Feb 6, 2023
The Man Behind Pimco's Great Debt Bet Closes In on His Next Big Trade
(Bloomberg) -- Daniel Ivascyn rode one big trade all the way to the top of the bond-market universe: speculative mortgage debt that he scooped up on the cheap in the wake of the great financial crisis. It made a fortune and, in turn, made everyone forget about the messy departure of his predecessor atop Pacific Investment Management Co., Bill Gross.
Now, more than a decade later, Ivascyn, Pimco’s chief investment officer, finds himself at a critical juncture. His $117 billion Pimco Income Fund, the world’s largest actively managed bond fund, has started to trail its very top-performing peers, and investors, burned by a brutal wipeout across the bond market in 2022, are losing patience. They yanked $23 billion from the fund last year, the most since its launch in 2007.
Ivascyn, 53, gets the angst that’s brewing out there but exudes confidence in his strategy. He’s been waiting, he says, for a big-score kind of moment like the one he found back in the late aughts and says he’s finally on the cusp of delivering it to investors.
The market he’s eying this time is corporate debt. As the Federal Reserve approaches the end of its aggressive rate-hiking cycle, companies face a big reset higher in borrowing costs while the economy is cooling. It’s a backdrop that he expects will eventually roil credit markets, creating buying opportunities in a variety of distressed securities.
“Our mindset is be willing to be average - for a time - and protect capital and then look to be a top cohort performer,” Ivascyn said in an interview. “You need significant dislocations in the market to go on offense to generate strikingly high differentiated returns.”
Ivascyn’s ascent to the pinnacle of the bond market has, in many ways, been a quiet one. He doesn’t crave the spotlight — on TV, at conferences and on social media — the way Gross and his partner Mohamed El-Erian did. Ask a casual observer of financial markets who the most important name in bonds is, and they’d probably offer up Jeffrey Gundlach or, until recently, the late Scott Minerd.
But not only does Ivascyn manage more money, he also has a track record with little parallel. The Income Fund, which he co-manages with Joshua Anderson and Alfred Murata, returned 4.2% annually over the decade through Feb. 2, more than all 218 peers with assets of at least $1 billion during that period, data compiled by Bloomberg show. Over the past five years, it beat 92% of competitors. On a three-year basis, its 1.2% return was better than 88%.
This slide in the rankings, while modest, underscores the pressure on the team now that the corner of the mortgage market that propelled the Income Fund to new heights after the great financial crisis has shrunk to maybe a quarter of its peak.
“It’s inevitable,” says Eric Jacobson, a fixed-income strategist at Morningstar Inc., “that they’re going to have a hard time maintaining this level of exposure” to that mortgage sector.
For now, corporate debt is holding its own. The extra yield investors demand to own US junk bonds over Treasuries has shrunk to less than four percentage points, below the 10-year average, and company issuance soared at the start of the year.
The strength may be masking growing strains on balance sheets. Moody’s Investors Service expects the global default rate for high-yield debt will rise to 5.1% in 2023, from 2.8% in 2022, as slowing growth and tougher financing conditions start to bite. Bloomberg Intelligence says the increase in defaults may extend into 2024. Cracks are also emerging in loans to risky companies, with downgrades rising, and banks are setting aside more money to cover potential defaults.
“This cycle is going to be different,” Ivascyn said. “Even in a soft landing, we could see a scenario of multi-year disappointments in the credit markets,” a drawn-out process marked by the restructuring of corporate debt and heightened losses.
Ivascyn, a native of Worcester, Massachusetts, and the son of a nurse and a school superintendent, made his name in mortgages. Driving around the Boston area with a realtor in 2005 to take the pulse of the housing market, all he saw was froth, journalist Mary Childs wrote in her book last year about how Gross built Pimco into a bond powerhouse. Based on such intel, the firm decided to shun subprime offerings. After non-agency mortgage-backed securities — those not backed by Fannie Mae, Freddie Mac or Ginnie Mae — plummeted in a wave of panic selling, Ivascyn and others at Pimco loaded up.
When the housing market rebounded, his fund soared. It returned 11% a year from 2009 to 2017, compared with 3.9% for its benchmark, a staggering outperformance in the usually steady fixed-income world.
That trade helped the fund outpace its rivals in terms of size as well: Its assets have ballooned from $176 million at the end of 2007. It also propelled Ivascyn to the helm of the $1.7 trillion asset manager in 2014, when co-founder Gross left.
“That non-agency-mortgage trade was more than likely a once-in-a-lifetime opportunity,” said Morningstar’s Jacobson. With that market having shriveled, “the question will be, at what point will they want to have as much as they want and not be able to have it? And at that point, what will that do to their future prospects?”
At the end of 2022, 33% of the fund’s assets were in non-agency MBS, according to its website. While that’s down from as high as 41% in 2018, it remains high relative to its peers, Jacobson says.
Still, he reckons Ivasycn can outshine most rivals, even if not as much as before, because of his skill as a manager and his firm’s deep-pocketed research prowess.
Last year’s performance hinted at that. The fund kept losses to around 8% in 2022, thanks to a more limited exposure to interest-rate risk, placing it in the 77th percentile relative to its peers, who lost about 11% on average, according to data compiled by Bloomberg.
Pimco Income has also seen fund flows reverse. About $2 billion poured in last month amid the bond market’s rebound, according to data compiled by Bloomberg.
James St. Aubin, chief investment officer at Sierra Investment Management, is among Income Fund investors sticking with Ivascyn, given the fund’s consistency over the years.
Ivascyn came across as laid-back, low-key and “very methodical” when St. Aubin met him in 2014. “I just found him to be a very measured individual,” said St. Aubin, who has followed the fund since its inception. “He’s a very astute investor.”
Ivascyn joined Pimco, which is based in Newport Beach, California, in 1998, following stints with Bear Stearns Cos., T. Rowe Price Group Inc. and Fidelity Investments. After burnishing his reputation at the Income Fund, Ivascyn emerged as the successor to Gross and helped steady the firm amid its management shakeout.
In October, he joined the managers running Pimco’s Total Return Fund – the fund Gross led, which was once the largest actively managed bond fund, with assets of $293 billion at its peak in 2013. It’s now about $57 billion.
In a Q&A posted on Pimco’s website last week, Ivascyn said bond markets are more attractive than they’ve been in the last few decades. Market “volatility should provide fertile ground for active managers with a broad, flexible opportunity set,” he said.
That describes the Income Fund, which invests in everything from bank loans to emerging-market debt, giving it more freedom than many peers. With a yield target of more than 5%, it attracts investors looking for steady and high dividends.
Discussions around the fund often turn to its size, which some see as a handicap. It’s the only actively managed bond fund above the $100 billion mark. Capital Research & Management’s Bond Fund of America is next with around $75 billion.
But Ivascyn calls that heft a strength, especially when banks, competitors and investors want to dump a big chunk of their holdings.
“When you are large, you get more calls, and our goal is to turn those calls into opportunities for our clients,” Ivascyn said.
--With assistance from Kenneth Hughes.
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