Mariappa of the PIMCO Global Bond Fund typically sticks close to the country weightings that make up the J.P. Morgan Global Government Bond Index. But he boosts the yield on the fund by making small adjustments to the portfolio weightings. The fund, which currently yields a modest 3.5%, invests only in AAA-rated sovereign credits. The yield may not be higher than that of his peers, but he sees his holdings appreciating as the euro strengthens against the dollar.
Mariappa also favors euro-zone bonds. Unlike others, he's loaded up on German bonds. The country is experiencing stagflation-recession and high inflation-resulting from high labor costs. German joblessness hit 10% at the end of 2002.
One of the greatest problems in the euro zone is the inflexibility of Germany's labor and product markets. When business slows, companies can't cut wages due to rigid labor agreements. And corporations have trouble cutting prices to spur sales.
Europe also may flirt with a double-dip recession because corporations have just begun to retrench. Plus, Europe is plagued with weak banks and insurance companies. "Europe needs a recession to force structural reforms," Mariappa says. "European bonds are yielding 60 basis points over U.S. Treasuries. Five-year German Bunds (German government bonds) yield over 80 basis points more than five-year Treasuries. Future rate cuts by the ECB (European Central Bank) will result in European bonds outperforming U.S. bonds this year."
Mariappa is less sanguine about the decline in the dollar. He sees the dollar dropping about 5% against the euro. The reason: Higher U.S. rates also will keep the dollar stronger than expected. He is underweighted in Japan and Asia. In Japan, the central bank's decision to purchase banks' stock holdings is expected to increase the money supply. Therefore, inflation could be a negative influence on the government bond market. Plus, the Japanese government bond market is richly valued, with five-year bonds yielding less than 30 basis points. So he is avoiding positions under three years and is underweighting bonds beyond five years. Asian bonds, he says, are overpriced.
He also is underweight in the United States. The fund has only 25% of its assets invested in U.S government securities and mortgage-backed bonds with short durations.