Why Emerging Markets Bonds Can Continue to OutperformInternational Investing presented by Morningstar.comJason Stipp: Im Jason Stipp for Morningstar its International Investing week on Morningstar.com and today were focused on the emerging markets. Ive got on the phone with me today. Michael Gomez from PIMCO emerging local bond and hes going to tell us a little bit about what hes seeing in the emerging markets bonds space. Michael thanks so much for calling in today. Michael Gomez: Thank you so much for having me.Jason: First question for you the category returns in the emerging markets bond category have been very good over several trailing time periods. My question for you is do you feel like this area the market maybe a bit overheated maybe the market has gotten a little bit a head of the fundamentals in the emerging markets bonds base whats your take on evaluations today?Michael: Oh we still think that theres good value remaining in emerging markets youre right that the total returns have been very strong and in 2010 year to date they are also very strong but I think that we need to take a more granular look at the different portions of the asset class and deconstruct where these returns are coming from so if you look at the external debt portion of the asset class we see is sort of a very long duration asset class over 7 years of duration and so the total returns in large part been drawn by the very strong row that youve seen in U.S Treasure yields any associated hail wind if thats given to emerging market external debt. Your spreads are only 15 basis points tighter on the year. When you look at local markets what weve seen is both the compression and local markets yield as fundamental – to exert themselves and also more recently youve seen a kale wind in terms of total returns coming from the current side so you know youre right to say that the returns have been strong yeah but our senses that this is NASA class continue to outperform relative to the global fixing come opportunity set. Jason: As youre looking out across your investment universe on your stomping grounds are you finding any areas where the opportunity to look particularly compelling and the flip side are there any areas where it looks like it maybe time to tri or to be a little bit more cautious?Michael: You know we continue to think that the local markets portion offers great value. When we look across emerging markets and we compare emerging local opportunities against sovereign external opportunities what we see is that you know moving away from external and into local essentially allows the investor to go up three notches in credit rating. They can go down about 2 years in duration and at the same time they wound up picking up roughly 75 basis points in carry so when we see those three characteristics higher credit rating down in duration and up and carry you now those are indicative of relatively attractive opportunities so weve been moving more of our assets into a local space and we continue to think thats very attractive.Jason: The question of fundamentals I think a lot has been written recently about how a lot of the emerging and developing world has pretty strong fundamentals compared to some of the fundamentals that we see in a developed world with some fo the debt problems that several countries have how would you characterize the fundamental situation in the emerging markets first is a developed world today?Michael: Well you know what I think youre right Jason for the most part we see that emerging markets fundamentals are relatively strong. So when you look at just basic stock, debt numbers emerging market get the GDP as an overall asset class. ITs about 35% in the developed world its about 100%. When we look at slow data we also that emerging market down to payments took a current account tend to be characterized by surplus wh—the deficits so far so none of us would stop basis from a flow a basis emerging market also look very comfortable. So the fundamentals look good so when you listen to the debt side and the bounce came inside also the gross outlook for merged markets looks much more robust and self sustainable. I think the other part of the equation that we always have to consider though is you know what is a pricing of those fundamentals and pricing of the risk and there I think we reach the point where after a multiyear voyage of emerging markets sovereign credits being under priced and undervalued I think today we would characterize them for the most part as being relatively share valued so much of the improvement in a story like Brazil which is a Triple B minus rating credit is now I think pretty much reflective in 5 year credit risk levels that trade around libel plus 110 basis points. A similar comparison can be made to a country like Indonesia which is a solid double B and perhaps very much on a – and a investment grade card in itself but again 5 year credit spare traits around libel plus one shifty so when we look that these have to spread we say you know this is ASA class whose economic volatility and also financial markets volatility you think is on a continued declining trend but were in evaluations I think for the most part reflect that fair value after many years of being mispriced and under valued. Jason: You mentioned near the interview answer there about volatility I want to ask you a question about the risk factors that invest your should have in mind if there are considering this asset class. I think a lot of investors have been seeking more yield especially fixed income investors given the low yield environment that we have today. What should be on their mind s as far as risk controls in this area? Michael: Well I think a temptation is to have very generalized discussions about emerging market sand you now for the most part we have had a very generalized discussions so far today but what we really need to stop and recognize and always keep in mind is that this is a very heterogeneous as a class 35 to 40 countries which are much different trajectories in terms of economic growth whose policy constraints are a widely varied and whos social structure and geopolitical realities are lost very different. So that coupled with a reality that the outlooks are developed throughout and the back drop for global growth is still quite challenging means that we think that now more than ever investors really need to take a prudent differentiated approach to investing emerging markets and we still believe that moving up in credit quality or having a higher credit quality bias is the right way to go. When we look at signals in the Fed of course most recent signals must come from 2 and we have to keep in mind that this sends a very cautious and in many ways send up a warning signal about the state of the U.S economy a full 2 years after Lehman brothers. So we have to make sure that were understanding the signals the policy makers are sending us about the state of a developer world and the risks and opportunities about investing within that.Jason: Speaking of the QE2 last question I wanted to ask you was with regard to currency and I think that the feds recent policy decision has soaked some conscerns about devaluation of the dollar over the medium or the longer terms whats your take on the currency situation today and the currency exposure that investors may get by investing any merchant market ?Michael: Well I think the nice thing about this asset classes sit ht you know we can pick and choose the areas that we want to express a sophisticated view and when it comes to the current side you know when our mind there are a wide. Theres a wide set of evidence that suggest the dollar needs to continue to correct in addition to the most recent policy measures. We mentioned—but you know the question is if were going to get a depreciation for dollar what is it going to depreciate against. You know what are the right and the perfect groups of currency to express that view and in our mind we still think that there is a plenty of opportunities to express that view against Asian currencies. You know here the long term fundamentals are very supportive of a continue to depreciation of Asian currencies. When we look at evaluations we still think that many of the currencies in this region are some 20 to 30% under value d against the dollar and when we look at the global economic landscape and we see the continued call for rebalancing of the global economy which is still to the stay fairly characterized by large imbalances between west and between Asia we think that the currency depreciation form the Asian block will be part of the tool kit that serves to rebalance this global economic construct and so from all those perspectives from the fundamental perspective from evaluation perspective and from a policy perspective we can gauge the currencies are a good way to express this trend to this idea of a weakening dollar. Jason: Michael Gomez of PIMCO Emerging local bond thank you so much for calling in today and for your insights.Michael: Thank you.Jason: For Morningstar Im Jason Stipp thanks for watching.