jonathan: pimco investment management is one of the most influential bond houses in the world. in their outlook, they underlined five key drivers that have insight on five key drops i that could disrupt the global market, and their offices in newport beach, california, we have the privilege of sitting down with the ceo. manny: we are making sure we have the results and a plan. jonathan: and cio dan ivascyn. dan: by far our interest is in credit markets. it is related to corporate risk. jonathan: the equity markets are

cratering, that credit market is arguably seizing up, and pretty much every one of the major funds at pimco delivers positive returns. how do we arrive at that moment? manny: i would say it is the occasion to shine, where you get tested, and we get tested in difficult markets. we had a view, thanks to dan, on value and what the right position was to have before q4. i would not say that we saw it coming, but proper risk management mitigated the problem. we are quite pleased about the result. jonathan: defensive to want to -- going into the final quarter of 2018, coming out of it and deciding to re-risk is a different proposition. to say now is the time

re-risk. derisking is one thing, then having the enthusiasm and confidence to say now is the time to re-risk is a different question. you approach it by saying now is the time, buying some of the weakness. dan: that is right. in response to an environment in the fourth quarter where we sensed markets were overshooting fundamentals, we decided as a firm, across these strategies, to add risk to more liquid areas in the market as a more tactical view, not trying to be too confident about using the opportunity where others needed liquidity at that point in time to add risk on the market and generate a bit more total return in the first half of the year. jonathan: liquidity is something i would like to talk about. you have talked about the potential for more gappy markets. participation has increased over the last several years. yet, fundamentally, in terms of the structure, it is a market that has gotten weaker. make sense of that for people. dan: people talk about it.

people are aware of the risk. then, you have a volatility event like the fourth quarter last year, where you look at returns, it appears more people are exposed to this, less liquid than woulde market, be suggested by the market. but, we have not been tested yet. volatility has been relatively low the last several years. you have to take a look and feel the markets from a day to day trading perspective to know that, when should you shift, there will be overshooting. we are not saying this will lead to another financial crisis per se, but it will lead to disappointment. in the form of overshooting fundamentals. jonathan: you're constantly in and out of the market. what has changed in the last five years? dan: it has really been the last decade. there is less willingness from market participants to provide a buffer when investor views change. in the type of markets we operate in today, it is about lining up a buyer and seller on the other side.

if that buyer does not happen to be there, the seller doesn't happen to be there, you end up with this overshooting dynamic. management, from the standpoint of an active investment manager, needs to the top of mind. it will be one of the rude awakenings we referred to in our more recent outlook. manny: and our international expense also matters. that is what we explored in terms of behavioral finance. when you are in a different business cycle, you recognize patterns. like this looks like 1991 and this looks like 1998. you have a whole generation of people who have seen a bull market since 2009 and have seen assets going up steadily for a very long time. jonathan: when you have the committee meetings, do you see the difference in investor biases? in pimco, based on the age,

based on the demographics. is that something you see clearly? dan: we have differences of view. whether it is bias or perspective, it is upfront. jonathan: which one is it? dan: a little of both, from time to time. it is a worry that it's been a long, long time since people have been through a period of heightened volatility or gone through a credit cycle. that is why sometimes, as an active asset manager, it is best to be patient and read economic history books as opposed to being on your terminal trading every day. manny: i will give you one bias -- we do like companies who eventually make money. it is ok to lose money for a while. it is even ok to lose money for a long time if you are acquiring customers, but at the end of the day, we hope that people make money. there is a generation of people who clearly think it does not matter. jonathan: essentially, look into being liquidity providers and not liquidity demand is. -- demanders.

there is a period of time you are waiting for. i have sensed it all day, speaking to you guys this could be several years away. are you willing to sit out the period of excess that could develop? are you willing to face what some of your peers gain by being defensive? dan: yes. there has been enough localized volatility dislocation over the last couple of years where you can be defensive, the patient, be patient, you can be relatively liquid and still generate incremental return. if you get to a point, like in 2005 or 2006, with a direct trade-off between short-term performance and being defensive, we are absolutely willing to do that. it is essential as an asset manager and consistent with generating strong returns. jonathan: it is something you are anticipating happening? dan: that is correct.

