What is PIMCO’s Emerging Market Investment Approach?
Consistent with PIMCO’s overall investment philosophy, our approach to emerging market investing begins with a secular analysis of the global economy which is fine-tuned on a cyclical basis. Within this framework we use a multi-step process to guide our emerging markets investment decisions. First, we identify countries with strong, underlying credit fundamentals (including strong fiscal positions, stable/improving political situations, comfortable reserve levels, and debt profiles that can withstand financial shocks, among others). We then consider the impact of our global outlook on these countries, including prospects for demand from advanced economies, commodity prices, interest rate trends and other components of the external environment. Finally, we evaluate the technical conditions of the credit to identify both the upside and the imbalances that could potentially lead to market dislocations.
This disciplined multi-pronged framework provides the basis for our country weighting, duration, curve, currency and instrument selection decisions, as well as relative value assessments. Our high quality emphasis allows us to optimize the set of strategies for a given investment environment while helping to limit downside risk.
| PIMCO’s Emerging Market 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 provides to key policy makers from various countries, helping us maintain an in-depth policy dialogue. PIMCO’s traditional and successful team approach is evident in our emerging market efforts.
PIMCO’s traditional and successful team approach is evident in our emerging market efforts. With over 12 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 emerge in this market. |
| Applications for Emerging Market Strategies |
PIMCO generally considers emerging markets to be any non-U.S. country, excluding those countries that have been classified by the World Bank as high-income OECD economies. In addition, PIMCO may consider additional countries as emerging market countries, based on a broader assessment on their development stage.
Emerging market bonds, used tactically, seek to increase performance within a core total return type bond portfolio, or strategically within dedicated emerging markets accounts. Tactical allocations have been shown to enhance the overall risk-adjusted return profile of bond portfolios. Strategically, the characteristics of emerging market bonds complement more traditional asset classes in terms of alpha generation, while providing the additional potential benefit of diversification. |
| Investment Philosophy for Emerging 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.
Sources of Added Value – The ways in which PIMCO attempts to add value are also consistent across strategies. These decisions include:
- Country overweights / underweights
- Security selection
- Duration
- Curve position
- Currency management
- Exploiting market information failures
- Taking advantage of opportunities occasioned by changes in the external environment
- Reverse inquiries
While the types of decisions are similar across accounts, the end result will depend upon the specific portfolio objectives and investment guidelines.
Tactical – In connection with a core bond portfolio, the addition of an emerging markets strategy offers investors compelling opportunity. Low correlation with other markets, declining volatility, and improving fundamentals advance the case for emerging market bonds. As is generally the case for any developing bond market, information and other inefficiencies prevail, thereby opening up important, tactical opportunities that PIMCO seeks to exploit through outright and relative value trades.
Strategic – PIMCO has been monitoring emerging economies since the late 1980s. 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, initiating an emerging market institutional mutual fund and, subsequently, separately managed portfolios. Dedicated emerging markets portfolios are typically managed against either the JPMorgan Emerging Markets Bond Index Global (EMBIG) or a custom index, though several other appropriate benchmarks are utilized. For portfolios managed against the EMBIG, we seek to maintain consistently higher credit quality than the index. Put differently, we seek to achieve superior risk-adjusted returns. |
| Long-Term Outlook for Emerging Markets |
| PIMCO believes that emerging markets will continue to present attractive opportunities in the years ahead. We believe that many emerging economies exhibit greater growth potential, especially in comparison to the developed world, as a result of stronger initial conditions exhibited by these countries in the period leading up to the global financial crisis. In addition, greater macroeconomic stability, non-U.S. direct investment inflows, improved liability management, and structural reforms (deregulation, privatization of key industries, further reduction of trade barriers, and greater orientation toward the international economy) should benefit emerging markets. Finally, the asset class also stands to benefit from a continued broadening of the investor base. |
| Risk Management / Controls |
One of the unique structural decisions made by the founders of PIMCO many years ago was to separate the process of managing money into three distinct functions: investment, trade processing, and client service. Each function is performed by a separate group within the firm. Investment decisions ranging from strategy initiation through trade execution are performed by the Portfolio Management Group. Trade processing falls within the purview of the Investment Operations Department. All client servicing requirements are met by the Account Management Group.
This structure has served PIMCO well in many ways, the most important of which is that it provides a system of checks and balances by placing compliance issues within the purview of each of the three groups. Portfolio Management, Investment Operations, and Account Management are all responsible for checking and/or monitoring client guidelines. Multiple layers of responsibilities for compliance issues make it difficult for any individual to act significantly outside of the guidelines established by the client without detection.
To monitor and/or check guidelines in the most efficient way possible, PIMCO has devoted considerable effort over the years to developing a network of integrated computer programs that provide information key to this process. It has also developed analytical tools that include variables overlooked by traditional fixed income risk measures.
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 conduct less frequent more detailed analysis that addresses these issues within larger trends and details the investment themes resulting from our analysis and country visits.
Naturally, the process feeds into PIMCO’s quarterly economic and secular forums where the emerging market asset class is also discussed in the context of broader global developments. It 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. |