PIMCO and other enhanced equity index managers that rely on short-duration bonds for their alpha are getting dented by the flattening yield curve.
Pacific Investment Management Co., Newport Beach, Calif., whose $29.3 billion StocksPLUS is the biggest and best known of these strategies, has seen performance lag the Standard & Poor's 500 index by 20 basis points for the first six months of 2005. The firm's StocksPLUS Fund A, a mutual fund, has lost a full percentage point against the benchmark.
Consultants and pension fund clients said they're not overly concerned about the rough patch. They said the flattening yield curve is tough on many short-duration bond and enhanced equity index managers that use short bonds to generate their alpha, which is then transported onto an S&P 500 futures contract or swap.
For PIMCO and managers with similar strategies, "the engine has been damaged by a flat yield curve. But the damage is not permanent. When the yield curve settles out, when interest rates settle, over time they should be able to get the performance back to where it has been. And, historically, StocksPLUS has done very well for PIMCO," said Anthony Minopoli, a consultant with Evaluation Associates LLC, Norwalk, Conn.
Added Michael Rosen, principal at Angeles Investment Advisors, Santa Monica, Calif.: "The flatter the yield curve, the one less arrow in the quiver of short-duration managers."
Here's why: When the yield curve is steeper, short-duration bond managers are able to take advantage of carry trades. To finance the purchase of S&P 500 index futures, the managers are implicitly borrowing at a short-term interest rate, such as LIBOR or the federal funds rate, and investing in a longer-term fixed-income instrument to pick up a yield premium.