Mark Kiesel is a work horse. The co-chief investment officer of Pimco, the world’s largest bond investor, works from 3am to 4pm in his office in California’s Newport Beach to liaise with colleagues in time zones around the world and get a jump on the competition.
The Allianz-owned firm has been through tumultuous times. Since taking over investment decisions from legendary investor Bill Gross, Mr. Kiesel’s chief job has been to halt the outflows from Pimco’s flagship Total Return fund seen after Mr. Gross’ acrimonious departure last year. The 45-year-old Mr. Kiesel was himself shaped by working 18 years with the one-time “Bond King”, who founded the Newport Beach, California-based firm.
Mr. Kiesel’s advice is simple: Avoid bonds with negative yields. That includes German government bonds, which have recently fallen out of favor with many investors around the world. He councils the savvy investor to focus on corporates and bank loan securities, especially in the United States.
Handelsblatt: Mr. Kiesel, are you buying sovereign bonds that produce no yield at all?
Mark Kiesel: We try to avoid markets with no yields. And, given valuations and improving private sector fundamentals, we do not believe interest rates are likely to go lower.
What exactly does this mean?
At this point in the economic cycle, we rarely buy government bonds from the Western hemisphere. We do like a few countries, such as Brazil and Mexico. There, we believe that interest rates will be lower in one or two years from now, i.e. their [bond] prices should be rising.
What is the yield on such sovereign bonds?
Mexico’s government bonds with ten years duration deliver returns of six percent, the respective Brazilian bond even twelve percent.
Two years ago, you said central banks were dominating the market like never before. Since that time, things have become even more extreme. Do you see asset-price bubbles developing?
There are bubbles developing. Very few single asset classes are still cheap nowadays.
Where exactly do see the worst bubbles?
Government bond yields which are negative or near zero in several developed markets offer no protection for inflation and should be avoided, given central bank policy globally is a ‘reflationary’ policy.
Do you think we are caught in a yield trap? Investors seem to keep on buying bonds despite record low prices.
I would not buy German government bonds given current valuations. In terms of yields, Southern Europe looks better, for instance Italy and Spain.
Why don’t you simply avoid sovereign bonds from the Western world entirely?
In fact, we are underweighting these assets. But we do need these government bonds because they constitute an enormous portion of the benchmark we are likewise judged by. That is, our share of interest risks in Germany, Great Britain, Japan, and the United States is smaller than in normal times. We are however overweighting Brazil, Mexico, and Australia.
How do you see German “Bunds” (sovereign bonds)? The yield of the ten-year bond recently increased more than tenfold. Does that make them more interesting now?
Even with the recent rate yield increase, there are much better alternatives in the bond market today than low or negative yielding government bonds.
Where can you still find attractive bonds outside the sovereign sector?
We go for mortgage-backed securities from non-public issuers. The market for residential real estate is recovering further, and these securities are definitely lucrative. We are also favoring securities in the form of bank loans. There we receive 4.5 to 5.0 percent for securities from companies with good growth rates and high total assets. Plus, the coupon from bank loan securities is rising with capital market interest rates accordingly.
Do you have a particular appetite for U.S. bonds?
Yes, we do favor select U.S. bonds in the credit market. The American economy is borne by their consumers. They contribute 68 percent of total economic performance. And consumers are cashing in on the recent overall trends: low oil prices and low interest rates for loans. We have gusto for bonds from the following sectors: automobile, real estate, aviation, hotel and banking industry, and gambling.
Are you betting on the U.S. dollar as well?
Yes, currently we are positioned for a higher dollar and a lower Euro and Yen.
Is this strategy linked to the bond-buying program of the European Central Bank?
No. Nevertheless, we believe that this unlimited purchasing announcement is one of the most important decisions for the financial markets. The ECB wants to hit an inflation rate of two percent. Nobody knows whether the ECB will be successful. But the ECB will definitely try to stimulate economic growth and inflation. Overall, we believe that the U.S. economy is doing better than Europe. And this causes a relatively weak euro compared to the U.S. dollar. We also believe the Fed will start to raise interest rates in the fall of 2015, which should support the dollar.
Are investors still betting against the dollar at all?
