Bob Fields and Lisa Kim Discuss the PIMCO Unconstrained Tax Managed Bond Strategy

The Unconstrained Tax Managed Bond Strategy represents the full expression of PIMCO’s secular investment philosophy and process in an actively managed tax-efficient portfolio. The allocation (at least 50% of total assets) to municipal bonds means that a significant portion of the strategy’s income is exempt from federal and, in some cases, state taxes. By design, the strategy is not managed relative to a specified market index benchmark.

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PIMCO’s Unconstrained Tax Managed Bond Strategy employs investment flexibility together with a significant degree of tax efficiency. The strategy also offers the potential for compelling risk-adjusted returns over the long term and proactive downside risk mitigation. In the following interview, product managers Bob Fields and Lisa Kim discuss the strategy’s investment approach and how it might fit into a comprehensive asset allocation plan.

Q: What is the PIMCO Unconstrained Tax Managed Bond Strategy, and what are its investment objectives?

A: The Unconstrained Tax Managed Bond Strategy is designed to target attractive after-tax returns over a full market cycle, three to five years. The strategy represents the full expression of PIMCO’s secular investment philosophy and process in an actively managed tax-efficient portfolio. The strategy combines a significant allocation (at least 50% of total assets) to municipal bonds – with their income exempt from federal and, in some cases, state tax – but also consists of a flexible multi-sector core fixed income portfolio that targets alpha across the full range of global markets.

Because the broad allocation to all fixed income markets is not constrained by benchmark-specific guidelines, the portfolio managers have greater flexibility than more traditional, benchmark constrained strategies to adjust duration, allocate across sectors and actively express the full range of PIMCO’s global economic views by taking more risk in sectors, markets or geographic areas where we see strong tactical opportunities while reducing or eliminating exposures where we see less value or heightened downside risk. The portfolio may include high-yield bonds, securities in emerging markets and other financial instruments. The strategy aims to provide more return potential than traditional active-bond approaches that are benchmarked to an index, while targeting many of the same potential benefits – capital preservation, liquidity and diversification – in a tax-sensitive context.

Of course, municipal securities may be exposed to interest-rate risk, default risk and early-payment risk. Yet, at PIMCO, we focus on diversified, high-quality issuers with strong credit fundamentals. These include essential service revenue bonds and bonds backed by dedicated taxes; these holdings have dedicated revenues from specific sources that are potentially less likely to be exposed to poor budgeting or political dysfunction. We believe municipalities remain strong credits due to their taxing power and underlying goal of providing infrastructure and services to residents.

Q: What is the investment philosophy and approach underpinning the municipal bond component of the portfolio?

A: The allocation to municipal bonds means that a significant portion of the strategy’s income is exempt from federal and, in some cases, state taxes. In addition, the municipal allocation is actively managed in order to target attractive returns. Munis typically offer high credit quality, attractive after-tax yields and historically low volatility relative to many other fixed income sectors. We manage muni investments with a goal of minimizing capital gain realization rates and taxable current income levels; we diversify across all major sectors of the muni market and apply sector rotation, yield curve positioning and duration management.

Q: What do you mean when you say the strategy isn’t tethered to a traditional bond index benchmark?

A: By design, the strategy is not managed relative to a specified market index benchmark, an important difference between the Unconstrained Tax Managed Bond Strategy and traditional tax-efficient or municipal fixed income strategies. The broad investment discretion means that sector weights, duration and other risk exposures are likely to vary to a (much) greater degree over time when compared with traditionally benchmarked fixed income portfolios. That said, the strategy does apply an after-tax U.S. LIBOR reference point, which is a common performance base for absolute return–oriented strategies.

The Unconstrained Tax Managed Bond Strategy is designed to benefit from greater investment discretion, which is meant to translate into higher performance potential over the long term and greater downside risk mitigation when compared with traditional core fixed income or municipal bond mandates and benchmarks. However, over shorter time periods, the strategy may underperform vs. municipal benchmarks and other after-tax indexes because of, say, a reduced risk posture or other tactical or strategic allocations meant to best capture our secular views and maximize risk- and tax-adjusted returns over the longer term.

Q: How “unconstrained” is the strategy, given its investment guidelines?

A: The 50% minimum of total assets in municipal bonds assures that a significant allocation in the strategy will be to domestic bonds with tax-free income, while the guidelines are designed to help maintain a higher credit quality focus. The guidelines also seek a risk profile that is similar to that of a multi-sector investment-grade core-bond portfolio.

Q: Is the Unconstrained Tax Managed Bond Strategy designed to be a core tax-efficient bond allocation or an alternative investment approach within a broader investment portfolio?

A: The strategy’s investment guidelines help investors determine where it fits within their broader investment portfolios. This will probably vary from investor to investor, depending on the approach to portfolio construction. The strategy is, by design and objective, an absolute return solution that incorporates at least 50% of total assets in municipal bonds. You could consider it an alternative investment approach in the sense that the active management discretion and alpha return potential is likely greater than that associated with traditional benchmark constrained, active core fixed income or muni approaches. The strategy may also provide diversification at the portfolio level, as it’s likely to exhibit a low or even negative correlation to the equity markets – another key benefit that investors associate with alternatives.

From a risk perspective, however, the Unconstrained Tax Managed Bond Strategy is most closely related to core fixed income and is designed to realize after-tax total return over the long term with a significant level of federally tax-exempt income. The strategy may also offer greater capital preservation benefits than a core bond strategy, due to the municipal bond allocation and duration flexibility.

Q: How does the Unconstrained Tax Managed Bond Strategy differ from PIMCO’s Unconstrained Bond Strategy?

A: While both strategies apply an unconstrained approach designed to embody PIMCO’s views of the global fixed income markets, the Unconstrained Tax Managed Bond Strategy is designed to maintain a significant allocation to municipal bonds, so its performance is more closely tied to performance in the muni market. Also, the tax-efficient strategy’s guidelines include a slightly wider duration band and a limit on non-dollar-denominated exposures.

Q: How is PIMCO positioned to design and implement this kind of investment solution?

A: PIMCO’s investment managers have extensive experience actively managing global and tax-efficient bond portfolios, and this is the first PIMCO strategy to combine core high-quality municipal bonds with multi-sector exposures on an unconstrained basis. We believe the firm’s almost four decades of experience, global and municipal fixed income expertise, long-term focus and stringent risk management culture provides us with the requisite combination of qualifications to successfully manage this type of investment solution.

Thank you both for your time.