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Emerging markets (EM) can offer attractive opportunities for fixed income investors, but navigating idiosyncratic country risks, accounting for the interplay of broader factors at work on global markets, and determining the right allocation can be extremely complex, particularly as the breadth of choices available to investors has increased over the past few years. In addition, the landscape is evolving. U.S. dollar-denominated sovereign debt is being issued by new countries coming to international markets for the first time. Local currency-denominated sovereign debt is being issued in larger sizes and with longer maturities in many nations. Corporate debt issued by firms within these countries now rivals that seen in corresponding sovereign markets. As a result, relative value can shift dramatically within and among these asset classes, and navigating tipping points can be difficult for most investors. The PIMCO Emerging Markets Full Spectrum Bond Strategy is a comprehensive solution for investing in EM fixed income that dynamically allocates across the various debt classes. The strategy has the ability to move quickly, tactically and aggressively in an effort to exploit fluid relative value across the universe of emerging market debt opportunities, thus benefiting investors by serving as a comprehensive EM fixed income asset allocation solution.
Over the last several years, and in particular since the 2008 financial crisis, emerging markets have become more prominent contributors to global economic growth. Many developed markets – looked to as more traditional investment havens – are facing slower growth, challenging demographics, and deteriorating credit quality. In addition, prospective returns in many developed markets are relatively low, forcing investors to look elsewhere for potentially higher returns.Despite being subjected to the headwinds of lackluster growth in the industrialized countries, emerging markets generally offer significantly higher growth rates, more supportive demographics, and improving credit quality. Many EM countries have cleaner balance sheets (i.e., less debt) than their developed market counterparts which affords them greater policy flexibility to respond to a fluid global environment. Importantly, these stronger initial conditions are coupled with potentially higher returns. The emerging markets have evolved from being a collective of defaulted sovereigns, and now offer diversity by issuer and type of asset class. For example, there are riskier, higher-yielding countries and those that have credit ratings rivaling some of the world’s wealthiest nations. There are also natural resource-rich, export-oriented countries and others with more production, or service-based economies. Initial conditions – such as U.S. dollar reserves, debt-to-GDP levels and inflationary pressures – vary widely among emerging markets. In addition, policy prescriptions and preferences – from interest rate cuts to exchange rate intervention and fiscal reforms – are also mixed.
The breadth and depth of asset types on offer have also increased. Sovereigns have realigned their sources of financing to tap domestic savings, helping to propel local currency-denominated opportunities to a size that now dwarfs hard currency sovereigns. Emerging market corporate bonds have matured and challenge the value proposition of sovereign debt in some cases. To add to the complexity, return drivers for each asset class vary as well. U.S. Treasury interest rates might dominate sovereign spreads (or vice-versa) in driving U.S. dollar-denominated sovereign or corporate bond returns in any given period; local interest rate changes or local currency moves could take turns driving local bond performance. Any of these factors might push one asset class to the top of the group one quarter and drive it toward the bottom the next.Investors who choose to invest in emerging markets now face two potentially daunting tasks: (1) determining which emerging market asset class is poised to outperform others and offer the best return as market environments can and do change, and (2) recognizing the best relative value opportunities, in light of current valuations, among a diverse group of countries and companies within a given asset class. PIMCO’s Emerging Markets Full Spectrum Bond Strategy is designed to provide investors access to the full suite of emerging market fixed income assets while managing the asset allocation and security-level relative value decisions, leveraging a seasoned and dedicated emerging market portfolio management team that monitors each of these asset classes continuously.
Investment philosophy and approach –
constructing the portfolio
The strategy incorporates both top-down and bottom-up considerations with respect to portfolio construction, which is implemented through investments in PIMCO’s existing EM fixed income strategies.The nuts and bolts of the process begin with the development of a target asset allocation across the eligible EM fixed income asset classes based on our preferences along the lines of duration, currency and credit. These targets are then translated into allocations among PIMCO strategies that invest in the various portions of EM such as local debt, external debt and corporates. Within each asset class, we then identify additional opportunities for country and security selection designed to add value. Finally, we layer in additional positions designed to amplify or mitigate risk factors or individual country exposures that result from allocating to the underlying EM debt strategies to ensure that the portfolio in its entirety is consistent with our views.The portfolio team begins with a framework, or benchmark, of 50% local currency exposure and 50% U.S. dollar exposure. The U.S. dollar-based universe is then further segmented evenly into corporates and sovereigns. As a result, the strategy’s neutral positioning is 50% local EM debt, 25% sovereign external EM debt and 25% corporate external EM debt.
Each of these three EM fixed income asset classes offers unique potential benefits:
Of course, emerging markets can be more volatile than developed markets, due to smaller market size, different reporting standards and political instability, among other factors. We seek to moderate some of these risks through our rigorous investment process with risk assessment at the portfolio, country and individual security levels. Aggregate risk exposures are identified, evaluated and calibrated to achieve a well-diversified portfolio, aligned with our fundamental views.The PIMCO Emerging Markets Full Spectrum Bond Strategy dynamically allocates to these asset classes based on evaluations of relative value opportunities across and within emerging market fixed income classes. Broad country and sector decisions specific to duration, currency, and capital structure positioning are guided by PIMCO’s top-down macroeconomic forecasts. Individual securities are then identified based on their risk-adjusted return potential. As the EM portfolio management team anticipates inflection points in the market, allocations can be adjusted to capture changes in relative values and to manage downside risk. The latter deserves special emphasis given the periodic bouts of volatility that emerging markets can experience. Furthermore, as the team looks to provide maximum returns, it can take advantage of additional opportunities when necessary to quickly add exposure where deemed most advantageous.
The strategy employs three sources of potential value in constructing the portfolio:
In addition, PIMCO’s risk-management framework allows the EM portfolio management team to target overall exposures such as spread duration, local interest rate duration, and currency exposure. After analyzing the resultant risk metrics from aggregating positions in various asset classes, the team will then fine-tune exposures to reach the desired targets.
PIMCO was an early investor in emerging markets and has built a world-class investment platform that includes a well-balanced team located throughout the world and in close proximity to EM countries. This presence ensures coverage during the most active trading hours of all global markets and facilitates constant, on-the-ground primary research. Our investment process is ideally suited to translate robust and sophisticated views on sovereign fundamentals into positioning across external sovereign and corporate debt, local bonds and currencies. The PIMCO Emerging Markets Full Spectrum Bond Strategy is thus ideally positioned to take advantage of the full range of skills that PIMCO offers in the EM fixed income space. Our firm-wide resources provide 24-hour global coverage and include the following (as of 31 January 2013):
The PIMCO Emerging Markets Full Spectrum Bond Strategy is designed to provide investors with a comprehensive, risk-managed global asset allocation solution for EM bonds. It can fulfill the role of an investor’s entire EM fixed income allocation – particularly for those looking to reallocate away from their existing developed market investment. Alternatively, it can also serve as a complement to existing, discrete allocations to specific portions of EM. The strategy provides investors with an actively-managed approach to EM fixed income, allowing PIMCO to dynamically adjust allocations to take advantage of new opportunities and guard against market shocks. This approach may help investors reduce overall portfolio volatility by adding a measure of diversification.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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