Why bonds are part of the picture

Following the recent addition of PIMCO as a fifth manager to our international equities strategy, some clients have asked: why is a bond manager involved – and does this mean we’ve increased their exposure to bonds? 

It’s a great question, and one that gives us the opportunity to explain an investment approach called portable alpha. To understand how it works, it helps to start with two key investment ideas: alpha and beta.

When you invest in an equity market, like the S&P 500 Index, you get the return of that market. That’s called beta. It reflects the ups and downs of the market itself, and it’s what you get simply from being invested. But some investment managers aim to do better than the market. That extra return is called alpha. It comes from skill: deep research, smart decisions, and experience navigating different conditions. In many traditional actively managed investment strategies, both beta and alpha are derived from the same market; the manager picks stocks from within the market with the aim of outperforming it. If they succeed, you receive the market return (beta) plus the additional return (alpha). But sometimes, the manager underperforms, resulting in a negative alpha, so your total return is less than the market return (beta).

Portable alpha is a way to get both the market return (beta) and potential extra returns (alpha), but from different places. This separation means that even if the alpha doesn’t materialise, you should still receive the market return (beta). 

Here’s how it works

• PIMCO uses a small portion of the capital invested to buy financial instruments such as equity futures or swaps – tools that provide full exposure to international equity markets (beta) without needing to physically buy the equities directly (as you would in a traditional investment strategy). These instruments require only a modest upfront investment. A portion of the capital is also set aside as collateral to support these instruments.  
• This leaves most of the capital available to be put to work elsewhere, and that’s where PIMCO’s bond expertise comes in. It invests the remaining capital into a short-dated, highly liquid, and high quality bond strategy, which is where PIMCO aims to generate alpha.

So, while the strategy does hold bonds, it’s still fully exposed to international equity markets. The bonds are there to add value - not to replace the equity exposure. In fact, they complement it by providing a return stream that’s less correlated with equity markets. 

Ultimately, your expected return is the international equity market return, plus the return of the bond component, minus the cost of the financial instruments. 

Importantly, PIMCO manages both the financial instruments and the bond investments, enabling coordinated decisions with a clear view of how each component contributes to overall risk and return.

PIMCO, who are one of the world’s largest investment managers, has been running portable alpha strategies for over 40 years. In our view, they’re one of the most experienced managers in this space.

We also know them well. PIMCO have managed a component of our international bond strategy for over a decade – investing in areas like global government bonds, mortgage-backed securities, and high-quality corporate credit. These are the same types of assets they use in the portable alpha strategy, and they’ve built a strong track record doing so.

PIMCO’s inclusion reflects one of our core investment beliefs: partnering with managers who bring expertise, a long-term mindset, and a proven ability to deliver results. 

Given their success in managing bonds, we’re confident in extending our partnership to include their portable alpha strategy – trusting that their disciplined approach and commitment to excellence will deliver value for our clients.

The addition of PIMCO is part of a broader reshaping of our international equities strategy. We now have a five-manager line-up which includes BlackRock, Franklin, LSV and Vontobel. Each manager brings a different investment style and approach, from systematic, rules-based investing to high-conviction stock picking.

The change also builds on earlier steps we’ve taken to reduce concentration risk in our international equities strategy – including the replacement of MFS with BlackRock in 2024. By reducing our allocations to Franklin, LSV, and Vontobel, and adding PIMCO, we’ve further diversified our sources of return with the aim of making the overall international equities strategy more resilient to different market conditions. Across our five-manager line-up, we believe we are well-positioned to deliver strong, diversified returns in international equities for our investors.

The inclusion of PIMCO also reflects another of our investment beliefs: using the right strategy in the right place. Portable alpha isn’t something we’d use everywhere, but in this case, we believe it’s the right tool for the job.

Your overall exposure to international equities is unchanged. What’s different is that a portion of it is now managed using PIMCO’s portable alpha strategy, which seeks to generate alpha by investing in bonds. 

If you’d like to learn more about our international equities strategy, or the PIMCO strategy, and how they fit into your overall portfolio, please talk to your Private Banker or investment adviser.