Top performing funds: How PIMCO delivered a 13.47% return in the financials sector despite peaking bank earnings

Australians love buying and holding onto their bank shareholdings. And why not, given the Big Four pays a fully franked dividend, benefit from tight regulation, and experiences reasonable share price growth? It's as if any time a broker puts a sell rating on these institutions, it just falls on deaf ears.

But while moves in the Australian banking space are rare and slow, there is a much larger changing of the guard happening in the global financials space. Increased regulation following the 2008 GFC and the collapse of Credit Suisse, changes to requirements around capital adequacy (the amount of reserve cash needed in case a crisis occurs), increased competition, and higher interest rates are all having a huge impact on the banking sector. 

All this together is creating what PIMCO is calling "a generational paradigm shift" - and with it, a massive opportunity for bank and insurance company bonds. 

"In concrete terms, this means that the quality of bank balance sheets and the amount of capital that banks hold has improved sharply," said Philippe Bodereau, Head of European Credit Research and lead PM for the Fund, and Matthieu Loriferne, Portfolio Manager for Capital Securities at Financials at PIMCO.

"These developments mean that the banking sector presents many attractive opportunities for investors able to successfully navigate and understand the wide variety of bank bonds in the market," Bodereau and Loriferne added.

To prove it, the PIMCO Capital Securities Fund topped the fixed-income managed funds league table for FY24. Per the data it submitted to Morningstar, it recorded a very healthy 13.47% one-year return. 

To discuss what went right, what went wrong, and most importantly, what happens now, we spoke to Bodereau and Loriferne recently.

What was the biggest decision you made as a team in the last 12 months from a performance contribution perspective?

Following the tumultuous market events in early 2023, we further reinforced the up-in-quality positioning of the portfolio across multiple dimensions including issuer selection as well as bond structure. By doing so, we sought to increase exposure to securities we believed would recover best in the aftermath of the US regional banking crisis and the merger of Credit Suisse with UBS. 

We did this by taking advantage of the indiscriminate selling in the banking debt market and were able to improve the underlying quality of the portfolio, without unduly sacrificing returns. 

Another key decision was to redeploy the ample liquidity of the fund into the new issue market, which since late 2022 has presented some of the best primary opportunities in close to a decade, with AT1s from high-quality institutions coming to market with coupons above 9%.

You’ve observed that the global banking industry is going through a “multi-year deleveraging process”. 

In simple terms, what does that mean and why does it matter to you and your investors?

The overarching impact of more than a decade of bank re-regulation and deleveraging has been that the fundamentals underpinning the European banking sector as well as large US banks have been strengthened substantially. In concrete terms, this means that the quality of bank balance sheets and the amount of capital that banks hold has improved sharply. 

These positive trends have stemmed from more robust regulation of the banking system and have dramatically increased the resilience of the sector to shocks such as the pandemic. In addition, the move away from negative rates in Europe over the last few years has led to a big increase in profitability for the sector. 

Taken together, these developments mean that the banking sector presents many attractive opportunities for investors able to successfully navigate and understand the wide variety of bank bonds in the market.

What was your best and worst trade from the last 12 months?

Whilst the last 12 months have been amongst the strongest for the fund from a performance standpoint, there has nevertheless been a dispersion of returns across various components of the financial bond market. AT1 performance was robust as the market continued to recover from the events of early last year and the instruments’ lower duration limited the impact of higher rates on their total returns. 

With AT1s being the biggest allocation in the portfolio, this helped performance recover well following the weakness in March 2023. However, in keeping with our up-in-quality bias, we have tended to avoid some of the second/third-tier banks in Europe or more aggressive bond structures, which amidst the very supportive backdrop, have outperformed.

What is your outlook for subordinated financials debt, as an asset class, over the next 12 months?

Tell us about a specific high conviction investment that you have high hopes for in the next year.

The recent elections in the UK led to a large majority in parliament for the new government, which should presage a period of relative political stability in comparison to the last few years. Alongside this development, the high-quality nature of many of the country’s banks, coupled with attractive yields on their subordinated debt, gives us confidence as active managers in the potential returns we can generate from the region.

Our positive view of the local banks translates into the UK being the largest region of exposure in our portfolio. Indeed, many British banks have already experienced a significant improvement in their fundamentals following challenges during the 2008 financial crisis, with greater regulation playing an important role in the process. The change has meant that some of the country’s financial institutions are amongst the strongest in Europe from an asset quality, capital, liquidity and profitability perspective.

Managed Fund

PIMCO Capital Securities Fund

Global Fixed Income

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