Pimco sees value in bonds of firms with government support

Wednesday 22nd October 2008

Concerted government efforts to support leading banks and institutions around the world have created value in the debt of some of the firms, according to Pacific Investment Management Co., manager of the world's biggest bond fund.

"If you believe that because of the rescue packages that the risk has diminished then you're looking at fixed income markets where prices have dropped and say there's value," Douglas M. Hodge, Pimco's Asia Pacific managing director, said in an interview.

Pimco has about US$830 billion under management, including US$70 billion in Asia and US$2.5 billion in New Zealand, where its clients include Tower. The firm is "underweight Treasury bonds and has become more underweight" on the prospects of more sales of government debt to fund the bailouts, Hodge said.

Central banks have injected $3 trillion into the global economy in response to the worst financial crisis since the 1930s, according to a Bloomberg estimate. That's helped provide support for leading banks whose bonds are yet to reflect the reduced risk of default, Hodge said.

The Federal Reserve this month doubled the size of its auctions of short-term loans to as much as $900 billion to try to thaw credit markets.

"There's value in mortgage-backed securities," he said. "Freddie Mac and Fannie Mae have effectively been nationalized but (their bonds) are trading at 200 basis points over Treasuries."

"If a government is going to inject Tier 1 capital into so-called 'national champion' banks then that sends a strong message that isn't reflected in bond prices," Hodge said. "The relative value anchors have become unhinged."

New Zealand's economy has been ahead of the curve in terms of falling into recession in the first half. The steps taken to rescue banks and free up credit markets are only aimed at the "financial economy," Hodge said. "The impact on the real economy is just beginning to start," he said.

"In our view, the U.S. housing market still needs an extended period of correction. House prices could decline another 10% to 15%," Hodge said.

"There's probably going to be a global recession or at least a U.S. recession. It's going to take time," he said.

In a sign that the financial crisis is widening, speculation has mounted that Argentina may face its second default in a decade after announcing plans to seize US$29 billion of pension funds.

Argentine bond yields have surged to more than 24% this week while stocks have tumbled.

Pimco hasn't made big shifts in its portfolios recently, mainly because of the difficulty to transact, the lack of liquidity, he said.

"We've all been caught in that vortex," he said.

By Jonathan Underhill

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