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By Jeremy Glaser | 06-19-2014 08:00 AM

How This PIMCO Fund Is Prepared for 'The New Neutral'

PIMCO Unconstrained Bond manager Mohit Mittal is taking a modest overweight in duration and sees three areas to find value in credit risk.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Mohit Mittal. He's a managing director and also a portfolio manager at PIMCO on the Unconstrained Bond fund. We're going to talk about his outlook for the economy and how that is impacting his portfolio decisions.

Mohit, thanks for joining me today.

Mohit Mittal: Thank you very much, Jeremy.

Glaser: PIMCO has moved from the New Normal to the New Neutral. Can you talk to us a little bit about what that means and what your secular outlook for the economy is?

Mittal: Sure. Let me just quickly define what the New Neutral is for us. First, it consists of the outlook for growth being lower than what it has been in the past. So, our outlook is that real growth in the U.S. will be around 2% instead of 3% real that we have seen precrisis.

Second, it means that monetary policy will be set at lower real neutral rates. Historically, we've seen 2% real neutral rates. Moving forward, we expect real neutral rates to be in the zero percent range, which means that the [federal-funds] rate will finish [the taper] at around 2% instead of 4%, which many have been expecting.

Glaser: If you expect those long-term rates to be lower, what does that mean for positioning in terms of the duration [a measure of interest-rate sensitivity] of your fund? How are you thinking about that?

Mittal: As far as positioning of the fund, we like a modest to long position in U.S. duration because we think that the neutral rates will be lower than what even the central bank is forecasting. We like to have this modest overweight.

At the moment, our aggregate duration positioning is about 2.5 years coming from the U.S., Brazil and Mexico, and that 2.5 years is about 40% of the duration of an aggregate bond index.

Glaser: Now, what about credit risk? In that world, how do you think about taking that on?

Mittal: I think we like taking credit risk in select areas. We are not a big fan of taking large amounts of high-yield or bank-loan risk, but we do like taking credit risk in areas where we see value. The examples include peripheral European sovereign and financial credit risk. The reason we like that is because of what European Central Bank did and is doing with the targeted long-term repo operations. So, we think peripheral European sovereign and financials bonds will do well in that environment.

The second place we like taking credit risk is in nonagency mortgages in the U.S. We think U.S. housing is expected to continue to recover, not at the same high pace that it has in the last year, but still a modest 5 to 10 percentage points over the next 12 to 24 months. So, nonagency mortgages would be the another area.

A third area where we like credit is select emerging-markets sovereign debt. So these combined, offer value to us at the moment.

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