Global equities have returned an astounding 14% per year since markets troughed in March 2009 (based on the MSCI All Country World Index through February 2019). But generating anything close to these levels of returns is likely to become far more challenging going forward, as the late-cycle environment is likely to put downward pressure on equity valuation multiples, and tightening financial conditions may slow profit growth. This outlook should alert investors that simply achieving index-level equity returns may no longer suffice; they will likely increasingly need significant alpha to meet their investment goals. Alas, traditional active equity management (stock-picking) – never an easy task to begin with – has become increasingly challenging over the past few years.
Given these headwinds, investors are realizing that it may be time to rethink their approach to equity investing – and many are looking into nontraditional solutions that go beyond the equity space in pursuit of sustainable alpha. In this Q&A, PIMCO portfolio managers Mohsen Fahmi, Bryan Tsu and Jing Yang explain the unique strategy design behind StocksPLUS, and why it may prove a timely solution for investors seeking a more consistent approach to excess returns at a lower cost than with most traditional active managers.
Q: Why should clients consider StocksPLUS for their equity allocations in today’s market, and how does its nontraditional methodology work to achieve alpha?
A: Given the challenges traditional stock-pickers are facing, we see a clear need for nontraditional solutions like StocksPLUS to seek alpha today.
In recent years, a regulatory and tech-driven democratization of information has made data on companies and market prices readily accessible, chipping away at the value added by active equity managers and creating a much more competitive landscape. At the same time, the opportunity set for active stock-picking has shrunk as increased mergers and acquisitions and a decline in IPOs have made the equity markets more concentrated. In fact, the number of stocks listed on U.S. exchanges is about half of what it was about 20 years ago.
The result is that the vast majority of active equity managers have underperformed their benchmarks over the past decade – and investors have understandably become less confident in their ability to select a high-performing manager. Moreover, looking at past results to select a manager can lead to performance-chasing, which can further erode returns.
The value proposition is starkly different for active bond managers. Our Bonds Are Different research presents compelling evidence that active bond managers can more reliably generate excess returns than equity managers. There are structural reasons for this advantage, including the large proportion of noneconomic bond investors, new-issue concessions for larger-scale buyers and a relative lack of widely available real-time data on the bond markets, to name a few. The stark contrast between the opportunity set for bonds compared to equities leads to the logical question: Why not look beyond equities in the search for alpha? Or, as we like to say, Don’t let your alpha be hostage to your beta choice! StocksPLUS offers an innovative solution for investors’ equity allocations by tapping opportunities in bonds – rather than stocks – to seek alpha.
StocksPLUS’ nontraditional methodology is nonetheless quite straightforward. We start by efficiently replicating the investor’s target equity benchmark performance through equity index futures or total return swaps. We seek to operate in the most liquid futures and swap markets, which offer well-tested and transparent means to achieve equity beta that require a low capital commitment. In this way, we free up around 95% or more of investment capital to pursue excess returns through a flexible, hi