Strategy Spotlight

PIMCO Introduces the Emerging Markets Full Spectrum Bond Strategy

​This strategy is designed to provide investors with a comprehensive, dynamic asset allocation solution for investing in emerging markets fixed income.

Emerging markets can offer attractive opportunities for fixed income investors, but navigating idiosyncratic country risks, anticipating the interplay of broader factors affecting global markets and determining the right allocation can be extremely complex. In addition, the breadth of choices available to investors has increased over the past few years. To help investors tap the risk-adjusted return potential of the full EM opportunity set, we now offer the PIMCO Emerging Markets Full Spectrum Bond Strategy. As lead portfolio manager Michael Gomez explains, this actively managed approach provides a single point of entry into this broad universe, with dynamic asset allocation decisions supported by our time-tested investment process, emerging markets expertise and sophisticated risk-management framework.

Q: What is the PIMCO Emerging Markets Full Spectrum Bond Strategy?
Gomez: The strategy offers a comprehensive solution for allocating to EM fixed income and aims to both simplify the process of investing in EM and provide investors with the most attractive risk-adjusted returns available across the full opportunity set.

We are investing in traditional emerging markets sovereign bonds denominated in U.S. dollars, as well as the ever-deepening market for bonds in local currencies – which are typically sovereign bonds – and corporate bonds in dollars.

The combination of our global macroeconomic views and EM expertise leaves us uniquely positioned to exploit relative value among these distinct asset classes and to navigate the idiosyncratic risks within each.

Q: What is the thinking behind the strategy? Why introduce it now?
Gomez: One key thing the world has learned over the last five years is that emerging markets economies are becoming a more important element of the global economic story. EM financial markets and investment opportunities are expanding as well.

The core value proposition offered by emerging markets investments relative to developed is this: They offer the ability to earn greater compensation while investing in cleaner balance sheets with higher growth prospects, notwithstanding the reality that investors will be underwriting higher volatility and potentially less liquidity.

More investors also understand that because developed market economies and financial markets face headwinds over the secular horizon of three to five years, they need to look beyond traditional modes of global investing and search for new and more diverse opportunities for investment.

The challenge for investors is to try to answer the questions of where and how. Our sense is that most investors are underallocated to emerging markets, the world’s growth engine. However, the term “emerging markets debt” encompasses many different types of exposures ranging from sovereign to corporate to local debt and even currencies. What we aim to do with this strategy is help investors by asking them to turn the decision of where to allocate within this multifaceted asset class over to PIMCO.

Q: Could you discuss the different asset classes the strategy focuses on and the potential benefits of owning them?
Gomez: We will dynamically allocate across the debt sectors mentioned, and as we decide whether to overweight or underweight a sector, we will work within the context of an allocation framework that is forward-looking and incorporates the evolution of emerging markets fixed income as an asset class. Over the last several years, the issuance patterns of developing nations have largely pivoted in favor of local market issuance, while corporates have supplanted sovereigns in the USD-denominated market. To reflect these developments, we begin with a benchmark comprising 50% local currency exposure, 25% external sovereign debt and 25% external corporate debt.

These debt sectors have different potential benefits:

  • With local interest rate and currency exposure, investors can take advantage of undervalued exchange rates, higher yields, attractive carry and potential for yield compression.

  • EM sovereign bonds provide direct exposure to the continued improvement in EM sovereign credit quality. In addition, dollar-denominated bonds may have more defensive properties at times when local currencies are under pressure.

  • Select EM corporate bonds can provide superior fundamentals and higher yields than those of developed country credits as well as a yield pickup versus sovereigns and are generally issued with shorter maturities, helping to reduce sensitivity to U.S. interest rates.

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.

Q: Could you expand on the differences between external sovereign and local bonds, as well as the market for corporates?
Gomez: The market for external sovereign bonds has matured significantly such that they could almost be considered plain vanilla credit investments, in our opinion. In some ways that is beneficial, but it also means the first mover advantage no longer exists, and market pricing more fully reflects this plain vanilla nature.

