Pacific Investment Management Co.’s Australian unit is using the developed world’s highest interest rates to reap profits by buying bonds offshore and hedging them back into the local currency.
Pimco, which manages about A$32 billion ($34 billion) of assets in Australia, favors investing in countries with steeper yield curves or buying Australian corporate debt sold abroad at more attractive prices, said Robert Mead, Sydney-based head of portfolio management, in an interview. Buying debt abroad and hedging the purchases offers yields of about 9 percent, he said.
Australia’s central bank has raised interest rates by 175 basis points to 4.75 percent since October 2009 to contain inflation amid a record mining-investment boom. The Aussie dollar climbed 29 percent against the greenback in the past 12 months as the yield gap between Australian and U.S. 10-year government notes widened to 227 basis points. Hedging allows Pimco to avoid currency volatility and benefit from the higher interest rates in Australia. Newport Beach, California-based Pimco manages $1.3 trillion worldwide.
“From a domestic investor’s perspective, taking advantage of that real yield offered in the Australian bond market is a no-brainer,” Mead said in an interview yesterday. “Buying Australian corporates offshore and hedging back has been an attractive yield-generating position.”
Australian government bonds have handed investors a 5 percent return in the past 12 months, while corporate notes have returned 7.9 percent, according to Bank of America Merrill Lynch indexes.
Flat Yield Curve
Reserve Bank of Australia Governor Glenn Stevens held the overnight cash rate target at 4.75 percent yesterday for a sixth straight meeting and acknowledged the subdued outlook for industries other than mining and energy.
The gap between yields on two-year and 10-year Australian sovereign bonds has fallen 15.5 basis points, or 0.155 percentage point, to 41.5 basis points this quarter, compared to a 259 basis-point spread between U.S. Treasuries of the same maturities and 139 basis points on German bunds, Bloomberg data show.
“One issue to consider in the Aussie bond market is that the government curve is so flat,” Mead said. “As a total return generator, there’s not as much opportunity. You have to do something different, for example buy credit or buy offshore bonds.”
The Federal Reserve has held its benchmark rate near zero since December 2008, while the European Central Bank lifted its borrowing rate to 1.25 percent in April, its first move in almost three years.
Australian bond investors have priced in 19 basis points of increases over the next year, a Credit Suisse Group AG index based on swaps trading shows. The ECB may lift rates 81 basis points while borrowing costs in the U.S. are likely to rise 18 basis points in the same period, according to separate Credit Suisse indexes.
“If you look at the euro or U.S. dollar curves, the view we’ve taken is that the market has been pricing in more tightening than the central banks would be able to push through the system,” Mead said. “You can earn capital gains if you take the view that rates will come down the curve much more steeply.”
Pimco likes debt sold by infrastructure-related commodity producers and efficient energy companies, and holds a greater percentage of financial company bonds than is contained in benchmark indexes, Mead said.
It’s also been buying New Zealand bonds to profit from a steeper yield curve than Australia’s amid swelling government deficits and record low benchmark rates after the nation’s deadliest earthquake in 80 years.
“The countries have very similar fundamental dynamics in terms of their economies,” Mead said. “Seeing as you’ve got one curve that’s flat, and one that’s steep, New Zealand bonds have represented an attractive investment opportunity.”
The difference in yields between three- and 10-year government debt was at 189 basis points in New Zealand, down from a record high of 229 reached on April 8, according to data compiled by Bloomberg since August 1992. The similar spread in Australia has narrowed to 36 basis points from a 2011 high of 53 reached March 15.