Fixed Income Analysts Society: Induction into Hall of Fame
Remarks by Mohamed A. El-Erian
April 14th, 2011
It’s a great pleasure and a huge honor to be here this evening.
Thank you Tom for your kind introduction. I have always known you to be an incredibly thoughtful and insightful person; that you are well read; and that somehow you manage to combine all this with elegance and poise. Now I also know that you are enormously generous.
It is an immense delight and a great honor to be inducted into the Fixed Income Hall of Fame. If you allow me, I would like to start my remarks this evening with one congratulation and three other thank-yous.
I would like to extend my heartfelt congratulations to Professor John Finnerty for his induction with me into the Hall of Fame this evening. John, we have long admired your work, especially on valuations and solvency. And it is not often that we come across someone with such a rich publication record of over 100 books and articles. Congratulations on your induction and thank you for your contributions to our industry.
Allow me also to express my deep gratitude to David Munves, President of the Fixed Income Analysts Society, and to other members of FIASI. Thank you for nominating me; for this wonderful honor; and for organizing this evening’s lovely event which has allowed me to catch up with some dear old friends and acquaintances.
This takes me to thanking you all for coming. It is wonderful to be here with you and I greatly appreciate your taking time from your busy schedule to make this evening’s event even more special and memorable.
Finally, I would like to address my PIMCO colleagues in the audience, and those that are in our offices around the world.
We all know that I would not be here this evening receiving this wonderful honor if it weren’t for you and for my wife Jamie and our daughter (who unfortunately could not travel to New York today). I am deeply grateful for the amazing support that you have provided me every single day of my incredibly fulfilling career at PIMCO.
In 1997, I interviewed for a job at PIMCO having worked for almost 15 years at the IMF in Washington DC and under a year at Salomon in London. I came to PIMCO as an economist and, at that time, I certainly would never have imagined that I could even aspire to be here tonight for this honor, let alone be a recipient. Yet, Bill Gross and my amazing PIMCO colleagues patiently taught me fixed income, portfolio management, and a whole lot more.
Bill and others did with me what they have done with many others—enable and teach us to become better professionally and personally. Every day, they instill in us amazing standards of excellence, high intellectual curiosity, and deep commitment to our clients.
In short, this award is much more about PIMCO than it is about me.
We gather tonight at a time of great fluidity and change for the global fixed income markets. The immediate causes are well known and speak to a whole host of exogenous factors: From the changing role of non-commercial players in markets (including the Fed via QE2 and the ECB via peripheral bond purchases) to a range of geo-political and other factors, including developments in the Middle East and Japan. They also include, of course, the political discourse on fiscal policy in this country and, therefore, the outlook for the largest issuer in global fixed income markets.
All this is consequential and complex. Our fiduciary responsibility is to navigate to the best of our ability this complicated world. Indeed, I would so love to engage you in a conversation on all this. But I won’t. Instead, I will share with you some thoughts on something else that is going on in global fixed income—something that is as deep, more durable, and very consequential yet it is insufficiently discussed notwithstanding the potential impact on our industry and the role it performs in society.
Like other markets, the fixed income markets are navigating some major national and global re-alignments. Think of this in terms of the distinction that we were taught at school between variables and parameters.
Variables change often and, in most cases, tend to be mean reverting. Parameters are fundamentally different. They provide foundations that, fortunately, do not change that often. They are de facto anchors for much of the conventional wisdom that prevails in markets and institutions, and they underpin many of the analytical shortcuts that are used (including benchmarks).
So, if and when parameters change, we should all pay close attention. And, today, many parameters are on the move.
Let me give you some examples to provide you with a sense of this important issue, starting with Europe where we have witnessed dramatic changes in the characteristics of the government bond market in the Euro-zone.