We would not recommend it. As measured by its purchasing power. the dollar is priced correctly in round terms. The U.S. central bank may raise the key interest rates. (But) the ECB will stick to its low level in the next two or three years. Moreover, the U.S. economy will expand about three percent in real terms in 2015 – noticeably more than the euro zone. This is what makes the dollar strong compared to the euro.
Do you expect a currency war?
We expect euro and dollar to be on par in roughly 1-2 years.
And the Fed will accept the re-emergence of a strong dollar?
A strong dollar will hurt some export-oriented companies, as we were able to observe at Caterpillar or Microsoft. But it will not be enough to stop this trend.
What else might be a driver for U.S. bonds?
European investors are buying U.S. corporate bonds because yields are vanishing in Europe. As such, capital will flow into the United States, where one can generate higher returns. This is going to be a positive scenario for select U.S. corporate bonds.
Why isn’t the ECB purchasing corporate bonds actually?
It doesn’t need to. The U.S. central bank, the Fed, didn’t buy corporates either. And exactly this triggered price changes in the corporate bond market. The ECB knows that private investors are buying corporate bonds. Low yields on government bonds and an improving private sector should ‘crowd in’ the private sector investor into credit spreads and corporate bonds.
Does this mean that the trend towards corporate bonds will continue in the euro zone as well?
I am not sure whether prices in Europe will rise further. We are operating in an environment of extremely low yields, and this is true for corporate bonds as well. Their yield is no longer higher than about one percent per year. That’s not really much compared to the United States, especially if you look at bank loans.
How high is the share of bank loans that you can hold in your flagship fund, the Total Return Fund?
In corporate bond funds, bank loans constitute eight to ten percent of the invested assets. In other funds this share can be up to one fifth of the overall assets. In the Total Return Fund it was one to two percent, but we added loan securities recently. I can image that we will ramp up their share over time.
But are these securities sufficiently liquid?
They are not as liquid as sovereign bonds. I am buying corporates with high liquidity, solid total assets, and a market cap of $500 million minimum. I do like sectors such as cable networks, gambling or the hotel industry.
What do you like in Europe?
In Europe we are holding bonds from sectors such as automotive, automotive suppliers, and from industrial companies which benefit from the weak euro, namely manufacturers of building materials. To be precise, we are holding bonds from building materials manufacturers Heidelberg Cement and Lafarge, from the French supplier of broadband cables Numericable, from Schaeffler, from Virgin Group in the U.K., and from Volkswagen. However, our largest overweight position in Europe is in banks: Intesa San Paolo, BNP Paribas, Credit Suisse, Barclays, UBS and Lloyds.
Which assets are you most excited about in Europe?
Stocks – they are the biggest profiteers of the ECB’s program. Even now, their prices still have the potential to catch up. Apart from stocks: bank bonds, the low euro, and sovereign bonds from southern Europe. Their yields should fall further. We also think that inflation-protected bonds are very appealing, so-called “linkers”: For Europe, the market is anticipating an inflation rate of just 0.5 percent over the next five years – measured against the two percent target of the European Central Bank, this seems to be entirely inconsistent. As in the United States, inflation risks are completely underestimated.
How did you change the portfolio strategy of the Total Return Fund when Bill Gross left the company last September? The fund’s performance was rather weak for a long period, but re-entered the top performers in his category since autumn 2014.
We are constantly adapting the portfolio structure. In that period, we mainly added Brazil and Mexico, overweight dollar versus the Euro and the Yen, and identified solid corporate bonds. We also reduced exposure in rates at the frontend of the U.S. yield curve, as we expect higher interest rates here.
When do you expect an end to the net outflows from your funds? These outflows have reached dangerous dimensions.
The outflows have dropped significantly, but we don’t offer any predictions on flows. It is our aim to deliver outstanding investment results to our clients over the long term. If we are successful with that, it will automatically serve the interest of our customers.
Virginie Maisonneuve, the head of your equity portfolios division, is leaving the company. And at the same time you are closing large parts of the equity portfolio management. Is PIMCO now returning to its roots?
We closed three actively managed equity funds. But we remain fully committed to our equity portfolio management. We have select strategies in active equities and a full spectrum of fundamental strategies and just recently we announced that we will further develop our fundamental equity strategies.
Anke Rezmer covers bonds and their investors and Robert Landgraf is deputy head of the finance section for Handelsblatt in Frankfurt. To contact the authors: firstname.lastname@example.org and email@example.com