this is a counter punching type market. sit back, be patient, wait for others in the market to ask for liquidity, then provide it. it is subtle, but means be defensive, be patient, be more liquid. look for lots of little trades along the way that could generate incremental return and then strike when there are bouts of volatility. we think it is a type of environment the next four or five years where that style of active management will in the -- will win out in the end. manny: i very much agree. we are hoping for a more difficult environment, and once again, whether it happens in six months or into years, it in two years, it is hard to call. but we are looking forward to more tumultuous markets and waiting for results in our game plan. inking about values options and -- thinking about values options

value opportunities is what we get paid to do. jonathan: so many people talk about the process -- no matter what asset manager i talk to, they say their process is different and it is on the edge. what is yours? dan: we have a large team and we have access to different areas of the market that certain firms do not. that is one of the key themes, and that is one of the reasons we are discussing the secular outlook today. we take a long-term orientation. markets try to time over various quarters. that longer-term orientation, we try to protect our clients from areas of the market where froth develops. jonathan: where do you think that froth is now? dan: across different areas of the market, but by far the area of most concern is in credit markets, specifically relating to corporate credit risk. that is an area where we have had a decade of low yields and an area where we are getting a lot more concerned about

fundamentals. manny: it has been a great time for weak issuers to issue papers in the u.s. and europe. when things get worse, we think we will have many opportunities to buy them cheap. jonathan: you think things will get worse? manny: for sure. on weak, high yield -- of course. jonathan: what is interesting about spending the day with you guys is how bearish you sound around corporate credit. manny: well, we are bond managers. jonathan: typically, that is a the story, but much more so relative to your competition. i've been struck by just how bearish the firm seems to be on corporate credit right now. dan: it is a subtle point. when we look at the world today, we see near-term uncertainty that could be resolved. at least to some degree. within the credit sector, spreads can go tighter over the

short term. this is the single area of the financial markets that are prone to overshooting to the downside, when people's views towards economic growth change. jonathan: you mention some of the excesses over the last couple of years. some members of the team think maybe things could get more excessive in the coming years. there was a comparison between mid-2000's. is that an outlook you are thinking of increasing over the coming years? manny: we will both say it is very hard to call the turn of the market. what you want to have as a -- is a framework where you think of value and you say, given a scenario, what are you going to do? what are you going to buy? and make sure we do what we say we are going to do. do we take pride in what our funds offer?

because in times activity markets, when equities go down 15%, we need to perform, at a -- we need to perform. building block in peoples portfolios to perform in difficult markets. the last thing they need for us is to be overweight in lazy credit, where credit drops 15 points. jonathan: coming up, pimco reveals where they are seeing growth and upside in current markets. manny: it is an opportunity, and it will become even more attractive when the business cycle turns. jonathan: that is ahead in "a conversation with manny roman and dan ivascyn." ♪

jonathan: you have been expanding. you have expanded into municipals.

what is left? any gaps you are looking to fill? manny: the main thing is not so much what you need to fill, it is whether you know something about it and how you're going to grow it. we are of the view that we want to grow organically and that, from time to time, there may be small things we can do and bring to the pimco organization. but, by large, it is hiring people, making sure we understand what we are good at and not good at it there is a not good at.e are there is a lot of introspection. dan: a lot of what we try to do is investigator the next anticipate the next

investment opportunity for our clients. we talk about credit -- a lot of that has occurred outside the united states, in emerging markets, asia, and even pockets of europe. growth areas where we anticipate the best return. you have to start, sometimes, multiple years but where that opportunity is actually out there and ready to be realized upon. that is one of our key areas of focus. jonathan: let's talk about private credit markets. is that an opportunity? manny: it is an opportunity and something we have been doing for 11 years. it is an opportunity, and it will become even more attractive when the business cycle turns. jonathan: how scalable is it? manny: it will never be as scalable as what pimco does on the liquid side, and it doesn't matter. what we do think is that there are opportunities because of what banks used to do that they do not do anymore, and it goes from buying cicadas and housing -- securities in housing to being able to opportunistically do direct lending, to do values

private credit transaction which, if managed properly and constructed the right way, should deliver 10% to 12%. and that is opportunity for us and other people. jonathan: the key question is other people. it is an incredibly competent of the environment. we talked about areas where there may be froth. is that an area where there may be a bit of froth? dan: again, consistent with our views on the corporate side, that is where we see the froth, corporate credit issuance outside the financial space. we look at areas like commercial residential real estate, private or public -- we continue to see considerable opportunity. that is a sector that, despite the global financial crisis being 11 years past, we still see frictions in markets, we still see opportunities for investors on the private side as well as a public side. that has been our focus for now, looking to harvest opportunities

in that space. jonathan: how important is that illiquidity premium that you can get out of credit markets? manny: it is twofold. it is probably a couple of percent. people get compensated for holding illiquid securities, and they are people who can easily hold these paper. think of pension plans, who do not need the liquidity, think of insurance. there are people who can own this. it is a way to structure transaction, where you think you have an edge, and understand an industry better than most. we are going to find part of what we are currently doing very attractive and some other things

