Q: The developing local markets sector has been one of the best-performing sectors in the global fixed income market so far in 2006. What has been driving the performance in developing local markets? 

Gomez: The performance in developing local markets so far in 2006 has been quite strong. For the year through the middle of August, it was actually the best performing asset class, among those that PIMCO traditionally invests in.

 

Two factors have driven the performance in developing local markets. One is the continued secular maturation process underway in emerging market countries that we have been talking about at PIMCO for quite some time. With that maturation process, investor interest in local markets products has increased and more money has entered these countries and these markets. As demand for local markets exposure from investors has picked up, that’s helped drive returns.

 

The second factor driving performance this year has been the weakness in the dollar, particularly against the euro. Those currencies and local markets that are more closely tied to Euroland have gotten a tailwind this year in terms of performance from the appreciation of the euro against the dollar.

 

Q: What is PIMCO’s outlook for developing local markets? Is this performance likely to continue? 

Gomez: The outlook for developing local markets continues to be favorable in our mind. The asset class continues to offer investors higher real yields to attract capital. It’s an asset class that offers benefits from diversification, in terms of having low correlations with other asset classes. And it’s an asset class that is likely to benefit not only from our continued outlook from a secular perspective that the emerging markets asset class continues to mature, but also from PIMCO’s secular view that the U.S. dollar is susceptible to a decline. When you invest in these local markets, you are investing in non-dollar assets, and so, to the extent that you have a correction in the dollar, many of these local markets may be beneficiaries of that correction.

 

Q: How is PIMCO’s favorable outlook for developing local markets shaping your portfolio management strategy in the sector? 

Gomez: The strategy we use in local markets is consistent philosophically to the strategy we’ve taken across emerging markets and across riskier assets in general, which is to emphasize higher quality. We have been focusing on countries and credits that have strong fundamentals supporting them, namely, current account surpluses, improving fiscal balances and large international reserves that tend to bolster investor confidence to invest in these local markets.

 

We also have been favoring the Asian region, in particular, based on our secular view that growth dynamics in the Asian region should shift over time, from being more mercantilist in nature to perhaps relying more on domestic consumption and internal demand dynamics. As that shift occurs, countries and currencies in the Asian region should have a greater tolerance for currency appreciation. This dovetails very nicely with our view that the U.S. dollar may experience a secular downturn and that the Asian region is likely to be the prime beneficiary.

 

Q: There have been a large number of elections in emerging market countries this year and there are several more to come. Has the political noise had an impact on the developing local markets sector? 

Gomez: The heavy election calendar was one of the main risks internal to the asset class heading into 2006. And so far, through the first three quarters of the year, it’s been a relatively smooth electoral period. There are a couple of elections coming up in the fourth quarter, and Brazil’s election in October will certainly be a big one to watch. But at this point, it looks like there will be relatively little volatility from that election as compared to years past.

 

The asset class and many of the countries in it have gotten to a point where local institutions and local political systems have developed sufficient checks and balances to make the election cycle and any particular election perhaps less important and less of a market event than in years past.

 

Q: Earlier, you mentioned that new investors have helped drive performance in the developing local markets sector this year. Who are these new investors and why are they entering the sector?  

Gomez: We’ve seen a pretty diverse group of players enter the developing local markets sector. There certainly is a group that is quite familiar with this secular maturation story that PIMCO has been stressing in emerging external debt markets and these investors are looking at the developing local markets sector as a next step in that maturation process. These are investors who understand emerging markets, understand the risks, and are comfortable with developing local markets opportunities.

 

The second group of investors we have seen entering the developing local markets sector are those who are looking to diversify their portfolios out of the dollar and are perhaps looking for a hedge against a decline in the dollar. Many investors are now becoming wary of potential long-term weakness in the dollar due to twin deficits in the US that PIMCO has been warning about. Those investors are finding the developing local markets sector attractive as it gives them important diversity benefits and also gives them a hedge against a dollar decline.

 

Q: What do you expect to be the next step in the maturation of emerging markets?  

Gomez: I think the next step in the evolution of the market really comes from the continued advancement of the longer duration space in local markets. More and more countries are now looking to develop liquid, five-year and 10-year local bond markets. In fact, many countries have started replacing financing in external markets with local markets financing. For instance, Mexico now fully finances itself in its local market in pesos. South Africa fully finances itself in its local markets in rand. Some of the second-tier credits—Peru, Colombia, Brazil, for example—are also developing larger and more liquid local markets, and these are serving as a viable source of financing.

 

You are starting to see increased external investor appetite for longer duration local markets risk. As investors have realized the strides that these countries and credits have made, they are looking for different ways to take long duration exposure and the local markets space is becoming increasingly sought after.

 

Q: Thank you, Michael.