Why Pimco stays away from emerging-market cocos and why BlackRock sticks to the opposite

Pacific Investment Management Co. manages one of the biggest funds dedicated to purchasing a new type of high-yield hybrid securities - contingent convertible bonds, or Cocos - and has been buying from European lenders but not from lenders in developing countries, says the Wall Street Journal.

Cocos carry higher yields than regular debt but holders are among the first to lose money if the issuer’s capital cushion falls too low or it needs a taxpayer bailout.

Pimco’s global head of financial research, Philippe Bodereau, says that if we have a look at some big bank issuers in emerging markets, there are signs of deterioration in their fundamentals. By contrast, “in Europe and the U.S., [banks have] spent the last six years deleveraging. They have made a lot of efforts to clear debts and what are left on their balance sheets are relatively low-risk assets.”

The fund's rejection is notable given the jump in these securities: in 2014 issuance globally jumped to $138 billion, about five times the 2013 total, and two-thirds came from banks in emerging markets, according to Dealogic. In 2015, sales in emerging markets total $16.3 billion, outpacing the $10.7 billion in sales in the developed world.

Other money managers, however, do not support Pimco's strategy, seduced by juicy returns at a time of rock-bottom interest rates world-wide.

Rick Rieder, chief investment officer of fundamental fixed income at BlackRock Inc., which oversees $4.8 trillion in assets, considers that today in the world there is nothing cheap about fixed income, and it makes sense to own some bank capital securities in order to enhance returns, including those issued by Chinese banks.

Cocos have been attractive, “especially in an environment where regulators are building up safety to the banking system…It will continue to be a good place to generate yield.”

Earlier in May, China Construction Bank’s sale of $2 billion in these hybrid securities drew more than three times the amount on offer from sovereign-wealth funds, insurers and other banks, the WSJ says.

In 2014, Banco do Brasil SA sold $2.5 billion, while Sberbank of Russia OAO raised $1 billion in February.

Rising bond prices show that other buyers are tiptoeing in, though Pimco keeps being skeptical.

Struggling with growing bad debt, a slowing economy and tighter regulations, Chinese banks are soon to become the biggest issuers of such risky securities in Asia, following a government-led credit binge to bolster the economy during the global financial crisis.

"Better valuation in developed market banks alongside better liquidity and stronger fundamentals” are the things Pimco favors. It also praises capital securities offered by the likes of a Swiss bank and a British bank over those from Chinese banks, as the price level of the Chinese deals did not meet the fund's pricing targets, Philippe Bodereau added.