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In this episode, PIMCO’s David Braun returns to the show to explain some important fundamental concepts that really unlock the potential of bonds, IMO.
David has been with PIMCO for 15 years and is a U.S. generalist fixed income portfolio manager in the New York office. His 30 years of investment, risk management, and actuarial experience make him a tremendous resource, so we covered a lot of ground such as the role of core bonds in a portfolio, the impact of rising yields and how that should reset our expectations for bonds, active vs passive management, and the impact of US national debt on bond investors.
Here are my notes from our conversation…
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What is the Role of Core Bonds in a Portfolio? (00:30)
We kick off the episode with a discussion about the advantages of bond funds over owning individual bonds. David explains that while many retail investors find comfort in holding individual bonds, there are significant trade-offs. The bond market is opaque, less efficient than the stock market, and more challenging for individual investors to navigate. Bond funds, on the other hand, offer diversification, professional management, and access to less generic securities that can provide better yields.
David emphasizes how actively managed bond funds can mitigate risks like concentrated positions and take advantage of inefficiencies that individual investors might overlook. Whether through a laddered bond portfolio, a hybrid product, or a fully active bond ETF, bond funds offer solutions for investors who want to maximize returns without sacrificing quality.
Core bonds remain foundational in any well-constructed portfolio, despite their recent bad press. David explains that core bonds are typically investment-grade securities, including U.S. Treasuries, agency mortgages, and corporate bonds. They serve three primary purposes: capital preservation, income generation, and portfolio diversification through negative correlation to equities.
However, the last few years have been tough on bonds. Rising rates in 2022 led to historic losses, and the traditional negative correlation with stocks temporarily broke down. But David believes investors are looking backward, not forward. With yields at their most attractive levels in 20 years and inflation largely under control, core bonds are once again poised to play their critical role in portfolios.
Rising Yields and Resetting Expectations for Bonds (04:46)
One of the most exciting developments in fixed-income investing today is the generational reset in yields. David walks us through the math: yields on high-quality bond funds are now between 4.5% and 6.5%, levels not seen in decades. This higher starting yield provides a significant cushion against future rate hikes and positions bonds as a competitive asset class relative to equities.
David notes that bonds are particularly appealing in today’s slowing economic environment. With recession risks rising and stock valuations at all-time highs, bonds offer a compelling combination of attractive yields and reduced volatility. Investors should focus on the long-term benefits of these higher yields rather than reacting emotionally to short-term price fluctuations.
Active vs. Passive Management in the Bond Market (10:00)
While passive investing has revolutionized the equity market, David explains why bonds are different.
See EP.99: The Problem With Investing In Bond Indexes
The bond market’s inefficiencies, turnover, and opaqueness create opportunities for active managers to add value. He points out that active bond funds consistently outperform their passive peers, with data showing that 75-80% of active bond funds beat passive options over five- and ten-year periods.
David also highlights some unique challenges of indexing in the bond market, such as debt-weighted indices that inherently favor the most indebted companies. Active managers can sidestep these inefficiencies, focus on less crowded areas of the market, and take advantage of price distortions created by non-economic buyers like central banks and pension funds.
National Debt and Implications for Bond Investors (19:12)
The growing U.S. national debt is a hot topic for many investors, and David doesn’t shy away from its challenges. While debt-to-GDP levels are projected to rise significantly over the next 15 years, David argues that the U.S. dollar and Treasury bonds remain indispensable as the world’s reserve currency and asset.
He explains how active managers like PIMCO position portfolios to navigate this environment, favoring curve steepeners and avoiding longer-term Treasuries. While the debt dynamic is concerning, David emphasizes that there’s no viable alternative to U.S. Treasuries in the global financial system, making them a continued safe haven for investors.
Future Trends in Fixed Income Investing (27:26)
David shares his insights into the future of fixed income and why “what’s old is new again.” The high yields available in core bond funds today make them far more attractive than riskier private credit or floating-rate products that became popular during the low-rate environment of the past decade.
He also notes that the inflation fight of the past few years has fundamentally changed how policymakers and investors approach bonds. With less room for fiscal or monetary stimulus in the next recession, high-quality, actively managed bond funds are well-positioned to deliver value in a more uncertain economic environment.
Addressing Misconceptions About Bond Math (31:42)
One of the most misunderstood aspects of bonds is the relationship between interest rates, duration, and returns. David explains the importance of bond math: when rates rise, the initial price decline is offset by the higher income generated from reinvested yields. He urges investors to embrace a “buy the dip” mentality in bonds, similar to how they approach equities.
The starting yield of a bond fund is a powerful predictor of future returns, with a 94% historical correlation over five years. Given today’s high starting yields and favorable macroeconomic backdrop, bonds are set to deliver strong long-term returns. Investors who understand this dynamic can make smarter, more confident decisions in fixed income.
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