What is PIMCO’s Emerging Markets Corporate Bond Investment Approach?
Investment opportunities in emerging markets (EM) corporate bonds have expanded dramatically in recent years. Governments across the developing world have sought to shift their economies to a higher growth plane by facilitating increased investment in key sectors, allowing private investments in formerly state-owned companies and supporting the growth of privately held companies. As a result, the EM corporates market has deepened in size and attracted more investor interest, and is now offering investment opportunities in many sectors like energy, metals and mining, transportation, telecommunications, social housing and banking, among others. The PIMCO Emerging Markets Corporate Bond Strategy aims to benefit from this development.
PIMCO’s process for investing in emerging markets corporate bonds takes place within the context of our robust emerging market investment framework. Sovereign research forms the foundation for this framework and, consistent with the firm’s overall investment philosophy, our approach begins with a secular analysis of the global economy. We then employ a multi-step process for analyzing sovereigns. 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). Second, we 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 market to identify both the upside and the imbalances that could potentially lead to market dislocations in a given country.
Within those countries favored by our sovereign research process, we leverage PIMCO’s credit research capabilities. This entails industry analysis wherein credit analysts and portfolio managers work together to identify those sectors which are likely to benefit from either explicit or implicit sovereign support or where there is an important and identified structural shortage which will be fulfilled by the sector. Individual issuer and issue analysis complement the industry assessment. Fundamental, entity specific analysis is one of the most critical components of our corporate bond investment approach and entails evaluation of the company or project’s viability; management’s capability; potential operational and financing challenges; and other technical risks. Issue specific factors such as guarantees, concessions, and covenants are likewise taken into account.
This disciplined multifaceted framework provides the basis for our country, industry, and issuers’ weightings, duration, curve, currency and instrument selection decisions, as well as relative value assessments. By emphasizing high quality countries and sectors strongly positioned for growth, often of systemic importance for the government, it helps us in our effort to optimize the set of strategies for a given investment environment while seeking to limit downside risk.
| PIMCO’s Emerging Markets Experience |
| PIMCO is one of the largest participants in the market for emerging markets debt. This helps place us at the forefront of information flows and new issuance, thereby supplementing the robust and timely understanding of the market dynamics so crucial to emerging markets investing. An additional benefit of PIMCO’s size in the market is the access that it provides to key policy makers from various countries. This helps us maintain an in-depth policy and industry dialogue and provides the basis for reverse-inquiry. 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 we rely in our efforts to anticipate where opportunities will emerge in this market. |
| PIMCO’s Global Credit Experience |
| PIMCO is one of the leading investors in the global credit markets. Corporate bonds have been a key component of our investment strategy in core fixed income portfolios since 1971. Today, the effort is supported by a team of dedicated credit analysts located in PIMCO offices around the globe. Research is organized by region and industry rather than by quality rating, enabling analysts to focus their experience and expertise within a small set of industries to identify best-in-class opportunities. Similarly to the emerging markets team, PIMCO’s size helps facilitate access to key decision makers in firms and enable a critical dialogue with competitors, supply chains, and regulators all of which serve to help us achieve an understanding of the dynamics at play within each industry. |
| Applications for Emerging Markets Corporate Bond Strategies |
The Emerging Markets Corporate Bond strategy is designed for investors seeking to capitalize on the secular factors which favor a strategic allocation to emerging markets more generally: their rising contribution to global economic activity and a trend improvement in creditworthiness. Continued growth--a high priority--will require investment, particularly in infrastructure. In addition, as emerging country governments seek to utilize the fiscal credibility they have built over the past decade to preserve growth amidst a global recession, their fiscal stimulus measures have been largely directed at infrastructure. This suggests that the strategy may benefit further from cyclical forces currently at work in emerging markets.
Emerging markets infrastructure bonds, used tactically, seek to increase performance within both core total return type bond portfolios and dedicated emerging markets accounts. Strategically, the characteristics of emerging markets infrastructure bonds complement traditional asset classes in terms of alpha generation, while providing the additional benefit of diversification. |
| Investment Philosophy for Emerging Markets and Corporate Bonds |
Three-Pronged Approach to sovereign analysis – Our disciplined approach guides both strategic and tactical decisions. All conditions are necessary – none is sufficient on its own.
- Strong underlying credit fundamentals
- Limited risk from the external environment and global economy (drawing on PIMCO’s secular and cyclical forums)
- Not susceptible to a defacto deterioration of credit quality or financial contagion due to imbalanced market technicals
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| Higher Quality Bias |
PIMCO’s emerging markets portfolio management style typically involves greater emphasis on high quality holdings. By emphasizing such issuers and those infrastructure names of systemic importance for the government, we look to retain upside potential while minimizing exposure to “big accidents,” thereby aiming to consistently outperform over a typical emerging markets cycle. |
| Sources of Added Value |
The ways in which PIMCO attempts to add value are generally consistent across strategies. These decisions include: - Country overweights / underweights
- Industry overweights / underweights
- Security selection
- Duration
- Curve position
- Taking opportunities due to first mover advantage in the right infrastructure projects
- Currency management
- Exploiting market information failures
- Taking advantage of opportunities occasioned by changes in the external environment
- Reverse inquiries
Tactical
In connection with a core bond portfolio, the addition of emerging markets infrastructure offers investors compelling opportunity. Low correlation with other asset classes and strong or improving fundamentals coupled with either explicit state ownership or implicit government support advance the case for emerging markets infrastructure 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 began investing tactically in this sector in the early 1990s. In 1997 we began to concentrate on emerging markets as a separate asset class, launching an emerging markets institutional mutual fund and, subsequently, separately managed portfolios. As the asset class evolves and investment opportunities in infrastructure continue to expand, the Emerging Markets Corporate Bond strategy encompasses the evolution of the opportunity set. The strategy is managed against the JPMorgan Corporate Emerging Markets Bond Index Diversified (CEMBI Diversified). |
| Long-Term Outlook for Emerging Markets |
| PIMCO believes that emerging markets will continue to be an important source of outperformance opportunity in the years ahead as there will be a continuing shift in the balance of economic power away from the major developed economies and toward important emerging countries. We believe emerging economies will divide into two groups. Countries with fiscal and economic imbalances will return to the old paradigm that alternates between austerity and instability. Those in stronger financial condition and with growing internal markets will maintain their development breakout phase. Infrastructure investment in the latter group of countries will further boost productivity gains and economic growth, thus rendering investments in selected opportunities in the asset class more attractive. |
| 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. |