PIMCO does not publicize it, but they have several bond market indexes. One index tracks global inflation linked bonds. Most investors are familiar with the TIPS, the US Treasury's inflation linked bond offering. Many governments offer inflation linked bonds. The yields on these bonds are different from one country to another, as each country has different interest rates and rates of inflation. The yield on an inflation linked bond is very revealing, as it indicates what the market thinks the return will be on a normal bond (fixed coupon payments) after deducting for inflation.
The table below shows real yields (based on the yields of inflation linked bonds) from the GLADI-Inflation Linked Bond Index on April 1st, 2013.
Country / Region
What I found Interesting:
- Real returns for developed markets are over 3 percentage points lower than developing markets.
- The United States, Japan and Germany (the most developed of the developed markets) have the lowest real yields of between -0.42% and -1.41%
- There is great disparity between the real yields within the European Union. While Italy has a real yield of 2.97%, the average for Europe is 0.53%.
- South American countries, specifically Brazil and Chile, had some of the highest real yields in the world.
Possible Explanations And PIMCO Positions
Developed Nations Are Considered "Safer," Thus Pay Lower Yields
Developed markets are perceived to be less risky than developing markets. Two of the primary sources of risk when investing in emerging market debt: Credit Risk and Currency Risk. Most developed market government debt, such as the US and the UK, is rated AAA or one notch below, while debt from emerging market countries is likely to have a BBB rating. Bill Gross in his October 2012 commentary "Damages" questioned the notion that US debt was safer in the long-run than countries like Brazil, Russia and Mexico. He focused on both the annual deficits of these countries and the future spending commitments that were being accumulated. In both these categories, the US looked like the country that would have a problem with mounting debt.
When you live in the United States and buy US bonds, there is no currency risk. However, taking on currency risk may add to your returns and may lower portfolio volatility.
Europe Is Still A Collection Of Nations, Not One Economic Unit
Italy's real yield is more than 2% higher than the Eurozone as a whole. Investors are demanding more yield to hold Italian bonds than nations like France and Germany. There is concern that the Italian government will not be able to get its fiscal house in order, which could lead to a default or Italy's exit from the euro. Unlike Greece whose economy is very small, Italy's might be too big to rescue if the market decides that it's likely to default.
South American Yields Look Very Interesting.
The highest real yields are from countries with high nominal (fixed rate coupon) yields. In Brazil, the fixed interest rate on a ten-year government bond is 9.66%. For Mexico, the ten-year pays 5.05%. Why do high interest rates coincide with high real yields?
The short answer is that in Brazil, Mexico and Chile have growing economies and high rates of inflation. Whereas inflation rates move in a fairly limited range in the United States and the developed world as a whole, inflation can be very volatile in developing nations. As a result, bondholders may want more of a cushion to protect their returns from spikes in inflation. Furthermore, the alternative to investing in bonds in these countries can be very attractive. When PIMCO and western firms started buying Mexican government debt pushing down yields, local pension funds started rotating their assets from fixed income to equities.
Bottom Line: The higher real yields in Brazil, Mexico and Chile are not an illusion. Investing in the debt of these countries will be a bumpier ride than owning US Treasuries but, the returns should be superior over time.
Unfortunately there is not an ETF that I am aware of which gives targeted exposure to the debt of these specific countries, however they are a part of the portfolio held by emerging market ETFs like EMB. In my opinion however the best route is to buy these bonds directly through a broker like Charles Schwab or Everbank, both of which offer the ability to purchase emerging market bonds directly.
For more on why you should consider investing in emerging market debt go here.