What for most investors was for years a market dominated by just interest rate risk, has become a volatile combination of both interest and credit risk. Indeed, there is even uncertainty as to where the line between interest rate and credit risk should be drawn within this important region for global fixed income. The result is a government fixed income market that behaves very differently—in terms of risk and return—than just 18 months ago; and one that plays an evolving role in traditional asset allocation and portfolios.
The same can, and should be said of the US municipal bond market. Here we are also experiencing a major transformation in terms of interest rate and credit risk.
This is another change that has caught quite a few investors by surprise. Consistent with this, there has been a tremendous reduction in investor exposures, especially among the retail sector. Witness the 21 consecutive weeks of mutual fund outflows, amounting to a staggering total of some $45 billion since November.
We should also note development in the emerging market segment of global fixed income. This is about much more than just the maturation of an existing market segment in the context of the developmental breakout phase being experienced by several systemically-important emerging economies. It is also about the creation of new market segments and the completion of links among sectors that are reaching critical mass.
Finally, there is the most material aspect of all, what is happening at the very core of the global fixed income market. At this critical core, lies the US Treasury market: the grandparent of the very few “risk free” instruments in the world; the AAA of AAAs; and the provider of a range of global public goods.
A strong core is essential to the good functioning of a market system that inevitably has to deal with all sorts of unexpected exogenous shocks. Simply put, it helps hold the system together.
In the midst of the global financial crisis, policymakers took the right decision in using public balance sheets to offset the massive disorderly de-leveraging of private balance sheets—those of banks, companies and households. To use the phrase of my good friend, Paul McCulley, the responsible thing was to be irresponsible.
But it has been two and a half years since the collapse of Lehman, and the core of the global system is still acting irresponsible. America’s fiscal deficit is still at an alarming 10% of GDP. The debt stock has grown materially. We still do not have consensus on a medium term fiscal reform vision, let alone a detailed plan. And contingent liabilities are piling up.
The longer this situation prevails, the greater the risk of erosion at the core of global fixed income markets.
This is not historically unprecedented. Great Britain was forced out of the core by the tragic events of two world wars. But there was a good candidate for replacing Britain—the United States of America.
If—and, fortunately, it is still an if—the global standing of US Treasuries erodes significantly from here, there is no readily available candidate to step in. Since you cannot replace something with nothing, the global system would, in this scenario, have to function with a weak core.
This scenario raises the interesting questions of how would global fixed income markets operate in such a world. This is an extremely complex question. For example, it is not even clear whether the right analytical framework is an absolute or relative one. Would everything simply re-align, or would the system recast in a fundamentally different manner?
Put all this together, and what you have is an interesting and uncertain evolution for the global fixed income markets over the next few years. With a number of parameters in motion, our collective responsibility is to be intellectual curious, open minded, operational agile, and culturally adaptable.
Inevitably, we will be forced over the next few months and years to question conventional wisdom, as well as long-standing analytical and operational short cuts—and we should be ready to do so. Benchmarks will need to evolve further, and investment guidelines will need to be updated.
We will all be challenged to be more global, and to find better way to compare and contrast a growing number of changing market segments.
It is critical that we all step up to this challenge. It is a key fiduciary responsibility that we owe to those who have entrusted us with their savings, pensions, investments and retirement funds. It’s a responsibility that must be met to the best of our ability.
It is also an important social responsibility. Remember, the global fixed income markets play a key role in mobilizing and allocating capital around the world. In the process, they impacts investment, consumption and employment. Most fundamentally, they impact the welfare and well beings of billion of people around the world.
So, in re-iterating my thanks to all of you for being with me this evening for this very special and memorable evening, I stand here in front of you with a mix of excitement, apprehensiveness, and humbleness.
I am excited at the opportunities for investors in global fixed income markets. I am apprehensiveness at what is required to navigate this exciting outlook. And I am humbled (or, to use PIMCO terminology, “constructively paranoid”) by the ability of markets to continuously evolve and challenge us. Once again, thank you very much for this wonderful honor, and for being here tonight.