Investors should look toward emerging markets rather than developed countries for bond opportunities, according to Scott Mather at PIMCO. The portfolio manager set forth his reasons in a Q&A published by the bond company on Monday, pointing out the headwinds faced by developed countries and the advantages those present for developing markets.
According to Mather, typical cyclical models should be put aside in the current environment, since for "the next three to five years, . . . market behavior may be vastly different than what models would predict." Sovereign debt, he added, "is undergoing a seismic shift." He points out that since sovereign debt is central to the global financial system, that means all bets are off for the near term.
As creditworthiness degrades over the next few years, he adds, investors must be wary of how they attempt to avoid credit risk, since "equities, real estate and all other investments will be affected if sovereign debt of a nation deteriorates." Instead, investors should focus their attention on emerging markets countries that have worked to improve their credit profiles. Inflation will rise gradually, he theorizes, with inflation in emerging markets running a bit higher than in developed countries.
Mather points out that "businesses that have taken advantage of lower rates to lower their financing costs, while the economic recovery has boosted their sales," present additional investing opportunities that can offer lower risk.
The currencies of emerging market nations, he adds, also offer opportunities, while those of developed nations do not. The bonds in developed nations that have worked to suppress short-term interest rates can steepen the yield curve, he explains, which "can create opportunities in carry and roll down to add to bond returns."