PIMCO's Gross Urges Investors to 'Revolt' Against US Government, Buy EM Debt

(May 4, 2011) — In the face of rising inflation, Bill Gross, founder and co-chief investment officer of Pacific Investment Management Co. (PIMCO), is urging investors to embrace local-currency emerging market debt.

Expressing PIMCO’s belief in the strength of developing and emerging markets, Gross wrote, in his usual colorful language: “Bond – and stock – investors have been sailing on the ‘Good Ship Lollipop’ for over 30 years following the Volcker Revolution and the return of high real interest rates to investment markets. Now, however, with governments attempting to impose financial repression, bond investors should revolt.”

Gross’s departure from Treasuries has been widely reported. Earlier this year, his $237 billion Total Return Fund said it would hold no government debt for the first time in over two years while also cutting its exposure to mortgage-backed securities from 42% to 34% of holdings. Instead, the fund is upping its exposure to emerging-market debt to 10% of its total assets. In his latest report, Gross wrote that investors in Treasuries are being ‘shortchanged’ and are ‘abdicating their responsibility’. According to Gross, the current high inflationary environment presents immediate threats to portfolios as Treasuries are set to be “overvalued for decades,” even following the end of the Federal Reserve’s QE2 stimulus in June.

“The argument over whether the end of QE2 on 30 June will result in higher yields and lower Treasury bond prices is, in a sense, a secondary one. Even if 10-year Treasuries stay where they are at 3.3%, and Fed funds close to 0%, savers and financial intermediaries are being shortchanged by both of these yields and everything in between,” Gross wrote. “An investor should expect these overvaluations to be with us for years if not decades. While that still leaves open the question of price behavior following QE2, there should be little doubt simply holding Treasuries at these yield levels for an extended period of time represents an abdication of responsibility.”

Despite PIMCO’s confidence in the sector, pensions remain cautious about fully embracing emerging market debt, according to a March survey by Aberdeen Asset Management. Aberdeen, the global investment management group overseeing more than $287 billion of assets for institutions and private individuals, reported that limited knowledge about emerging market debt was perceived as the most popular roadblock to investing. Nevertheless, the firm acknowledged the significant value of investing in the asset class. “Emerging Market Debt (EMD) has generally remained one of the best performing asset classes for over 10 years, despite high-profile crises,” the firm stated. “In our view EMD has the potential to enhance returns, providing diversification benefits for investors. We believe that most investors should at least allocate a modest holding to emerging debt, while investors more tolerant of risk should consider a more significant holding.”

Click here to read Gross’s full letter.