As the emerging markets asset class continues to evolve, strategic investment

opportunities have expanded to include local-currency denominated securities

issued in developing countries. Traditionally, investors have limited their

emerging markets participation to securities denominated in major currencies,

such as the U.S. dollar. However, as developing economies have matured,

the credit quality of sovereign and corporate debt denominated in local currencies

has improved, attracting the interest of a growing number of international

investors seeking higher returns.

Local markets offer an increasingly wide array of securities, including fixed-rate,

floating-rate and inflation-linked bonds, interest-rate swaps, options and currency  

forwards. This growth in local-currency debt offerings provides many opportunities,

but also presents the challenge of identifying which emerging economies and

currencies are still improving and stand to benefit from global trends. To help

investors find the most attractive opportunities in this landscape, PIMCO created

the Developing Local Markets Fund, which invests in both local-market currencies

and fixed income instruments denominated in those currencies. This Fund seeks to

capitalize on PIMCO’s long experience in emerging markets and our global market

presence. Our emerging markets team has more than 68 years of combined

experience, with members based in Europe, Asia and the United States.

The Benefits of Developing Local Markets Exposure
There are several reasons to consider a developing local markets strategy. Trends

toward deficit reduction and increased dollar reserves in these developing economies

have improved the fundamental credit quality of many emerging markets. Stronger

fundamentals have attracted new investors, reducing overall market volatility and

improving the overall risk/reward ratio of investing in local-currency markets.

PIMCO expects the growth of developing local markets to continue. Emerging

market governments are increasingly looking to their own local markets for financing

in order to insulate themselves from external capital markets volatility and foreign

exchange risk. As a result, investing a portion of a broader portfolio in local-currency

debt offers several key advantages:

• Improved diversification: Local-currency investments have low correlations with traditional asset classes: 48% with the S&P 500, 25% with high-yield corporate bonds, and negative correlations of -3% with the Lehman Brothers U.S. Aggregate Index and -8% with U.S. Treasury bonds¹.
• Enhanced returns: The local-markets strategy may allow investors to benefit from high local interest rates, which compare favorably with the current low rate of return offered by U.S. and European sovereign debt. Local-market debt has also historically exhibited notably lower volatility and better risk-adjusted returns than many other asset classes. The table below compares the return per unit of risk ratios for various fixed income and equity indices. It illustrates that developing local-market securities can deliver attractive risk-adjusted returns through a combination of solid performance and moderate volatility.

Return per Unit of Risk (10 years ended 6/30/07)

Source: PIMCO, JPMorgan Chase, Lehman Brothers, Merrill Lynch, Citigroup, Morgan Stanley.  U.S. Treasury Bonds are represented by the Lehman Treasury Index; High Grade (High grade corporate bonds) are represented by the Lehman U.S. Credit Index; Yield (High yield US bonds) are represented by the Merrill Lynch High Yield BB/B Constrained Index; TIPS are represented by the Lehman Global Inflation Linked U.S. TIPS Index; Foreign Hedged are represented by the JPMorgan Non-U.S. Index Hedged Index; Foreign Unhedged are represented by the JPMorgan GBI non U.S. Unhedged Index; EM Equity are represented by the MSCI Emerging Markets Index. EMBI Global = JP Morgan Emerging Markets Bond Global Index; LBAG = Lehman Brothers Aggregate Bond Index; DJ AIG Comm. = Dow Jones AIG Commodity Total Return Index; ELMI+ = JPMorgan Emerging Local Markets Index Plus. This chart is not indicative of the past or future performance of any Allianz Global Investors product.

• Currency diversification: As fundamentals in these emerging economies improve, investors may benefit from an appreciation in local currencies, relative to the dollar. Because the strategy is not hedged, investors take on exposure to local currencies. PIMCO expects continued weakness in the dollar over the long-term, primarily due to the large and growing U.S. current account deficit. In such an environment, an allocation outside dollar-denominated securities could provide investors additional returns.

PIMCO’s Active Approach to Local-Markets Investing
Achieving success in local markets requires solid research and risk assessment capabilities. PIMCO’s Emerging Markets team includes professionals on three continents, working in concert to uncover potential opportunities. The goal: to take both underweight and overweight positions in some of the sector’s more advantageous credits.

PIMCO begins its search with a careful study of the external environment, analyzing factors such as global economic prospects, the interest-rate outlook and commodity prices.

Next, the team evaluates the attractiveness of various country markets within the context of the firm's long-term macroeconomic outlook for the major regions of the global economy. For example, if PIMCO expects the U.S. economy to be sluggish, the team may underweight developing local markets that are heavily dependent on exports to the U.S. Similarly, a developing nation whose major source of revenue is derived from commodity exports would be more attractive when PIMCO expects robust global economic growth, an environment that would lead to higher worldwide oil consumption and firmer commodity prices. For example, PIMCO expects China’s continued economic growth to support global commodity prices, which should benefit emerging markets that export commodities to China and elsewhere.

Next, our team looks at a variety of internal factors that are good indicators of a government's ability to meet its debt obligations. These include the country’s balance of payments, economic policies, socio-political developments and domestic savings and investment flows. Our team takes a highly selective and cautious approach when evaluating the creditworthiness of emerging market issuers. We are seeking strong or improving country credits and will forego issues with higher yields if we believe there is an unacceptably high risk of default. For example, we decided to move completely out of our Argentina holdings more than a year before that country’s default in 2001.

The overall baseline macroeconomic forecast that the Developing Local Markets team uses to evaluate investment choices is updated frequently, and a daily report assesses significant market developments and their impact on current investment strategy.

This multi-layered process provides a robust framework for identifying attractive investment opportunities while minimizing the risk of adverse credit events.

Analysis and Disciplined Risk Management Are Keys to Local Market Success
Investing in developing local markets requires deep insight into economics, politics, currencies and credits, making it one of the most demanding segments of the market. PIMCO’s dedicated experts use on-the-ground expertise and our proven investment process to manage risk while seeking attractive and innovative sources of return.