PIMCO: Where to seek diversification from the AI investment theme
In this week’s Credit Market Lens, PIMCO Multi-Asset Strategist Lotfi Karoui discusses where investors should look in the credit markets if they want to diversify away from AI-related investments.
Key Takeaways:
- AI diversification is becoming a key challenge for credit investors. The U.S. midterm election results could slow the AI buildout and near-term issuance but are unlikely to materially reduce its ultimate scale or financing needs. The pace of supply may slow, but concentration risk is unlikely to dissipate, reinforcing the case for diversification into high quality securitized products and emerging markets (EM).
- Agency mortgage-backed securities (MBS) markets appear resilient, with attractive carry. The agency MBS sector has handled this cycle’s higher interest rates and volatility better than it did in 2023, offering a meaningful carry pickup relative to broader investment grade credit for comparable risk. Also, real estate investment trusts (REITs) have shown an ability to buy into weakness rather than being forced sellers.
- In non-agency residential MBS, we see attractive risk-adjusted return potential. Extension risk, rather than credit risk, has pushed AAA spreads wider among nonqualified mortgages (non-QM) and improved the asset class’s carry profile. The market is starting to respond by issuing deals designed to speed up senior tranche paydowns.
- EM debt offers less correlated sources of risk. The diversification argument for EM debt is that it offers exposure to a different mix of risks than the domestic U.S. market. The EM opportunity set is also expanding beyond index-eligible bonds.
