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 While a lot of attention has been paid to a dramatic falling out
between co-founder Bill Gross and former CEO Mohamed El-Erian, and
the underperformance of and outflows from its flagship Total Return
Fund, few have taken notice of the firm's failed investments in
emerging markets debt.
In particular, it has made made some ill-timed bets in the
Brazilian, Mexican and Russian debt markets. It made substantial
investments in some companies that have gone belly-up, such as
Brazilian oil company OGX Petróleo e Gás Participações SA, which was
controlled by Eike Batista, who only two years ago was estimated to
be the world's seventh-richest man but whose business empire has now
largely crumbled.
Gross, El-Erian, and a Pimco spokesman declined to comment for this
article.
Already, investors have pulled almost $2 billion from Pimco's
emerging markets debt funds during the first four months of this
year, according to Morningstar data, with $639 million of that
departing in April alone. By comparison, the funds bled $2 billion
of net outflows for all of 2013.
The missteps suggest that Pimco, which is owned by Germany's Allianz,
may have been tempted given the low returns available from safer
bond investments to make outsized bets in riskier markets, fund
consultants said. Pimco's $1.94 trillion asset base, which gives it
the ability to play a dominant role in the U.S. Treasury and other
major debt markets, may not provide it with such an advantage in
illiquid emerging debt markets where large investments can be
difficult to exit and losses can mount when prices are plummeting.
Pimco probably got caught in "a vicious circle" as wrong calls led
to fund redemptions by investors that forced it to sell bonds into a
volatile market, driving the prices of remaining holdings down even
further, said Todd Rosenbluth, director of mutual fund research at
S&P Capital IQ. The problem is worse because Pimco's size means it
has "to make bigger bets" to move the dial, he added.
MONGOLIAN MINING
Pimco's troubled debt investments in the past two years have
included a Mongolian mining company, Mexican homebuilders and a
Brazilian sugar and ethanol producer.
The firm also had large holdings in Russia as President Vladimir
Putin ordered the invasion of Crimea and unrest in eastern Ukraine
grew, triggering Western sanctions against Moscow. Pimco has said
bond prices in Russia have dropped to appealing levels, while it
also sees risks. "Though de-escalation of the crisis is our base
case, potential miscalculations cannot be ruled out," Pimco said in
first quarter investment report published on March 31.
Russia was the firm's top country holding in its emerging market
corporate bond portfolio at nearly 25 percent at the end of March,
according to Pimco's website. Russian debt has dropped 12 percent
and the rouble is down more than 8 percent so far this year.
The performance stats reflect the reversals.
The $10.86 billion Pimco Emerging Local Bond Fund, which invests
primarily in local currency government bonds in emerging markets,
declined almost 11 percent in 2013, trailing 88 percent of its peer
category. This year, things have improved but it is still lagging
behind 52 percent of its peers, according to Morningstar.
The $1.37 billion Pimco Emerging Markets Corporate Bond Fund, which
invests in fixed income securities issued by corporations in
emerging markets, has also suffered - with a negative 1.89 percent
return for the 12 months to April 30, versus a 0.002 percent gain in
the benchmark JPMorgan Corporate Emerging Markets Bond Index
Diversified, or CEMBI. Since its inception in 2009, the fund has
trailed the benchmark on an annualized return basis by an average
1.55 percentage points.
And the blame for at least some of the underperformance of the Total
Return Fund, with its $232 billion in assets, can be traced to the
impact of its 6-8 percent holding in emerging market investments
over the past 12 months. The fund, which is mainly in U.S.
Treasuries and mortgage-backed securities, has seen a massive $55
billion outflow of money since last May.
To be sure, the plunge in emerging markets has taken a bite out of
the performance of funds managed by some of its biggest rivals,
including top names on Wall Street, including BlackRock Inc., Morgan
Stanley and Goldman Sachs.
And while Pimco has gone through tougher times in the past couple of
years, its longer-term investment track record for a firm of its
size is unmatched.
Pimco's emerging markets bond funds are also some way away from
being the worst performing this year - in the first four months, its
four funds in the sector were ranked 43rd, 53rd, 68th, and 81st out
of 100, according to Morningstar.
But such positions in the table are a far cry from the days when El-Erian's
daring yet highly profitable bet on Brazilian bonds in 2002, when
others had unfounded concerns about the election of a left-wing
government, helped to make his and Pimco's reputation as a strong
player in the sector.
