Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Cautious optimism from PIMCO on emerging market bonds
(Pictured: Ramin Toloui)
In a briefing paper to clients, PIMCO, the world’s largest fixed interest manager, has addressed the question as to whether investors should buy back into emerging market bonds after the recent sell-off. The answer is: perhaps.
The paper, written by Ramin Toloui, the global co-head of emerging markets portfolio management, says:
“From a fundamental point of view, we see value in the higher yields available on many EM bonds, both in local currency and US dollars. In a global environment characterized by continued concerns about growth – even amid firmer economic indicators – policy interest rates in both developed and emerging countries are poised to stay low.
“In that context, yields (as of August 13) of 6.54 per cent on EM local currency government bonds, 5.95 per cent on US dollar-denominated EM sovereign bonds, and 5.73 per cent on US dollar-denominated EM corporate bonds offer advantages to cash and a defined income stream in a world of questionable corporate profit growth. Moreover, we continue to expect a reallocation by global investors away from lopsided allocations to developed countries and into emerging markets to provide support for EM asset prices in the years ahead.
“On the negative side, we expect that there will be continued volatility in EM assets alongside the continued reconciliation of market positioning with expectations about Fed actions. Even if our view on weaker global growth is correct, it could be negative for EM currencies as softer economic conditions produce less appetite for investors to go abroad. In other words, what is good for EM yields might not be good for EM currencies in the short term.
“This is especially true of countries with weaker fundamentals (current account deficits, mismatched currency denomination of assets and liabilities, unorthodox policy regimes, and low foreign reserve coverage). These countries are vulnerable on both the interest rate and foreign exchange fronts.
“Adding this all together, we think that investors should consider using the valuations in EM bonds after the sell-off as an attractive entry point to build positions toward a long-term strategic target, emphasizing strategies with a higher-quality bias. This is premised on the observation that the starting point for most investors is very low exposures to EM bonds – which represent only about 7 per cent of total US mutual fund investments in bonds (and therefore an even lower proportion of overall US investor portfolios), according to EPFR. In a world where large global investors are rotating into EM assets, periods of market weakness provide an opportunity for smaller retail and institutional investors to build toward their strategic allocations, while retaining dry powder for additional purchases should market volatility persist.”
For the full paper: http://www.pimco.com/EN/Insights/Pages/What-Role-for-Emerging-Markets-After-the-Sell-Off.aspx
