Emerging Local Bond: Part of PIMCO’s Emerging Markets Practice
Emerging market countries continue their maturation process, capitalizing on the fundamental reforms undertaken over the course of the past nearly two decades. In recent years, this has been marked by a continued shift away from the imbalanced reliance on external sources of both demand and financing. As part of the latter trend, sound fiscal policies and monetary policies, more flexible currencies, growing private pension systems, and higher savings rates have enabled governments to develop domestic bond markets. These bond markets enable investors to get exposure both to local interest rates and to the currencies of emerging markets, both of which PIMCO view as important return engines in the context of the changes taking place in the global economic landscape.
The emerging countries have not been immune from the dislocations that have consumed the global economy over the course of the past two years. However, their strong initial conditions--low levels of public indebtedness compared to past crises, strong budget positions, credible monetary policy, and high levels of international reserve cushions--enabled them to respond with fiscal and monetary stimulus. In many cases, countries were able to either grow through the crisis or recover quickly. Nonetheless, even as the focus shifts away from aggressive easing, interest rates in these countries generally remain attractive relative to those in the developed markets, offering not only an attractive yield pickup but potential for yield compression as well.
Local bond exposure also allows investors to access the fundamental appeal of emerging market currencies. The investment underpinnings of such exposure--favorable growth and inflation differentials and strong balance-of-payment dynamics--remain intact for most of the emerging world. In addition, despite having recovered meaningfully in 2009, valuations remain attractive relative to the long-term fair-value assessments to which currencies gravitate over time. Emerging currencies also afford investors a hedge against potential U.S. dollar weakness which PIMCO expects will facilitate the rebalancing of global economic activity.
Not only do the local bond markets represent the next frontier of emerging markets fixed income beyond U.S. dollar-denominated assets, but they are an increasingly liquid asset class owned by a highly diversified investor base. As emerging countries have increased debt issuance in their own currencies, pursuing liability management programs and developing their domestic capital markets, local yield curves have extended and local investment opportunities have increased. As a result, local bond markets have become quite liquid, in some cases more liquid than the external debt markets.
PIMCO’s Emerging Local Bond Strategy invests primarily in fixed income instruments denominated in the currencies of the emerging markets. PIMCO generally considers an emerging market to be any country that has not been classified by the World Bank as a high-income Organisation for Economic Co-operation and Development (OECD) economy for the past consecutive five years though we retain broad discretion to invest in countries which exhibit developmental characteristics consistent with emerging markets. The current per capita Gross National Income (GNI) cut off level is defined by the World Bank as $11,906.
| PIMCO’s Emerging Local Bond Markets Experience |
PIMCO has been monitoring the development of emerging economies since the late 1980s as part of our economic forum process. We started investing tactically in this sector in the early 1990s. In 1997, we began to concentrate on emerging markets as a distinct asset class with the introduction of an institutional mutual fund and, subsequently, separately managed portfolios. PIMCO is one of the largest participants in the market for emerging market debt. Our size and breadth places us in the forefront of information flows from developing countries, thereby supplementing the robust and timely understanding of the market dynamics so crucial to investing in these markets. An additional benefit of PIMCO’s stature in the market is the access that it may provide to key policy makers from various countries, helping us, in an effort to maintain an in depth policy dialogue.
PIMCO’s traditional and successful team approach is evident in our emerging market efforts. With over 14 years of average industry experience, our team applies a great depth of knowledge to our emerging markets strategies. The team-oriented strategy also allows us to stay involved in the market while conducting valuable on-the-ground research in the countries that we follow. In addition, specialized resources are added to the team based on PIMCO’s secular views which anticipate where opportunities will likely emerge in this market. |
| Role of Emerging Local Bond Markets in a Portfolio |
The principal reasons for investing in emerging local bond markets are the potential for attractive risk-adjusted returns and diversification. Local currency denominated bonds in emerging markets countries typically have low correlations with other assets classes and investments in emerging local bond markets may also afford investors a hedge from a potential decline in the value of the U.S. dollar vis-à-vis other currencies. |
| Investment Philosophy for Emerging Local Bond Markets |
PIMCO’s emerging markets strategies focus on adding value through an emphasis on the high quality countries which tend to offer the most attractive risk-adjusted-return opportunities over a market cycle. By contrast, we seek to avoid countries which subject investors to the risk of default or credit deterioration. This philosophy embodies the following key principles which guide our disciplined investment process:
- Favor countries with strong or improving underlying fundamentals, attractive valuations, and potential return catalysts
- Synthesize PIMCO’s top-down macroeconomic forecasts with individual country assessments to gauge risks from the external environment and global economy
- Avoid countries which lack an economic and policy framework supportive of their fundamentals as well as those which are susceptible to a defacto deterioration in credit quality or financial contagion due to imbalanced market technicals
- Complement fundamental analysis with a rigorous security selection process to both ensure consistency between views and portfolio positioning and take advantage of relative value opportunities across and within markets
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| Sources of Added Value |
| Value added strategies come from both macro and microeconomic levels of analysis. With the firm’s secular and cyclical Economic Forums as a foundation, we examine investment opportunities in four key areas: Emerging Markets interest rates, Emerging Markets currencies, cash management and relative value |
| Risk Management / Controls |
Fundamental to the process of risk control are the analytical tools, which are available to measure and monitor exposures in the portfolio. PIMCO has invested considerable resources in developing its own proprietary models to help in this analysis. Extensive use of analytical models allows us to leverage our investment professionals and provides a dispassionate check on our investment decisions.
In the emerging markets area, in addition to the measures referenced above, we closely monitor economic, political, and other developments that impact various domestic and external markets of the economies. This process, which reflects a disciplined recognition of the fluidity of the asset class, is “formalized” in a daily note that assesses, on a timely basis, developments vis-à-vis our existing investment strategy. We also produce monthly and quarterly notes that address these issues within larger trends and detail the investment themes resulting from our analysis and frequent country visits.
Naturally, the process feeds into PIMCO’s quarterly economic and secular forums where developing economies are also discussed in the context of broader global developments. The forum process also provides a real time opportunity for exchanges of views with other PIMCO investment professionals, thereby maximizing the scope for cross-fertilization and relative valuation assessments. |