Local bond markets, however, continue to be highly differentiated in terms of fundamentals and require the investor to navigate a diverse set of custodial, tax and regulatory issues. However, these issues produce market inefficiencies and generally mean higher yields. We believe that over time PIMCO can exploit these inefficiencies for our clients, as country fundamentals continue to improve and these markets increasingly become more transparent.

Separately, while many investors still look at EM corporates as an extension of EM sovereign exposure, we have long argued that EM corporates should also be contrasted with the global corporate credit universe. Whether relative to EM sovereign or developed market corporate debt, we believe EM corporate debt offers a compelling combination of higher yield and still strong credit metrics.

Q: Could you discuss your investment process and philosophy? How will you manage asset allocation?
Gomez: We incorporate both top-down and bottom-up considerations as we approach portfolio construction, which will largely be implemented through investments in PIMCO’s existing EM fixed income strategies.

The nuts and bolts of the process begin with 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 various portions of EM, such as external debt, local 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 that may result from our allocations to the underlying EM debt strategies, and to ensure that the portfolio in its entirety is consistent with our views.

Q: What is your outlook on emerging markets bonds and currencies, and how will you invest considering that outlook?
Gomez: This is a group of countries, generally speaking, that is growing more quickly, has cleaner balance sheets (i.e., less debt), and has more policy flexibility than the developed world, and yet, investors get paid more to lend to these countries than to developed economies.

That being said, because of their size and because they still have financial markets that are less robust and mature, they are still very much influenced by the growth and financial dynamics of the developed world.

Our sense is that the very strong tailwind that has come into financial markets from the long-lived duration rally in developed market rates is likely close to its end. We want to make sure we are positioning this strategy with a more defensive stance with respect to interest rates, so, if U.S. Treasury yields back up significantly, our clients are shielded. This will likely mean a more defensive stance in the traditional sovereign external debt portion of the strategy.

At the same time, we would tend to emphasize local markets within EM that tend to exhibit higher nominal yields, positive real yields and steeper curves with attractive carry and roll-down characteristics. The currency component is also appealing given the starting point of undervaluation and the negative effects of quantitative easing on reserve currencies in the developed world.

In the corporate sector, we see abundant opportunities to pick up yield in shorter duration, three- to five-year corporate bonds where issuer credit fundamentals are sound.

Q: Could you discuss PIMCO’s resources dedicated to emerging markets?
Gomez: This strategy is designed to target all facets of the emerging markets fixed income opportunity set, so it requires a deep and experienced global team.

Our 17 emerging markets portfolio managers located in Munich, Singapore, Hong Kong and Newport Beach, as well as our nearly 50 global credit analysts across the world (as of 31 January), provide on-the-ground research capabilities 24 hours a day.

Risk management is a critical additional factor for success, especially as we start combining various portions of EM with their divergent risk exposures. We have devoted significant resources to understanding and parsing out risks so that we can construct portfolios that accurately capture our views and to avoid exposing investors to unanticipated volatility.

Q: How does this strategy differ from PIMCO’s other emerging-markets-focused strategies?
Gomez: This strategy is designed to be our most holistic approach to investing in emerging markets fixed income. In contrast to our other strategies that are focused on a single portion of EM, Spectrum allows clients to make a single, strategic allocation to EM whereby PIMCO will then undertake cyclical and tactical shifts on their behalf across the universe of emerging markets debt opportunities.

Q: What role might this strategy play in a client’s portfolio?
Gomez: We expect to see more clients looking to broaden their fixed income exposure beyond the developed world as they seek higher levels of income and total return from their fixed income strategies.

Overall, this strategy is designed to provide investors with a comprehensive asset allocation solution for investing in EM fixed income. It can thus serve as a client’s entire EM debt allocation. Alternatively, Spectrum can serve as a complement for an investor already allocated to discrete portions of EM.

The Author

Michael A. Gomez

Head of Emerging Markets Portfolio Management

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Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed.  Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market liquidity. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.  The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Diversification does not ensure against loss.

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