June 5 (Bloomberg) -- Pacific Investment Management Co., which runs the world’s biggest bond fund, said investors should favor short-maturity debt for the next three to five years and buy outside the U.S. as the nation’s borrowing increases.

“Yields on short maturities are likely to be anchored near current low levels,” Pimco said in a Secular Outlook published on its Web site. Shorter-term bond yields tend to track central bank interest rates while longer maturities are more influenced by inflation.

Pimco expects deflation in the “short term” and inflation in the “long term,” the report said, adding that Treasuries face a “sovereign risk” as the nation’s debt rises.

Merrill Lynch & Co.’s U.S. Treasury Master index handed investors a 4.3 percent loss in the first five months of this year, the worst performance since it began in 1978, as President Barack Obama increased borrowing to record levels. The government will sell $3.25 trillion of Treasuries in the fiscal year ending Sept. 30, according to Goldman Sachs Group Inc., one of the 16 primary dealers required to bid at the U.S. debt sales.

Investors should also protect themselves against the risk of a weakening dollar, the report said.

Bill Gross, co-chief investment officer of Newport Beach, California-based Pimco, manages the $156.9 billion Pimco Total Return Fund. Pimco is a unit of Munich-based Allianz SE.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

Last Updated: June 4, 2009 20:44 EDT