Pimco’s Gross Savors Free Lunch as Peso Bonds Beat Stocks

PIMCO's co-CIO Bill Gross
Mexican bonds are giving investors led by PIMCO's co-chief investment officer Bill Gross the best chance to profit from the nation’s economic growth. Photographer: Andrew Harrer/Bloomberg

Mexican bonds are giving investors led by Pacific Investment Management Co.’s Bill Gross the best chance to profit from the nation’s economic growth and its bid to open the energy industry to private investment.

Government peso notes gained 2.8 percent this year after adjusting for price swings, the most since 2005, according to data compiled by Bloomberg and Bank of America Corp. The benchmark IPC index of 35 Mexican stocks posted risk-adjusted returns of 1.7 percent in the period, while emerging-market debt gained 2.1 percent. Mexican bonds, which have outperformed stocks for three straight years, also beat the peso in 2012.

Foreign investors poured a record $7.36 billion into Mexican debt securities this year to take advantage of economic growth that is four times Brazil’s and yields that are still triple those for U.S. Treasuries. Yields on government peso bonds due in 2024 have fallen 1.19 percentage points to 5.48 percent this year as investors gained confidence that President Enrique Pena Nieto, who took office Dec. 1, will push through reforms of the country’s tax and energy policies to bolster the expansion in Latin America’s second-biggest economy.

“Adjusted for volatility, the truth is the bonds have been the best asset class in Mexico,” said Mexico City-based Luis de la Cerda, the chief investment officer of Afore Sura, which has about 21 percent of its 252 billion pesos ($19.5 billion) in peso bonds and 7 percent in Mexican equities. “Looking ahead, foreigners are not going to leave the bonds. They came to stay.”

‘Attractive’ Bonds

In the U.S., the Standard & Poor’s 500 Index has delivered larger risk-adjusted returns than 10-year Treasuries since 2009, data compiled by Bloomberg show.

Gross, Pimco’s co-chief investment officer, said in an interview on Bloomberg Television on Dec. 13 that Mexico’s bonds are “attractive” because they offer higher yields than U.S. and European debt and because the Latin American nation has lower debt levels.

“With inflation well behaved, a strong government balance sheet, and steady growth prospects, Mexico has exhibited a sound macro policy mix, and has navigated well headwinds from the developed world,” Michael Gomez, managing director and co-head of emerging markets at Pimco, said in an e-mailed response to questions on Dec. 21.

Pimco, the biggest holder of Mexican fixed-rate bonds due in 2021, 2022 and 2024, also said the country’s debt was one of its favorites on Oct. 3.

Foreign Investment

The firm’s holdings have helped push foreign investment in Mexico’s $146 billion fixed-rate peso bond market to as high as 54 percent earlier this month, the highest proportion since February 2000, according to regulatory filings and central bank data compiled by Bloomberg.

Mexican bonds due in 2022 yield 3.66 percentage points more than similar-maturity Treasuries and 4.04 percentage points more than German bunds. Mexico’s 4.5 percent interest rate compares with benchmarks of less than 1 percent in the U.S. and Europe.

The International Monetary Fund forecast in April Mexico’s government debt will equal 43 percent of gross domestic product next year, versus 110 percent for the U.S., 77 percent in Germany, 91 percent for the euro area and 77 percent overall for the Group of 20 nations.

Foreign investors have also been piling into Mexican fixed-rate bonds in anticipation of Pena Nieto’s policy overhauls, according to Alejandro Urbina, who helps oversee about $800 million of emerging-market assets at Silva Capital.

Relative Value

“There’s been a rush to invest in Mexican bonds,” Urbina said by phone from Wilmette, Illinois. “That’s made the curve compress in yield terms significantly because of this large amount of foreign interest.”

Mexico will probably grow 3.8 percent this year, versus 1 percent in Brazil and 2.2 percent in the U.S., according to the median of forecasts in Bloomberg surveys.

Carlos Fritsch, a strategist and president of Prognosis Economia Finanzas e Inversiones in Mexico City, says equities are the best pick next year even after accounting for risk because stocks are more economically sensitive and will provide outsized returns as growth accelerates.

“Sell bonds and buy stocks,” Fritsch said in a telephone interview from Mexico City. It’s time to “move from defensive positions into more cyclical and aggressive positions.”

Default Swaps

The cost to protect Mexican debt against non-payment for five years rose one basis point to 97 basis points at 4 p.m. in Mexico City. Credit-default swaps pay the buyer face value in exchange for the underlying securities or cash equivalent if the issuer fails to comply with debt agreements.

The peso fell 0.5 percent to 12.9870 per dollar.

Afore Sura’s de la Cerda says Mexican equities are already expensive relative to corporate earnings.

Mexico’s IPC index soared to a record on Dec. 18, and prices have climbed to 18.7 times trailing earnings as of Dec. 21. That’s more than 50 percent higher than the average 12.3 times earnings for the MSCI Emerging Markets index. The IPC also traded at 3.1 times net assets, double the valuation in developing nations.

“The performance of the Mexican bond market has been superior to other local investments,” Urbina said. “There are people from outside Mexico that want a clean play on the idea of Mexico being a good investment. This is via the Mexican sovereign bond market.”