A few times a year, the PCM Encore investment team sits down with leading asset managers where we allocate client capital. We do this not to review slide decks or listen to quarterly updates, but to pressure-test assumptions, challenge positioning, and ask questions that don't make it into prepared remarks. We recently held our inaugural Investment Forum in the Bay Area, which brought together our team and a select group of leading asset managers for exactly these kinds of conversations.
What follows are a number of themes that rose to the top and how they're shaping the way we think about portfolio construction today.
The Mag 7 And Equity Valuations
The conventional wisdom on mega-cap technology has been straightforward for years: these are exceptional businesses, and exceptional businesses deserve premium valuations. That logic held, until it quietly stopped being true for some of the most prominent names.
In our conversations with equity managers, a contrarian perspective emerged: several of the largest technology companies have grown earnings substantially in recent years, yet their share prices have not appreciated commensurately relative to the rest of the market. The result is that some of the names most commonly dismissed as "overvalued" are beginning to look more interesting. One particular example: Walmart currently trades at a higher earnings multiple than Amazon, despite Amazon's durable earnings growth and high quality business. Over the past 5 years, AMZN stock has lagged the S&P 500 by nearly 30%.
The takeaway is not that mega-cap tech is cheap, or even that we are recommending a sectoral rotation. Rather, our takeaway is that there is beauty in owning the index as a whole, as markets don't always reward what constituents believe to be the most obvious companies. In the past five years alone, we have seen a shift of capital from high-flying software names, to semis and materials (the bottlenecks of AI), and most recently, to energy given the Middle Eastern conflict. In this most recent macro regime of geopolitical uncertainty, we expect to see tailwinds to mega-cap names who are highly cash generative.
On Active Fixed Income
The rise of passive investing has been one of the defining mega-trends of the past two decades, and in equity markets the logic is hard to argue with. Index funds weight their holdings by market capitalization, which means the largest, most successful companies naturally receive the most representation, while the laggards fall off. The index is, in a sense, self-correcting and has worked incredibly well in a decade where returns have largely been driven by large-cap and mega-cap businesses.
Fixed income work differently. Market indexes typically weight by debt issuance, which means the most indebted borrowers receive the largest allocations. In other words, passive bond investing systematically overweights towards companies that have borrowed the most. That is not necessarily how a rational investor would construct a bond portfolio from scratch, and it creates a structural inefficiency that skilled active managers can exploit.
This insight was a meaningful driver of our decision to incorporate PIMCO as PCM Encore's active fixed income manager. In our view, the risk-return is particularly attractive taking a two-pronged approach to fixed income investing. For short and intermediate duration fixed income, we employ low-cost passive funds that provide exposure. For the long end of the curve, where we believe there is more ability to generate alpha, we allocate to PIMCO's fund of funds, which dynamically reallocate to different underlying active constituents depending on market conditions. With this approach, we anticipate generating superior yield and better risk-adjusted returns versus a passive approach alone.
Tax-Aware Long/Short & Direct Indexing
While we have written previously about direct indexing and tax loss harvesting more broadly, a popular discussion of late amongst advisors and clients has been around long/short strategies.
Tax-managed long/short equity strategies, when applied to the right client profiles, can meaningfully reduce tax drag in excess of what one would get from direct indexing while preserving full market exposure. For clients who anticipate a significant capital gain event in the near term (i.e., a business sale, a large stock vesting, an inheritance) these strategies can be a highly effective tool for managing the tax consequences without stepping out of the market.
Tax-aware long/short also address one of the lesser-discussed limitations of traditional direct indexing: over time, as the cost basis in a portfolio falls, the opportunity to harvest losses diminishes -- a phenomenon known as ossification. Long/short and equal-weight index approaches preserve this harvesting capacity for a longer runway, without requiring additional capital contributions to do so. It is not a universal solution, but for the right client at the right moment, the impact can be substantial. It should be noted that tax-aware long/short should be considered a longer-term strategy and not a one-time fix for a capital gains event, as the unwinding process can take a while.
On Private Credit
Alternative asset classes, specifically private credit, have attracted their share of skepticism in the financial press recently, and we think it's worth separating signal from noise.
As part of our Investment Forum, we had the chance to have conversations with leading private credit and real asset managers, including teams from Blue Owl and Blackstone. On private credit, it is important to break down the difference between financial risk and headline risk. The structural characteristics that make private credit attractive have not changed: floating rate structures that benefit from elevated rates and low correlation to the volatility of public equity markets. Yet there is real risk of gating and proration if clients try to pull out their money all at once. These are structural characteristics put in place to protect remaining investors, as asset managers cannot immediately sell illiquid assets to raise the cash to return capital all at once. The mismatch between "illiquid" and "semi-liquid" is what the media is picking up on.
We fully anticipate there to be gating on many private credit funds over the next quarters, but so long as the underlying loans and investments are sound, we are not necessarily concerned for our clients. In an environment where inflation remains a concern and public market swings (in both equities and fixed income) have become a regular feature, we believe there is still a place for private credit in client portfolios over the long run.
Position sizing matters as much as asset selection. The question is never simply "should we own this?" It is also "how much, for whom, and why." At PCM Encore, we've generally been conservative with our sizing of alternative assets, and for most clients private credit should remain an adequately sized portion of the overall portfolio.
The Value of Being In the Room
There is a pattern in this industry that we think about often: advisors tend to communicate with clients least when markets are most unsettling. When fear is elevated and headlines are alarming, the phones go quiet. We believe the opposite approach is right.
Staying in the room -- with managers, with clients, with the hard questions -- is how good investment decisions get made. The themes above are not abstract. They are shaping how we build portfolios, which managers we partner with, and how we think about risk on behalf of our clients right now. We will continue to share what we're learning as those conversations evolve.
Want to discuss how these themes apply to your portfolio? Reach out to your PCM Encore advisor or schedule time with our investment team.