not so attractive. we are cognizant of that. jonathan: within the secular outlook, number five is the one that stuck out -- financial market vulnerabilities. the idea that the market no longer absorbs the news, it makes the news, talk to me about that. how concerned are you about this financial market vulnerability you highlighted in the report? dan: we are quite concerned. this dynamic -- it may take time for this dynamic to rear its ugly head, but we are concerned about the markets being able to facilitate risk transfer when investor mindsets change. we saw a preview of that in the fourth quarter. manager, you need to be prepared for market overshooting. if you are prepared, you can make your profit from that. jonathan: the keyword is active. i imagine the argument for active is a lot stronger over the last 12 months than it once was. manny: we are active on fixed income. we have a different view than most. there's a reason why this the

case -- there is a structural reason. in terms of how the indices are computed. there are behavioral reasons why some agents on the market have a noneconomic reason to buy the papers. think of the central bank. companiesnsurance with insolvency issues. so, waiting for those as an internal benchmark is easier than other investors. when i think of active versus passive, i say don't talk to us. we deliver on a one year, three year, and 10 year basis. our job is somehow easier than equity managers. and we acknowledged this. but there are a lot of tools we can do. a company always has 200 bonds outstanding. some trade in dollars. some trade in euros. back.n swap them there are so many things we can

do. so many things we can do to enhance value and deliver better alpha. jonathan: it sounds like you think you can avoid the rest of the insolvency. manny: you need to say this is our value proposition. we will never be the cheapest . we try to add value day after day. we need to invest into our business and have other things to offer, which go beyond temporary performance. jonathan: do you think that is unique to pimco or to fixed income bond investors? there is a difference between the equity investor and the fixed income investor. is it specific to pimco or specific to fixed income investing? dan: the advantages that we have relate to the fact that we are operating in the fixed income asset class, where you have noneconomic players that work every day in the trading markets.

i do believe pimco has some advantages this stage of the cycle. we've had some convergence in terms of beta compensation. going forward, we think it will be much more challenging, and environment with lower basecase returns but higher volatility. in that type of environment, pimco should excel, given the breadth of our resources. manny: the reality is have a lot of people who help deliver performance, from 75 credit analysts to 100 core -- those people matter. what often people do not see is the need for investment inside the kitchen and the need for investment is growing one way. if you needed people 20 years people 20 years ago, you need 200 today.

jonathan: up next, how people are investing in technology and their team. dan: we literally have teams at that look at senior portfolio managers, how we make decisions across markets relative to what is optimal. it reminds you how the brain plays tricks on you. jonathan: that is ahead in "a conversation with manny roman and dan ivascyn." ♪

jonathan: i hear so many people say i need a bigger team, big technologynvest in more, big data is the future -- help me understand what you guys are actually doing now. how do you create alpha, develop that story, by investing in tech and people? how does it work? dan: one area is technology. technology and analytics. acquiring larger data sets. utilizing those data sets. understanding key drivers of return. been using this for economic forecasting, combing through a lot of offerings as

well. that is one area, the highly technical assets of data collection. another area we have been spending a lot of time is in behavioral finance. working with this research to make better personal decisions. at ourselves in the mirror. the biggest problem of fund management is overconfidence. so we center this partnership with the university of chicago to see what we do well and what we do less well, how do we optimize risk and apropos leo, being able to back that with data. jonathan: can you give a real-life example of how this has helped in the last 12 months? dan: sure. we literally have teams at look -- that look at senior portfolio managers, how we make decisions across markets relative to what is optimal. for example, do we tend to hold onto losers a little longer than

we should you do we run with -- than weshould should? do we run with trades, working on behalf of investors, long enough? sometimes it puts us in an accountable area, because it reminds you how the brain plays tricks on you, but we are in an area where we can understand biases even in the pimco group, learn from it, and make better decisions moving forward. this is a type of research we will continue for many years to come. jonathan: you have acted on these conclusions? manny: we do. it is a constant evolution. we welcome those to think about how we make decisions. everyone has a chance to opine, and the most senior guy is not the one who lectures everyone for 10 minutes before everyone has a chance to talk. people usually do not disagree with the boss after he has spoken for 10 minutes. you need to have a process and

you need to think about the process, so everyone has a voice from other portfolio managers to behavioral finance. to makene this together the best possible portfolio. jonathan: you have your office on the west coast. how does that attract the talent you ultimately want? manny: we thought -- our executive committee thought we needed an office to be able to hire talent in technology. i think it is fair to say, when it comes to higher tech people, we compete against other financial companies, and we also compete against big tech companies and also startups. and we looked at six different locations and concluded that the university was the best place for us to hire a significant amount of talent in technology. we will move a smart part of the -- small part of the business,

which makes sense to be in texas. that is attractive, and we made a quite in-depth study, and so far we have about 150 people down there. ♪

♪ carol: welcome to bloomberg businessweek. i'm carol massar. jason: and i'm jason kelly. carol: in this week's issue, how one indigenous tribe earned $1 billion. jason: the battle between donald trump and two of the world's richest men over the famed plaza hotel. carol: we begin with one of the most difficult problems in learning, how to bea