WOOED BY BATISTA
Perhaps Pimco's biggest single misfire in emerging markets debt was
the firm's investment in the bonds of Batista's OGX. Batista's
fortune dropped from an estimated $30 billion in March 2012 to les
than $300 million two years later, according to Forbes, mainly due
to the ugly combination of a large debt burden and investments in
assets that failed to produce returns.
Batista's empire was already beginning to collapse even as Pimco
amassed a big position in OGX bonds maturing in 2018 and 2022.
Sources familiar with the situation have told Reuters that they
estimate the bet got as high as $800 million at one point in May
last year.
Pimco declined to answer questions about the position.
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OGX, which in October made Latin America's largest bankruptcy filing
with more than $5 billion in liabilities, has since changed its name
and is now known as Óleo e Gás Participações SA.
The company's bonds maturing in 2022 fell 93.7 percent in 2013, and,
according to one of the sources, Pimco's losses from its OGX
investment are now estimated to be more than $300 million.
The timing of the OGX debt purchases by the firm was particularly
perplexing, the sources said.
team at Babson Capital Management in London.
Su Fei Koo, an emerging markets portfolio manager at DoubleLine
Capital, one of Pimco's main competitors, said: "Everyone was
excited about OGX around May 2011 - right before they issued bonds -
and I thought to myself: 'Here's a company with no EBITDA (earnings
before interest, tax, depreciation and amortization) and no
discovery of oil," adding that she saw "no improving credit path"
and therefore didn't buy the bonds.
It is unclear who at Pimco made the decision to invest in OGX debt.
According to Morningstar analyst Eric Jacobson, Mark Kiesel, global
head of corporate bond portfolio management, and his credit team
have led the way on Pimco's OGX coverage. Kiesel has recently been
elevated to become one of six deputy chief investment officers under
Gross in the wake of El-Erian's departure.
Kiesel met with Batista one-on-one in late 2012, months before OGX
debt came under severe selling pressure, and at a time when Pimco
was building its investment in the bonds, a person familiar with the
situation told Reuters.
The results of that meeting could not be ascertained.
Brigitte Posch, who was head of emerging market corporate debt
investing at Pimco until last fall, would not comment for this
article. She is now leading a new emerging markets debt investment
Neither would her last boss at Pimco, Michael Gomez, who is co-head
of the firm's emerging markets portfolio management team.
Pimco declined to make Kiesel available for comment.
OGX declined to comment for this story. Efforts to reach Batista for
this story were unsuccessful. The law and investment firms advising
Batista, Pimco and some of the investment management companies
involved in the OGX restructuring plan declined to comment.
Among some of the holdings that Pimco's Emerging Markets Corporate
Bond Fund had over the past year were bonds issued by coal producer
Mongolian Mining Corp that have fallen 30 percent over the past year
as prices of coal fell to a record low.
Another reversal was in the bonds of ailing Mexican homebuilders
Corporación GEO SAB (which filed for bankruptcy in March), Urbi
Desarrollos Urbanos SAB and Desarrolladora Homex SAB, which have all
grappled with curbs in government subsidies for commuter-town
projects and a tumble in the value of their landholdings. Their bond
prices all dropped by at least 50 percent in 2013.
As of the end of last year, Pimco also owned bonds from Brazilian
sugar and ethanol producer Aralco SA Indústria e Comércio, which
this March filed for bankruptcy after sugar prices fell to a
three-year low and Brazil would not ease caps on fuel prices,
hurting its ethanol business.
LEERY OF HORSEMEAT'
It is unclear how much of a role Gross and El-Erian have had in the
misfires.
Early last year, Gross was encouraging investors into Brazil and
Mexico just before their currencies plunged. On January 16, 2013,
Gross wrote in a Twitter message that the Brazilian real and Mexican
peso were a better use of cash than high-yield junk bonds. Gross
then followed a month-and-a-half later with another tweet: "Be leery
of horsemeat & currency mispricings. Yen, Pound & Euro reflect weak
economies. Underweight them. Buy Mex peso, Brazil real."
The following month he made similar noises about Brazil and Mexico,
and had a similar tale in June.
Gross had changed his views by January of this year. He said at the
2014 ETF Virtual Summit in January that Brazil was no longer a major
preferred emerging market for Pimco.
By late April this year, though, Kiesel said in a report for clients
that he was "more bullish" on Brazil after a recent trip and he sees
opportunities in sovereign notes and debt from Brazilian companies,
including oil producer Petrobras.
(Reporting By Jennifer Ablan and Guillermo Parra-Bernal; Editing by
Martin Howell)
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