• Use of multiple strategies: We believe that no one strategy should dominate risk. We therefore employ a range of diversified strategies, including duration and yield curve management, country positioning and sector rotation as well as bottom-up security selection.
  
• Long-term orientation: We believe that focusing on longer-term secular trends offers greater opportunity to add value relative to short-term market ups and downs. Through our rigorous investment process, we look to identify long-term value and prevent our investment decisions from being influenced by short-term market sentiment.
  
• A broad investment universe: Finally, the strategy looks to capitalise on opportunities across the broad European fixed income universe as we believe this provides us with the potential to enhance returns and control risk through portfolio diversification.

To control and monitor the overall risk of the strategy, we evaluate the portfolio across several risk dimensions, such as country, duration, sector, credit quality and yield curve exposure.

Q: Can you speak to the importance of active management for this strategy?
Balls: Active management has always been a key return source for PIMCO’s Euro Bond Strategy. Going forward, given our expectation for lower yields and lower index returns, alpha will play a more significant role in the strategy’s total return. Furthermore, the current financial landscape presents some specific opportunities for active euro-denominated fixed income investors.

First, the divergence in developed economies’ fundamentals and policy presents relative value opportunities between global rate and currency markets. Second, the shape of the yield curve presents some attractive carry and roll-down opportunities. And third, bottom-up security selection is extremely attractive, both within sectors and within countries, given the level of financial fragmentation across European markets.

Q: What is PIMCO’s outlook for the eurozone over the next 12 months?
Bosomworth: For 2015, we expect a marginal improvement in growth for the eurozone, with real growth ranging between 0.75% to 1.25%, as the region continues to be hampered by weak demand dynamics. While an accommodative monetary policy, the recent drop in oil prices and a lower euro may provide some respite, the eurozone continues to be stuck in a liquidity trap. To add to the already gloomy outlook, the spillover from the geopolitical tensions with Russia as a result of trade linkages and other indirect channels with Europe is also likely to have a negative drag on regional growth.

The collapse in oil prices has pushed headline inflation into negative territory in December 2014 for the first time since October 2009 as the eurozone Consumer Price Index (CPI, a common measure of headline inflation) came in at -0.2%. However, even without the downward pressures from oil, inflation in Europe has been running close to the zero bound for 2014. More importantly, prolonged low-to-negative inflation could create a decline in inflation expectations, which has the potential to lead to a deflationary spiral as seen in Japan.

Given the growing macroeconomic pressures facing the eurozone, the European Central Bank (ECB) announced on 22 January 2015 its widely anticipated plan to enter into broad-based quantitative easing (QE) to bring back eurozone inflation toward its target of below, but close to, 2%. Beginning in March 2015, the ECB intends to purchase €60 billion worth of investment grade bonds per month until September 2016. Totaling just over €1 trillion in asset purchases across eurozone government and agency bonds, QE will also include the ECB’s exisiting covered bond and asset-backed securities purchase programmes. We believe that if QE is effective, it should cheapen borrowing costs and raise inflation expectations, which could provide the eurozone with a much-needed boost to growth.

However, QE is not a silver bullet; real self-sustaining growth will require improvements in productivity, something that cannot be achieved without public and private investment.

Q: Where are you finding interesting opportunities in Europe’s fixed income markets?
Balls: Although current yields are low compared to historical levels, we expect the ECB to maintain a supportive monetary policy over the cyclical horizon in light of low nominal growth and increased deflationary pressures in the eurozone. We see European duration remaining well-supported as core rates remain relatively well-anchored by ECB policy rates. We expect that spread sectors, such as peripheral sovereign bonds and European financials and credit, will likely outperform as an expanded ECB asset purchase programme could lead to further spread tightening. Finally, even with no changes to spreads, we continue to see attractive carry and roll-down opportunities given the steepness of the European yield curve.

Over the cyclical horizon, we remain overweight the intermediate portion of the yield curve, while underweighting longer maturities. We are overweight peripheral sovereign issuers, which offer additional yield over core European rates, and we are selectively overweight European corporate credit. Looking at currency, we are underweight the euro currency versus the U.S. dollar as we expect central bank policy divergence between the ECB and the U.S. Federal Reserve.

Q: What role might PIMCO’s Euro Bond Strategy play in an investor’s portfolio?
Pagani: Strategically, the PIMCO Euro Bond Strategy may serve as a great fit for investors’ low risk or core fixed income allocation. It seeks to offer income, capital preservation and diversification versus riskier assets, such as high yield or equity beta, when you need it most. On a tactical basis, the strategy may offer investors a compelling low risk option to benefit from the ECB’s expanded asset purchase programme, i.e., QE.