his office in Newport Beach, Calif., on inflation, interest rates, where he sees risk and why he’s reducing exposure to US bonds. An edited version of the conversation follows.

Barrons: The consumer price index reached its highest level in 40 years last month, but it is still very high. Investors had hoped for a sign that inflation had peaked. Do you see any?

Dan Ivascyn: Both headline CPI and core CPI exceeded market expectations. The CPI peak may be behind us, or almost behind us, but it will remain frustrating. You have both supply side uncertainty and strong demand momentum. Part of that has to do with the robust reopening process [after Covid]. This only reinforces what the Federal Reserve has suggested [this month]…that for the foreseeable future, they’re going to remain very, very diligent in getting inflation back on target. The CPI report is just one number that allows them to be aggressive.

Are the comparisons with the 1970s justified?

We believe we are a long way from where we were in the 1970s, when inflation expectations went wildly out of whack and there was a self-fulfilling inflation dynamic. But there are certainly risks that, if left unchecked, inflation will take root more deeply in people’s psyches, which would be a problem from a central bank perspective, but also a long-term challenge. for the markets.

Some people worry that the Fed will raise rates to a level that will tip the economy into recession. Do you?

It is a risk, and the war in Ukraine has increased the possibility. There is about a 30% chance of a recession in the United States over the next 12 to 18 months. It’s going to be difficult for the Fed to know exactly what rate it needs to go to, and that further complicates the situation because the Fed also has a balance sheet it’s looking to shrink. Given the politically inevitable delays, he has his work cut out for him and the risk of a harder landing has increased quite significantly.

What are Pimco’s 2022 macro themes?

Extreme uncertainty, slower growth and high inflation for a longer period.

You made a name for yourself after the financial crisis by successfully betting on non-agency mortgage-backed securities (MBS) or residential mortgage pools issued by private institutions. Where do you see mispriced opportunities today?

Valuations are fair or a bit expensive from a longer-term historical perspective. Given the high risks of recession, you need to be careful in some of the riskiest segments of the business credit market. We still like mortgage-backed securities – not the new creations or the loan-backed securities that borrowers have taken more recently, but rather those that have benefited from a decade of steady house price appreciation. .

We always like securitized risk, which offers far better underwriting fundamentals and security than you typically get in unsecured corporate credit markets. We like agency mortgage-backed securities [issued or guaranteed by the U.S. government or a government-sponsored enterprise]. We also like financial sector credit, which benefits from very high capital levels due to post-financial crisis global regulation, and relatively low risk taking at most major banks.

We continue to have much lower interest rate exposure than in the past. We definitely prefer higher quality or higher quality yield sources to lesser quality ones. And we favor consumer-related investments. The US consumer has not taken much risk in the mortgage market and consumer balance sheets are strong.

Which sectors seem unattractive?

Corporate debt below investment grade. Although it has depreciated, it is premature to add exposure. It is the segment of the market that has grown the most in recent years and the quality of underwriting has deteriorated in absolute and relative terms compared to structured credit or consumer credit.

We are most concerned about segments of the corporate market that are exposed to rising interest rates, i.e. the senior secured market or the bank loan market, because the combination of hedging levels higher debt service and the possibility of lower earnings may result in significantly higher defaults over the next two years.

How has the Pimco Income Fund changed over the past decade?

We are more diversified today than at almost any time in the fund’s history. Because we’re not in a very dislocated market environment, we think the fixed income sectors are fairly well priced relative to each other.

The philosophy and style haven’t changed much. We continue to be obsessively focused on generating an attractive and consistent stream of income, while focusing on preserving capital in more challenging market environments. We seek to achieve these objectives in a manner consistent with Pimco’s macroeconomic outlook.

One of the themes we care about the most is that our portfolios are positioned not to be hit as much by rising rates as others, including the main index bond investors look to, the Bloomberg US Aggregate Bond. Index. We kept duration, a measure of a portfolio’s sensitivity to changes in interest rates, at the low end of its zero to eight-year range. At three years now, we are still more defensive than the broader market, as evidenced by the index, which has a duration of around 6½ years.

Investing in China?

We are cautious about near-term Chinese growth and avoid most credit in China. We are underweight the currency and avoid lower quality or below investment grade segments of the Chinese market. We remain focused on the Asia region. In the long term, there is huge potential for growth and potential for capital markets expansion in China.

What is the least consensual point of view that you express in a significant way in the portfolio?

Probably the biggest differentiator of our strategy today versus others is that we have sought to reduce exposure to US credit in favor of other sectors and segments. For most of the past decade, there has been a strong global preference for US assets – equities and credit assets. Although the United States has a lot of relative strength from an economic point of view, it is an area that is a bit crowded. If we were to enter a period of economic downturn, it could be set to underperform other areas of the defined opportunity for the first time in a long time.

This is probably our biggest contrarian perspective: seeking to focus on structured risk, securitized risk, while placing less emphasis on the more generic areas of US credit markets.

How should individual investors think about their bond allocation?

Be patient. It is very difficult to time the markets, and after the fall in rates that we have seen in recent months, valuations in the bond markets are starting to look more reasonable. We are going through a period of volatility today, but investors should be patient and even consider adding fixed income exposure.

What should they add?

One of our favorite sectors is agency mortgage-backed securities with very high credit quality. This is an excellent alternative to high quality corporate bonds. We also like securitized risk, including asset-backed and mortgage-backed bonds that originated more than a decade ago and benefit from strong documentation, healthy household balance sheets and strong collateral sets. , which should provide resilience even if the economy weakens.

House prices have skyrocketed. Is it a bubble?

We don’t think it’s a bubble. We don’t see the same type of underwriting or excess in the mortgage market today as in the years before the global financial crisis. But higher interest rates and a slowing economy may cause home prices to plummet in some parts of the country.

What are the main risks for the global bond market?

Inflation remains a big risk. Our baseline view over the next two years is that inflation is starting to come down, but in the short term there is huge uncertainty both ways. The war in Europe is one of the reasons. With the type of modern weaponry we have today, there are risks of accidents and the spread of this conflict. This could have a significant impact on the financial markets if it were to happen. Thus, inflation and global conflicts are two areas of concern.

Thanks Dan.

Write to Lauren Foster at [email protected]