PIMCO released a new video entitled, "Quick Takes: Can De Risking Portfolios Support Returns Too?" The description says, "For investors looking to earn income and de-risk portfolios, short-term investments may be an attractive opportunity. Portfolio manager Jerome Schneider discusses why an allocation to the asset class should be more than an afterthought." They also recently published the paper, "How to Overcome the Structural Bias in Cash and Short-Term Investing," which tells us how "behavioral science can help identify biases that result in poor investment decisions." We review both below.
The video says, "My name is Jerome Schneider head a short term portfolio strategies here at PIMCO. For investors, the past few months have been quite volatile and as a result many investors are looking to de-risk their portfolios. We've seen an increase of over $300 billion of assets specifically into traditional money market funds as a result over the past year. In fact, the curve has flattened tremendously between the 2-year and the 10-year note. What investors don't understand is that they actually might stay in these money market fund strategies much longer than they've typically expected."
He explains, "So for investors looking to earn a little bit more income, the front end of the yield curve offers traditional opportunities that we haven't seen for quite a while, simply because they're taking less interest rate risk than the longer into the yield curve but earning approximately the same yield. The current environment has created a unique opportunity for the short term universe -- significantly higher yield potential than just three years ago, with considerably less duration risk, than the longer end of the yield curve. Investors need to be focused on active management possibilities for that de-risking portfolio."
Schneider continues, "Traditionally investors have simply looked at the yield and sought to achieve some type of de-risked return. But really the focus of the opportunity these days is on total return. The composition of income, plus opportunities for capital appreciation along the way. That total return produces incremental opportunities. So for us, active management is a clear differentiator for investors who want to be thinking about preserving liquidity, maintaining capital preservation, defending themselves against market volatility and also having some income along the way."
He adds, "So at this point in time, these strategies are effectively not just an afterthought, but an actual active allocation to your portfolio strategy. Given the flat yield curve, given the opportunity for total return, this is an opportunity in the uncertain environment that is potentially ahead of us."
The "Structural Bias in Cash" paper tells us, "Behavioral scientists are skilled at analyzing why we make mistakes, and financial and investment decisions have been a ripe field to till. The challenge lies in overcoming our biases that result in poor decisions, particularly in today's late economic cycle environment with moderate economic growth, dramatic bouts of market volatility, and low long-term interest rates. Jerome Schneider, head of PIMCO's short-term portfolio management team, and Jan Faller, portfolio risk manager, discuss in the following Q&A some key biases and share their thoughts on one area where they believe individual and institutional investors can improve: managing their cash and liquidity."
The Q&A asks, "Jerome, how does behavioral science apply to investing?" He responds, "Schneider: Some of the most basic premises of investing are steeped in biases that are innate in human nature, and this is what makes behavioral science such a fascinating field to us. As investment managers, we could discuss dozens of biases, but among the most prevalent for investors are status quo bias, loss-aversion bias, and confirmation bias. All can be hazardous to a portfolio and to reaching investment objectives."
Schneider continues, "We believe the awareness of these biases and the insights that behavioral science can provide have a highly useful purpose amid current high valuations for many assets and the maturing economic expansion. As active investment managers, we should not only be aware of and address our own biases, but also consider those prevalent in the marketplace. In this way, we can be more cognizant of the biases that may limit investment performance, and by doing so we believe we can provide a valuable service to clients."
Faller comments, "PIMCO incorporates behavioral finance into its investment and risk management processes – particularly the concept of loss aversion, meaning that the psychic pain of losses can lead investors to make poor risk/return decisions that put their investment objectives at risk. Daniel Kahneman, a 2002 Nobel laureate, and colleague Amos Tversky were the first to document this human bias, and Richard Thaler, a 2017 Nobel laureate, contributed to advancing our understanding of its applications."
Schneider adds, "Within short-term portfolio management specifically, we aim to limit bias, including loss aversion, through our team-based approach. Each member of the short-term investment team brings different views and experiences – often in sectors beyond the cash and short-term management space. Along with input from our analytics group, the team approach allows us to routinely challenge market norms and adjust portfolios as needed. Our risk management group also plays an important role by asking questions of portfolio managers in an effort to improve objectivity and help discover potential biases in portfolio positioning."
He also comments, "In short-term investing, we aim not only to preserve clients' capital but also to limit volatility, and we believe addressing biases like loss aversion can help us achieve both goals.... A good example is the bias to considering only one choice when managing liquidity, when in fact there are many strategies that have track records in managing short-term assets. The world has more opportunities than it did during the last recessionary period, and yet investors continue to allocate to traditional money market funds and Treasury bills as a psychological default. Money market funds held more than $3 trillion at the end of March, according to Bloomberg, the highest level in about a decade – and back then, investors were putting money in these funds in the wake of the global financial crisis."
Schneider tells us, "When it comes to portfolio liquidity, we appreciate that vehicles such as money market funds can be appealing to invest one's cash and wait out market turbulence. However, investors may want to consider that the return on these funds generally comes mainly from yield − often below benchmark rates − rather than from a combination of yield and capital appreciation, and also that both the loss-aversion and status quo biases can result in leaving assets in such vehicles for long periods."
Finally, PIMCO says, "We believe it is critical for investors to approach cash and short-term investments as a true structural allocation instead of an afterthought or default reaction. This process begins with considering how much liquidity is actually needed over various horizons and how much risk an investor can tolerate.... Tiering liquidity can enable investors to target assets that best match a given investment horizon and risk tolerance, and help investors overcome the status quo and structural biases that could be detrimental to their investment goals."
