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In his last monthly Investment Outlook, Bill Gross stated that the end of quantitative easing may have dramatic consequences. He is quite bearish on US Treasuries and asks the question “Who will buy Treasuries when the Fed doesn’t”? Gross believes that Treasury yields are perhaps 150 basis points or 1.5% too low when viewed on a historical context and when compared with expected GDP growth of 5%. Treasury yields may have to go higher to attract buying interest.

Bill Gross and PIMCO have been moving money from the sale US Treasuries into other asset classes that offer higher yields and capital gains potential. One asset class that should benefit is emerging market bonds.

Mark Kiesel, PIMCO’s head of corporate bond portfolio management, recently wrote a report “Rising Stars”, where he states that PIMCO

Is finding numerous opportunities in investments tied to emerging markets as these countries provide supportive macro-economic tailwinds of healthy economic growth, low leverage, rising consumer wealth and favorable demographics, and sovereign resources.

Within the closed-end fund universe, the Morgan Stanley Emerging Markets Debt Fund (MSD) offers a way to invest in emerging market debt. MSD uses a modest amount of leverage, has fairly low expenses and is currently available at an attractive discount to net asset value.

MSD uses a value-oriented approach and seeks a high total return from income and price appreciation by investing in a range of sovereign, quasi-sovereign and corporate debt in emerging market countries. The management strategy combines top-down country allocation with bottoms up security selection. The funds investments are mostly denominated in U.S. currency.

Security Type Breakdown (as of 01/31/2011)

Sovereign Non-Brady

72.22%

Local Currency

16.94%

Quasi-Sovereign

14.35%

USD Forward

-7.11%

Corporate Bonds

3.99%

Other

-0.39%

MSD has a good long term NAV performance record. Over the last ten years, it has had only one losing year in 2008 when the net asset value fell by -12.66%. Most of the damage in 2008 occurred in just two months, September/October 2008, when MSD experienced back-to-back monthly losses of -7.25% in September followed by -14.76% in October. But MSD recovered nicely with an 8.55% NAV gain in December, followed by a 36.42% NAV gain in 2009.

MSD is currently selling at a discount to NAV of -9.40% compared to the 6 month average discount of -7.74%. The 1-Year Z-Statistic is -0.77. This means the current discount to net asset value about ¾ of a standard deviation below the mean.

MSD is run by two portfolio managers:

  • Eric Baurmeister, CFA, Managing Director. Joined Morgan Stanley in 1997 and has 17 years experience. Received a B.A. from Cornell in Economics and Government and holds the CFA designation.
  • Federico Kaune, Ph. D., Managing Director. Joined Morgan Stanley in 2002 and has 17 years experience. Has prior experience at Goldman sachs and the IMF. Received a B.A. from University del Pacifico in Economics (Lima, Peru) and an M.A. and Ph. D. from the Unicersity of Chicago in Economics.

Country Breakdown (as of January 31, 2011)

Mexico

12.68%

Russia

12.04%

Brazil

10.47%

Turkey

8.96%

Venezuela

6.99%

Argentina

5.80%

Ukraine

5.71%

Peru

5.48%

Indonesia

4.85%

Philippines

4.68%

Bond Rating Distribution

AAA

-0.60%

A+

2.54%

A

3.08%

BBB+

0.53%

BBB

22.54%

BBB-

25.49%

BB+

0.80%

BB

16.91%

BB-

8.89%

B+

7.22%

B

8.70%

B-

1.44%

D

0.47%

NR

1.97%

Here are some summary stats on MSD:

Morgan Stanley Emerging Markets Bond Fund (MSD)

  • Total Assets: 332.1MM Total Common assets: 272MM
  • Annual Distribution (Market) Rate= 6.15% (Note: 9.22% including the last year-end distribution).
  • Portfolio Current Yield= 6.99%
  • Portfolio YTM= 6.49%
  • Last Regular Monthly Distribution= $0.16 (Annual= $0.64)
  • Last Year-End Distribution= $0.3277
  • Fund Expense ratio: 0.94% Discount to NAV= -9.40%
  • Portfolio Turnover rate: 105%
  • Average Credit Rating= BB+
  • Weighted Average Duration: 6.57
  • Effective Leverage: 18.1%

Overall, I think MSD is a worthwhile purchase at current levels with the discount nearly 10%.

Source: MSD: A Cheap Way to Join PIMCO in Emerging Market Bonds