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It’s not easy being a bond investor these days.
With central banks in many developed economies keeping interest rates low, investors in traditional government bonds are caught in what Bill Gross, head of Pimco, recently described as “a Devil’s Bargain”.
Gross, whose $236bn Total Return Fund makes him one of the bond market’s most influential figures, argued that the (low) interest government bonds are paying was being eroded through inflation, currency debasement or both.
So are emerging markets a sensible alternative? Yes, if you look in the right places, says Pimco.
According to a report from Michael Gomez – the fund’s executive vice president - Asian currencies (and not just the renminbi) have remained undervalued vis-a-vis the US dollar and the euro, as governments from Thailand to South Korea sought to keep exports competitive. But the upside potential for investors is becoming increasingly evident as these countries let their currencies appreciate to combat inflation.
Elsewhere, Gomez argues that Brazil and Russian oil and gas sector debts offer similar value investment opportunities.
The value contrast in local duration exposure between much of Latin America and the rest of the world is significant, particularly in the case of Brazil. As opposed to the majority of the G-3, much of Asia and much of emerging Europe, where real rates are sharply negative, Brazil has among the highest nominal and real rates in the world. Put differently, Brazil local markets currently compensate an investor substantially more for inflation and currency risk than do traditonal G-3 fixed income markets…
… Russian oil and gas stand out as an example of a sector attractively positioned to potentially benefit from high commodity prices and able to deliver a steady supply of energy as other sources may look less viable.
Emerging market bears might argue that these are not inflation-proof strategies. With rising prices scaring policymakers in EMs around the world, it is by no means clear that EM authorities will win their battle with inflation, given the combined impact of excess liquidity coming from the developed world and rising commodity prices. At the very least, some countries will manage the challenges much worse than others. Not for nothing is gold at around $1,500 an ounce.
Pimco has not been shy about putting its money where its mouth is. It made headlines this month by taking a short position on US Treasuries, effectively betting that the value of debt issued by the US government would fall as the country’s shaky finances drive interest rates higher.
Given this and the fund’s track record – the Total Return Fund has outperformed the benchmark in seven of the past 10 years, according to Morningstar – investors might want to follow Pimco’s lead and allocate a larger portion of their holdings to emerging markets assets.
Related reading: Pimco manager bets against US debt, FT Top investors raise alarm on inflation, FT Asia should decouple from loose Fed policy, FT
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