Pimco amassed a $2.6 billion position in Russian bonds and CDS

Pimco was exposed to around $2.6 billion of Russian sovereign debt at the end of 2021, with the bulk of that allocation in its flagship income fund.

The exposure took the form of credit default swaps (CDS) worth $1.1 billion and $1.5 billion of country bonds, the FinancialTimes reported.

It was held in five funds, primarily in the $139.4 billion Pimco Income fund, as well as the group’s $67.4 billion total return fund, Emerging Markets Bond, Diversified Income and Low Duration funds. , according to the document.

A CDS is an instrument where the seller insures the buyer against the default of an obligation. This means that the seller actually owns or has long exposure to the bond, betting that the bond will not default, and the buyer has either protection on a long position or short exposure if he does not own the obligation at all.

Pimco Income had sold approximately $940 million of CDS linked to Russian bonds by the end of 2021, the FT reported. The fund is down 5% for the year to March 9, putting it in the bottom third of Morningstar’s multi-sector bond fund category.

Over the past decade, the fund’s 5.9% annualized return puts it in the top percentile of the peer group.

CDS rose to prominence in the run-up to the 2007/2008 financial crisis, when hedge funds bet “the big short” against bad mortgage-backed bonds. Many bought swaps, effectively buying insurance on the bonds, but not holding them, with insurance company AIG ultimately responsible for paying defaults.

In this episode, companies buying insurance to establish short positions led to the creation of “synthetic” long positions, giving AIG more exposure than it otherwise would have had.

A feature of Pimco’s approach to the bond market since the days when Bill Gross ran Pimco Total Return, was to gain long exposure to various parts of the bond market or to individual bonds via such swaps.

Emerging market bonds can be far less liquid than the stock market, with many bonds traded on a date basis, and a large company like Pimco may sometimes find it easier to gain long exposure by selling swaps rather than by trying to buy the bonds in cash.

The Pimco Income fund has become hugely popular over the past decade, eclipsing its tamer sibling Total Return, as low yields pushed investors towards more aggressive funds.

MorningstarDirect data shows that 2.44% of the fund consisted of exposure to Russia at the end of last September, although it is unclear whether Morningstar data captures exposure to both bonds cash and swaps.

While a default would instantly affect cash bonds, the FT The article noted that the swap determination committee would decide how the swaps would be settled in the event of default. Pimco is himself a member of this committee, which is already deliberating on the country’s decision to pay interest in rubles.

The ruble recently depreciated dramatically following economic sanctions against Russia after its February 24 invasion of Ukraine.

According to Morningstar data, Pimco Income’s $4.9 billion sibling, Pimco Diversified Income, also had a 2.1% exposure to Russia at the end of September 2021 as well.

The data also shows that six funds in Morningstar’s Multi-Sector Bond Fund category have more than 1% of their portfolios in Russia in recent months, including the $3.1 billion Hartford Strategic Income fund with 1.55% in January 31 and the $1.4 billion Western Asset Income Fund with Exposure of 1.53% at the end of 2021.

Garland K. Long