Pimco’s Dan Ivascyn is relieved firm’s lawsuit with Bill Gross is over

Ace manager talks about the Fed, interest rates and his biggest worry as a bond investor.

Daniel Ivascyn is group chief investment officer at Pacific Investment Management Co., lead portfolio manager for the Newport Beach, Calif.-based company’s fixed income strategies and the successor to Bill Gross, the company’s founder. A graduate of University of Chicago Graduate School of Business, Mr. Ivascyn manages or co-manages 13 Pimco funds, including the $79.1 billion Pimco Income fund (PONAX), which ranks fifth among all multisector bond funds.

InvestmentNews senior columnist John Waggoner spoke this week with Mr. Ivascyn about his outlook for the economy and bonds — and the transition from the Bill Gross era at Pimco.

InvestmentNews: How do you feel now that the lawsuit with Bill Gross has been settled?

Mr. Ivascyn: I think that we come in every day and do our jobs. Managing fixed-income portfolios is a process. It’s not glamorous: You’re just grinding out returns. We’ve been doing that since the day he left the firm. It’s only a relief in that clients see us moving forward. Personally, I’m excited that we have this behind us. But Bill Gross created a lot of the framework that we continue to use to make decisions. He brought me into the firm. A lot of his great skills have rubbed off.

InvestmentNews: Even though the Federal Reserve minutes, released Wednesday, hinted that the central bank would continue to nudge interest rates higher, the bond market rallied on the news, sending interest rates lower. Is the bond market skeptical about the pace of economic growth?

Mr. Ivascyn: I think the bond market is not only listening to the Fed, but what is going on in the fiscal policy side and the European election cycle as well. Quantitative easing remains significant outside the U.S., and there’s a lot of uncertainty around Brexit. That puts a premium on investments that provide safety and capital preservation.

That said, the Fed’s news shouldn’t be taken lightly. They still have a large balance sheet, and they do intend to take rates higher. We’re seeing a robust jobs market, inflation expectations are trending higher, and there’s potential for cyclical overheating. And we don’t know who will be making decisions at the Fed next year. So there’s still a healthy amount of uncertainty. And on a technical note, investors in the bond market were pretty short going into the year because they were worried about the White House’s aggressive pro-growth policies. Some of that seems to have reversed.

InvestmentNews: People were predicting 3% and even 4% GDP growth in the wake of the election. Do you think that will happen?

Mr. Ivascyn: We see growth somewhere in the mid-2% range this year. Three percent is possible, but the Fed is looking to slow the economy a bit. There’s lots of uncertainty. For a bond investor, the bottom line is that there are plenty of paths for fiscal policy. Higher productivity can lead to higher real rates, and that would be a weakness for bonds. At current rates, you have to be comfortable with lower returns going forwards.

InvestmentNews: You have quite a few policy analysts at Pimco, including former Fed Chairman Ben Bernanke. Among the Trump administration’s policy goals, which do you think are most likely?

Mr. Ivascyn: We do think there will be a tax package. It will take longer than they think. Like many administrations in the past, when you start dealing with tax packages, you begin to think big, and then you run into opposition — aggressive lobbying from constituents that will be impacted. And tax reform is incredibly detail-oriented: It takes a long time to do it right. Having the votes at the end of the day is very difficult.

Also, tax reform means that there will be winners and losers. A tax cut is more like winning today and losing down the road when you have to pay for it. I think it will be less like reform and more like a traditional tax cut — but it will be more balanced than the current proposal, targeting the middle class. We see that happening late this year or early next year.

InvestmentNews: How many Fed hikes do you see this year?

Mr. Ivascyn: We still think there will be two more, with the chance of a third. The bond markets seem generally comfortable with either two or three. The big question going forward is who will be the Fed chair, and what will the Fed look like. We think the new Fed chair will look a lot like [Fed Chairwoman Janet] Yellen. But we have a healthy degree of humility: We don’t know for sure. I’m not willing to bet on the Fed either way at the moment.

We do think this administration will respect central bank independence. Since they will appoint a new Fed chair, it’s likely to be a person who is close to the administration. But what this administration wants is not that different from Yellen. They want a gradual, nondisruptive approach to balance sheet reduction. We’ve seen plenty of curve balls on policy the past couple of years. As an active manager, we don’t need to predict the future, but we need to be prepared for multiple outcomes.

InvestmentNews: What do you like in the mortgage market?

Mr. Ivascyn: Well, non-agency mortgage securities have credit risk, while agency mortgage securities have prepayment risk. We still like the non-agency mortgages. They’re yielding a lot, but are a lot safer than they used to be. We looked at non-agency in 2006-07, when the loan-to-value ratio was up in the 120-130% range. When you look at the remaining borrowers in those pools, we see the loan-to-value as low as 70% from when no one had equity. Those people have had their mortgages for 10 years now, and that’s a good indication of future payments. We like the sector, and it’s done well this year.

InvestmentNews: What’s your biggest worry as a bond investor?

Mr. Ivascyn: I just worry. As a bond investor, you always worry. The entire firm’s culture is based on worry. The most you get is a low coupon and par back if things go right.

In the longer term, debt levels are high, nominal growth rates are low. One way or another, whether it’s three years or 10, there’s going to have to be some restructuring of debt, either through inflation or write-downs. You always have to be on your toes, respectful of uncertainty. An active manager need to think of risk management first.