The financial system will be left in a fragile state even after the world emerges from the pandemic, according to the investment chief of one of the world’s most powerful bond fund managers.
Dan Ivascyn of Pimco warned that the world will have to live with the consequences of the huge extra debts taken on by companies to see them through the crisis and by governments to bail out their economies.
“We will come out of Covid with a lot more debt for companies and governments and that leaves us with inherent fragility,” Mr Ivascyn told the Financial Times.
Pimco is cautiously optimistic that the development of vaccines will bolster the global economy next year, but Mr Ivascyn said investors needed to continue to be careful.
“We remain fairly defensive from a credit perspective,” he said. “We are cautiously optimistic we [can] get through this but it is a challenging environment for investors. These are uncharted waters and you need to respect where this takes us.”
Earlier this month the IMF estimated that the leading G20 countries had “provided around $11tn in necessary support to individuals, businesses and the healthcare sector since the start of the pandemic”.
With central banks supporting credit markets, corporations have sold and refinanced record amounts of debt this year in an effort to amass reserves to finance their businesses beyond the pandemic.
This flood of debt across markets has found receptive buyers intent on securing fixed income in a climate of near zero long-term government bond yields.
In the past week, the average yield on US junk bonds fell to 4.8 per cent, marking “a new all-time record low” for the asset class, according to Bank of America.
Mr Ivascyn said liquidity in the financial system had been limited since the financial crisis more than a decade ago, and markets continued to be dominated by central banks.
Low liquidity risks causing big swings that could catch investors off guard. Mr Ivascyn said: “Outside of central banks there is not a lot of transactional liquidity in markets and it’s always better to plan ahead.”
Pimco, which manages $2tn in assets, installed Mr Ivascyn as chief investment officer in 2014 after the sudden departure of the company’s founder Bill Gross.
The flagship $125bn Pimco Income Fund managed by Mr Ivascyn has recovered sharply from the turmoil of March and extended its long run of beating the broader market.
“Our highest conviction is in the housing area of the credit market,” Mr Ivascyn said, with mortgage-backed bonds offering security because of high house prices across the US, UK and Europe. Housing affordability was strong thanks to low borrowing costs, he said.
Mr Ivascyn said securities based on pools of residential mortgages that were originated 10 years ago contained loans with high levels of home equity. This helped to insulate bondholders from weaker home prices in the future.
That preference leaves Pimco poised for underperformance versus funds that are more aggressively weighted towards high yield debt, should a stronger economic recovery result next year.