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“As emerging markets have matured, it is much more of a credit asset class” Michael Gomez, Pimco |
Michael Gomez, co-head of emerging markets at Pimco in California, has run more emerging-market debt than anybody else in history – and that includes his predecessor, Mohamed El-Erian. But Gomez doesn’t have El-Erian’s predilection for making his presence felt: as he approaches the first anniversary of the announcement of El-Erian’s departure to run the Harvard endowment fund, he’s still considered something of an unknown quantity by much of the emerging markets universe. Gomez runs Pimco’s $21 billion stock of dollar-denominated debt, as well as its $8 billion local-currency portfolio; his partner Curtis Mewbourne is in charge of the diversified income strategy, which splits allocations roughly three ways between investment-grade credit, high-yield credit and emerging markets. The split puts Gomez squarely in charge of the big asset-allocation decisions in emerging markets: the decisions – like that of El-Erian to go heavily overweight Brazil both before and after its presidential election in 2002 – that can make or break an emerging-market strategy.
Less comfortable
Gomez has less say, however, on the amount of Pimco’s discretionary funds that the firm decides to invest in emerging markets. And that amount has actually fallen in 2006. “At the end of the first quarter, the firm became less comfortable with credit,” says Gomez, explaining why Pimco scaled its tactical emerging-market allocation back to the bottom end of its historical 2% to 5% range. “As emerging markets have matured, it is much more of a credit asset class.” So Pimco rotated its dollar funds out of emerging markets and into areas such as mortgages and municipal bonds.
The decision is a sign of just how unexciting emerging market debt can be these days. Gomez points out that 40% of the asset class is now investment-grade, and 80% is BB-rated or higher; the Embi index is trading at less than 200 basis points over treasuries. As a result, he says, emerging market bonds “trade much more like true fixed income” and have much less of the equity-like swings seen in the past. What’s more, with emerging market bonds trading flat to or even through like-rated US corporate bonds, Pimco is hardly giving up yield by moving to a more conservative stance. Indeed, given the impressive run-up of the emerging market portfolio over the past five years, Pimco can be forgiven for taking some profits.
The rotation out of emerging market credit means that most of Gomez’s dollar-denominated funds are now being run as part of dedicated mandates: he estimates he has about $15 billion in dedicated money and $6 billion in Pimco tactical funds. It’s also a decision that raised a few eyebrows as to the dedication of Pimco to the asset class, coming as it did shortly after the departure of El-Erian.
What many observers didn’t realize, however, was that the decision to scale back on credit was a consequence of a more generally bearish view on the US economy, in particular a bearish view on the US dollar. As a result, most of the money that has been flowing out of Gomez’s dollar funds has been flowing into his local-currency portfolio, which is now up to an eye-popping $8 billion, of which some $4.5 billion is tactical. Pimco’s dedicated local-currency fund is also off to a cracking start, having raised $2.3 billion in one year.
“The Asian bloc are the main beneficiaries of the dollar’s secular weakening trend,” says Gomez, most of whose local-currency funds are in Asian currency forwards. Asia is not only the recipient of Pimco money – the region provides a lot of it too. Pimco runs funds for Asian central banks, and Gomez says that Japanese investors alone invested some $4 billion to $5 billion in Pimco funds last year.
Gomez is also seeing more interest from institutional investors in longer-duration instruments, and a proper local-bond (as opposed to local-currency) fund looks inevitable in the near future. At the same time, his funds are going to have to start investing more in non-sovereign issuance: emerging market corporate bond issuance actually exceeded sovereign issuance in 2005.
But the trends are still relatively slow. “Three years ago, 85% to 95% of our emerging market mutual fund was emerging market hard-currency sovereign debt,” says Gomez. “Now, it’s 80% to 90%, with 5% to 10% hard-currency corporate debt, and 5% to 10% in local markets.” With the exception of a couple of high-profile bonds from the likes of Telmex, Pimco still has no real money in emerging market local corporate bonds.
In terms of asset allocation, Gomez says that Brazil is still one of his top picks, calling it “a secular credit story which will continue to improve”; he also likes Russia, which he sees getting a single-A credit rating soon and surpassing Taiwan as the country with the third-largest foreign reserves. But even as more emerging market countries become net creditors, he’s confident that the market will remain deep enough to absorb any amount of money that Pimco can throw at it.
